ITT Pressured By Delayed Cost Recoveries And Weakening Short-Cycle Markets

Above-average organic revenue growth and margin expansion haven't helped sentiment around ITT (NYSE:ITT) all that much, as this diversified industrial has continued to underperform relative to the broader industrial group. A cautious tone from management about 2023 hasn't really helped (even if I think it's a more realistic view than what other companies have offered), and investors are trying to figure out just what the macro outlook for 2023 is going to be.

Down more than 10% since my last update on the company, I have mixed feelings about the stock. I think the company has better cycle exposure than the valuation reflects, but delays in driving better price/cost mix and a heavy exposure to auto builds are not what the Street really wants now. High single-digit long-term annualized return potential isn't bad, but I think it may take a few quarters for these shares to work again, and it's hard to call this a must-own when investors have a wider selection of undervalued industrial stocks to choose from at the moment.

 

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ITT Pressured By Delayed Cost Recoveries And Weakening Short-Cycle Markets

ITT Managing Fierce Headwinds Well, And Underlying Demand Is Strong

 

Industrial demand is recovering sharply, but ITT Inc. (ITT) is having a hard time meeting it given ongoing supply chain issues. That ITT posted the margins it did in the fourth quarter should be a testament to management, but cost headwinds are going to remain fierce through at least the first half of the year, dampening the near-term operating leverage at this industrial name.

I was lukewarm on ITT back in August, seeing okay long-term potential in the name, but more near-term challenges, particularly in light of valuation. Since then the shares have declined about 5%, doing a bit worse than the broader industrial space, but holding up pretty well compared to names like Eaton (ETN) and IDEX (IEX). Given what I think is realistic (if not conservative) guidance at a time when other industrial management teams seem to be taking more chances with guidance, and given a more attractive valuation, I think this is a name that is once again worth a closer look.

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ITT Managing Fierce Headwinds Well, And Underlying Demand Is Strong

ITT Inc. Delivers Impressive Margin Leverage, But The Market Wants More

 

Markets ebb and flow, but here recently it looks like valuation may actually matter a bit again, and that’s not good for a generally expensive industrial sector. While I continue to like ITT (ITT) as a long-term holding, and the shares did modestly outperform the larger industrial sector since my last update, a negative rerating for the wider sector won’t leave this stock untouched.

ITT is showing impressive margin leverage, and although the market has recently been obsessed with growth and theme over quality, margins are a powerful long-term driven of multiples and valuation. Moreover, I do think ITT has some thematic positives, including leverage to EVs and longer-term cyclical recoveries in the aerospace, oil/gas, and chemical end markets. The shares still have worthwhile long-term potential, and they’re more reasonably-priced than many industrials, but I can’t really pound the table at today’s price.

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ITT Inc. Delivers Impressive Margin Leverage, But The Market Wants More

ITT Inc. Already Seeing Strong Incrementals Ahead Of A Full Revenue Recovery

 

Expectations were already high for late-reporting ITT Inc. (ITT), but this multi-industrial nevertheless managed a good top-line beat and an even better performance on margin leverage. Better still, the company broke with a general trend of relatively conservative guidance for the rest of 2021.

I previewed my "but" in the last piece; namely, that Street expectations had already risen pretty notably for this company. The shares have lagged a bit since that last piece, rising around 10% and slightly outperforming the S&P 500, but slightly underperforming the broader industrial sector. Again, I think already-high expectations are part of the issue, as well as a little more investor wariness about auto volume growth in 2021 on component shortages.

Bargains are few and far between in the industrial sector today, and I think ITT can still outperform as important end-markets like aerospace, chemicals, and refining recover in 2022 and beyond. I'd categorize the potential returns here as more "okay" than "compelling", but it is still a relative bargain compared to many industrial names and one that I think has better exposure to later-moving sectors as the recovery matures.

 

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ITT Inc. Already Seeing Strong Incrementals Ahead Of A Full Revenue Recovery

ITT Executing Well, But The Bull Case Has Become The Base Case

As a shareholder, I can’t really complain about the performance of ITT (ITT) over the last few months. I liked ITT better on a relative value basis to names like Dover (DOV), Eaton (ETN), Emerson (EMR), and Parker Hannifin (PH) back in November, and ITT shares have outperformed that group, as well as outperforming the broader industrial space by more than 15%.

All good things come to an end, and so too with ITT being a standout value/GARP option in the industrial space. I still like ITT operationally, and I’m still bullish on under-appreciated opportunities in auto, control technologies, and process, as well as margin improvement potential and M&A optionality. Still, I feel like more of this is recognized in the share price now. ITT shares still offer a better-than-average total return potential, but it’s not a name I can pound the table as hard for as before.

 

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ITT Executing Well, But The Bull Case Has Become The Base Case

ITT Posting Better Margins As It Moves Past The Trough

Although I still think that there is more risk to growth for industrial companies in 2021 than is reflected in valuations, there’s been a relatively good tenor of companies guiding that the second quarter was indeed the trough. That was true for ITT (ITT), and I likewise think it’s important to note that decremental margins have been better than expected, as this company has done quite well with its expense reduction efforts. Prolonged weakness in end-markets like aerospace and oil/gas is certainly a threat, but I likewise see a still-underappreciated opportunity to gain share in auto brake pads.

I bought ITT shares close to the price of my last update on the company, and I can’t complain about the performance since then – up over 20% since my last update, beating industrial peers by around five points. I’m a little concerned that worries about weakness in aero, oil/gas, and process industries is going to loom larger, as ITT is likely to undergrow peers/rivals like Dover (DOV) over the next few quarters, but the valuation is still fairly good (particularly on a relative basis). With that, I’m content to continue owning these shares, and I still think it’s an above-average idea in the industry sector.

 

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ITT Posting Better Margins As It Moves Past The Trough

ITT May Prove More Resilient Than The Market Believes

The next couple of quarters will be ugly ones for ITT Corp (ITT), and with meaningful exposure to end-markets like aerospace, oil/gas, and process industries like mining, it’s not unreasonable to think that some of those recoveries will take a while. Even so, that overlooks this mid-cap industrial’s strong friction business (brake pads) and its significant short-cycle aftermarket exposures.

Given where the shares are priced now, it seems to me that the market is focused far more on what can go wrong with this story, and that’s a little strange to me relative to other industrials with similar end-market exposures. I fully expect an awful 2020 for ITT, but if long-term revenue growth in the 3% to 4% range and low double-digit FCF margins remain valid long-term assumptions, these shares are meaningfully undervalued today.

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ITT May Prove More Resilient Than The Market Believes

Near-Term Market Issues Open A Window Of Opportunity At ITT

Good stocks don’t tend to get, or stay, very cheap for very long, and while there are still some meaningful short-term risks for ITT (ITT), the recent declines look like an opportunity to consider. Not only does ITT serve some attractive long-term process markets, but the opportunities to gain share in automotive friction are still significant, and there are some appealing margin improvement drivers that management is working on now.

I don’t know whether Monday’s sell-off on coronavirus fears will continue, or whether this is a long-awaited correction in what I’ve seen as frothy multi-industrial valuations, but with ITT’s prospective annualized return now above 10%, I see enough upside to take a more bullish position on these shares.

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Near-Term Market Issues Open A Window Of Opportunity At ITT

ITT Inc. Executing Well, But End-Market Weakness Could Create Opportunities For Investors

Industrials don’t move in lockstep through their cycles, and multi-industrial ITT Inc. (ITT) continues to benefit from both a stronger skew to process industries and company-specific share-gain drivers, not to mention better than expected margin leverage. With that, the stock has been a notable outperformer over the past year, beating its peer group by over 20%, with a strong run since reporting third quarter earnings.

Although I’m concerned that ITT could still see slowdown in the business (orders have been negative for two quarters), I think the nature of the company’s business mix will lead to a shallower, shorter slowdown than what many industrials are seeing. On top of that, the company appears to have more options to drive better operating margins over the next couple of years. I can’t say that ITT is all that cheap now (though a high single-digit expected return isn’t terrible), but if the company were to stumble a bit over the next few quarters on weakness in short-cycle markets, chemicals, or so on, it would definitely be an opportunity to reconsider these shares.

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ITT Inc. Executing Well, But End-Market Weakness Could Create Opportunities For Investors

Keep An Eye On ITT Through The Reporting Season

The conversation around industrials has shifted away from whether there would be a correction/downturn and toward the question of how long it will last and how deep it will get. Specific to ITT (ITT), the company looks vulnerable to ongoing deceleration in oil/gas capex investment, project delays in the chemicals end-market, and further weakness in the broadly-defined “general industrial” category, not to mention weakness in autos. Some of this seems to be anticipated in the stock price, as the shares have more or less matched the S&P since my last update but modestly underperformed the broader industrial space.

I do believe that ITT is more on the front end of its downturn than in the middle, and I’d look to updates from companies like Emerson (EMR), Flowserve (FLS), Gardner Denver (GDI), and Chart Industries (GTLS) as to the health of oil/gas and chemicals project books, not to mention ongoing aftermarket demand. While I don’t expect any dramatic restructuring efforts from ITT, I do believe the company is well-constructed to “muddle through” the downturn and I would keep a close eye on this name for an opportunity to exploit near-term market pessimism if results/guidance disappoint the investment community. I still believe there is a credible case for a mid-to-high $60’s fair value for ITT at this point, though I do also believe there is some downside risk to earnings expectations for the next 12-24 months.

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Keep An Eye On ITT Through The Reporting Season

ITT Overlooked And Undervalued As A Late-Cycle Play

I'm not sure it's entirely appropriate to call a stock followed by over a dozen sell-side analysts and widely-owned by institutions "overlooked", but I don't get the sense that ITT (ITT) is as widely-known among investors as it should be. And, that's a shame. ITT isn't perfect, but I like this diversified industrial's philosophy of adopting best practices irrespective of their source, not to mention broad late-cycle exposure and a strong growth auto business.

Below the mid-$60s, I think ITT is undervalued. While there is some asbestos liability here, I believe it is well-covered, and the company has the dry powder available to make select acquisitions to build out its operations further. I believe the perception of the auto business has already corrected, and ITT's short-cycle industrial exposure is moderate, and so I believe this is a good time and place to consider this name.

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ITT Overlooked And Undervalued As A Late-Cycle Play

Seeking Alpha: Colfax's Benefit Of The Doubt Has Deservedly Gone Away

I have openly granted the growth potential of Colfax (NYSE:CFX), but I haven't ever really liked the valuation that the Street was willing to give the stock. While investors and analysts have expected a lot of magic from the company's welding, gas handling, and fluid management businesses, I think they have overlooked some of the structural challenges in the welding business and the end-market risks in the gas and fluid businesses.

The shares are down about 40% since my last article on the company, as multiple days of reckoning have hit its valuation hard. The evolution of the company's businesses over the last ten months has led me to slash my expectations and valuations, though I can now at least say that the valuation looks sane. I do have competitive concerns about the welding business, and I don't share the assumption that management has a magic touch that will turn every M&A transaction into a winner. That said, if you're shopping for ideas that have been pummeled into the ground, this is a name to consider.

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Colfax's Benefit Of The Doubt Has Deservedly Gone Away

Seeking Alpha: Two Valuable Lessons From Kaydon's Sale To SKF

I wrote on bearings and velocity control products company Kaydon (KDN) in early March of this year, and I didn't see a lot of value at the time. As the year went on, that call looked worse and worse, as the stock climbed about 18% - well above the S&P 500, and well above industry peers/competitors like Timken (TKR) and SKF (SKFRY.PK). To top it all off, Kaydon announced this morning (September 5) that it had received and accepted a buyout offer from SKF valuing the company at $35.50 - some 45% higher than the price when I thought it looked only about 10% undervalued. So what did I get wrong here, and what can investors do to avoid a similar mistake?

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Two Valuable Lessons From Kaydon's Sale To SKF

Investopedia: The Market Already Convinced Colfax Will Meet Or Beat Its Goals

It's an underappreciated fact of investing in industrial companies, but margin performance goes a long way toward explaining stock performance. With the market basically sold on the ability of Colfax (NYSE:CFX) management to turn around the ESAB welding business (now part of Fabrication Technology), the shares have done well this year and sit just below a 52-week high despite ongoing wobbles in industrial orders and soft welding demand. Although I don't doubt management's ability to drive better-than-expected margins, it's getting harder to justify the stock's premium.

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Seeking Alpha: Kaydon's Strong Niche Focus Doesn't Produce Quite Enough Value

I love somewhat obscure and under-followed industrial companies, particularly when they are leaders in their markets and have quality investors like Royce & Associates on board. That said, I find it hard to find a lot of value in Kaydon (KDN) shares today. Although the company has considerable market share and pretty solid margins, the bottom-line return on capital and free cash flow generation just aren't quite where they need to be relative to valuation to make this a must-own right now.

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Kaydon's Strong Niche Focus Doesn't Produce Quite Enough Value

Seeking Alpha: Is Gorman-Rupp Overpriced, Or Is Cash Flow Not The Right Metric To Use?

The water industry is a nearly perennially hot topic - almost every investment writer looks at the trends in freshwater infrastructure and eventually writes their "water is the commodity of the future" piece. For better or worse, the long-term potential of many players in the water space is pretty well accepted by investors, and many of these companies sport valuations not only higher than non-water industrials, but higher than what their cash flow would seem to be able to support. So it is worth asking, then, whether the well-run and well-respected Gorman-Rupp (GRC) is indeed overpriced today, or whether discounted cash flow just isn't an effective way to value this stock.

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Is Gorman-Rupp Overpriced, Or Is Cash Flow Not The Right Metric To Use?