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In May of this year, I believed that ITT (NYSE:ITT) was moving along, steady as she goes. The company had seen continued and long term value creation since the 2010s on the back of an improved growth profile, better margins and consequently higher earnings per share.
Amidst a comforting 2023 guidance, the valuation looked quite fair, and actually compelling at levels in the lower $80s. Little could I have imagined that a solid performance would drive a near 50% price return in the remainder of 2023, leaving shares more than fully valued here, even as the business does just fine.
On ITT
ITT has a long and turbulent history as an industrial conglomerate, with its history including many M&A deals, restructuring and spin-offs. A >$10 billion business in the late 2000s was restructured and simplified to become a >$2 billion business in the 2010s, albeit a much better positioned business.
During the 2010s, the company has steadily grown revenues from a >$2 billion business in the early part of the decade to $3 billion as of today, which looks uninspiring. The bigger trend has been the fact that operating margins have risen from 10% of sales to 15% of sales, providing a huge boost to earnings growth, complemented by share buybacks as well.
A $70 stock pre-pandemic rallied to the $100 mark in 2021, when all boats were lifted, trading at $84 this spring, after a more difficult 2022 amidst inflationary pressures and dollar strength. This was based on an 8% increase in 2022 sales to $2.99 billion, derived from motion technologies, industrial processes and connect & control technologies.
The company posted segment margins of 17% and change, translating into earnings of $4.44 per share, as the company actually operated with a net cash position of just over a dollar per share. With 2023 sales seen up 7-9%, adjusted earnings per share should grow in line with topline sales, translating into an earnings outlook of $4.55-$4.95 per share.
After the company announced a bolt-on deal and communicated sound first quarter results, it upped the earnings guidance. With shares trading at 17-18 times earnings, this looked like a very fair multiple, certainly as the business operated with a flattish net cash position.
Given all this, I concluded to become a buyer in the lower seventies, but shares only fell to the $75 mark in May, as I missed the opportunity to acquire a stake.
Runaway Story
Since May, shares of ITT have seen spectacular returns, having risen some 50% to a current high of $119 per share, in fact trading at an all-time high at current levels.
In August, ITT reported a 14% increase in second quarter sales to $834 million, almost entirely driven by organic growth. Amidst strong operating leverage, adjusted earnings rose by over a third to $1.33 per share, prompting the company into hiking the midpoint of the full year earnings outlook to $5.05 per share.
As the company returned to operate with a modest net cash position, the company announced a big one billion share buyback program early in October, although no specific time frame has been communicated during which this was expected to be completed.
Early in November, ITT announced its next deal, this time a slightly larger one. The company has reached a $395 million deal to acquire Svanehoj Group A/S. The Danish company supplies pumps and aftermarket services in cryogenic applications for the marine sector, including LPG, LNG, methanol, hydrogen and CO2 applications, being a great play on the decarbonization of the economy. The business has been around for nearly a century, with 400 workers adding $140 million in annual sales, revealing that a 2.8 times sales multiple has been paid.
The day thereafter, the company reported a 9% increase in third quarter sales to $822 million, with adjusted earnings up ¨just¨ 14% to $1.37 per share. Despite the slower growth, the company upped the full year guidance, calling for 9% sales growth and adjusted earnings at a midpoint of $5.18 per share.
What Now?
The 82 million shares of ITT have risen to $119 per share here, pushing up the equity value of the firm to $9.8 billion, or $9.6 billion if we factor in a $185 million net cash position as of the third quarter. With revenues trending at nearly $3.3 billion, the company itself trades at just over 3 times sales, making the purchase of Svanehoj look quite fair. Pro forma net debt is not an issue at all, as the deal will boost pro forma sales by around 4% of sales.
The problem which I have is with the valuation of ITT itself. After trading at a market multiple of 17-18 times earnings in May, this multiple has expanded to 23 times earnings here. While 2023 growth has been solid, it is evident that most of the gains so far have been driven by valuation multiple expansion.
This means that I of course wished that I would have initiated a position in May, but I absolutely see no reason to get involved here, certainly not as shares are trading at fresh highs.
