Q4 2020 Illinois Tool Works Inc Earnings Call
Good morning, My name is Joanne and I'll be a conference operator today.
John I would like to welcome everyone to the conference call all.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
I would like to ask a question. During this time simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question. Please press the pound key.
But that was participating in the Q&A, you'll have the opportunity to ask one question and if needed one follow up question. Thank you Karen Fletcher Vice President of Investor Relations you May begin your conference.
Okay. Thank you Julien good morning, and welcome to Itw's fourth quarter 2020 conference call on.
I'm joined by our Chairman and CEO, Scott, Santi and senior Vice President and CFO Michael Larsen.
During today's call, we'll discuss Itw's fourth quarter and full year 2020 financial results and provide guidance for full year 2021.
Slide two is a reminder, that this presentation contains forward looking statements. We refer you to the company's 2019 form 10-K, and subsequent reports filed with the S. T C for more detail about important risks that could cause actual results to differ materially from our expectations, including me on.
The effects of the COVID-19 pandemic on our businesses.
This presentation uses certain non-GAAP measures and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release.
Please turn to slide three and it's now my pleasure to turn the call over to our chairman and CEO Scott Santi. Thank.
Thank you Karen good morning, everyone.
The ITW team closed out 2020, with another quarter of strong operational execution and financial performance.
From my perspective, the highlights are the Q4 revenues got back to year ago levels, Despite food equipment being down 17%.
Net operating income operating margin and after tax ROIC see where all Q4 record for the company.
It was a pretty solid finish to a year that needless to say provided some unique and unprecedented circumstances and challenges.
On indicates good momentum as we head into 2021.
While it was the challenges brought about by the pandemic that dominated our attention in 2020.
It was the collection of capabilities and competitive advantages that we have built and honed over the past eight years.
Through the execution of our enterprise strategy that provided us with the options to respond to them as we did.
Early on as the pandemic unfolded, we were focus the entire company on only two core imperatives.
A to protect the health safety and wellbeing of our people.
And b to continue to serve our customers with excellence.
And in my view, we executed extremely well on both.
Our manufacturing operations and customer service teams around the world deserve special recognition.
For their extraordinary efforts and leadership in support of these two key pandemic priorities.
Their dedication and commitment to keeping themselves and their colleagues safe.
Continuing to deliver excellent service to our customers was truly inspiring.
And there is no question that we differentiated ourselves with many of our key customers as a result of our ability to sustain our normal rock solid quality and delivered performance.
Throughout 2020, as a result of their efforts.
We also did our best to take full advantage of Itw's position of strength as we thought through how we should manage the company through the pandemic.
Back in the spring as we analyzed and stress tested the company's performance across a wide range of scenarios.
It became clear that the financial and competitive strengths that we had built up over the past eight years.
That resulted in a very strong and very resilient company.
And then as a result, we didn't have to just pull out our old recession playbook of hunker and hunker down there.
For ITW. This was a unique opportunity to react smartly and to stay focused on the long term.
This conclusion led to two key decisions that we made regarding how we're going to manage ITW through the pandemic crisis.
First we chose to leverage the strong financial foundation that we've built over the last eight years to reinforce our commitment to our people.
First by providing full compensation and benefit support to all ITW colleagues through the entirety of Q2, when the economic effects of the pandemic were at their most widespread and severe.
And by deciding that we would not initiate any enterprise wide employment reduction mandates of programs at any point in 2020.
These were not obvious are easy decisions given the unprecedented in unprecedented and uncertain circumstances.
But we believe that they were the right decisions for our company.
And I know that our people will remember them.
These decisions also turned out to be the right ones for us operationally.
Given the pace of demand recovery that we saw beginning in Q3.
Yeah.
Second we chose to leverage our position of strength by implementing our win the recovery agenda mindset across the company.
When the recovery was not an opportunistic new strategy.
What it was and is as a commitment to staying the course and continuing to prioritize the execution of our long term enterprise strategy.
Despite the unique and unprecedented challenges brought about by the global pandemic.
When the recovery for us did not mean ignore the pandemic.
Across the company, we had to read and react to the realities of the near term situation as we always do.
But it does mean that we are committed to protecting key investments supporting the execution of our long term strategy.
And that we have from very early on given our divisional leadership teams. The mandate to continue to think long term and to remain aggressive through the pandemic.
For 2021, or when the recovery posture and mindset continues on and.
And serves as a central theme driving the 'twenty 'twenty one operating plans for every one of our 83 divisions.
Before I turn the call over to Michael for more detail on our Q4 performance and our 'twenty 'twenty one guidance.
Let me close by thanking all of our ITW colleagues around the world for their exceptional performance and dedication in the face of the most challenging and unprecedented circumstances of the past year.
The performance that they delivered in 2020 provides another proof point.
Net ITW as a company that has the enduring competitive advantages resilience and agility necessary to deliver consistent top tier performance in any environment.
Like many of you I'm sure we are hopeful for a return to somewhere in the vicinity of normal at some point in 'twenty 'twenty, one and with that getting back to giving our full attention to taking ITW all the way for the company's full potential.
Between now and whenever that is.
We will continue to leverage the full breadth of itw's capabilities and competitive advantages to keep our people safe.
Continuing to serve our customers with excellence.
And execute our long term enterprise strategy.
Michael over to you.
Thank you Scott and good morning, everyone.
Please turn to slide four.
In the fourth quarter, we continued to see solid recovery progress in many of the end markets that we serve as evidenced by our revenue being up sequentially, 5% versus the third quarter.
The increase is 8% when you adjust for equal number of days when historically our revenue per day.
<unk> has increased by 1% from Q3 to Q4.
Overall, we delivered revenue of $3 5 billion operating income of $883 million, an increase of 7% year over year.
Operating margin of 24, 4% free.
Free cash flow of 705 million and.
And GAAP EPS of $2.02.
After tax return on invested capital improved to 32%.
And as Scott mentioned operating income operating margin and after tax ROIC see where fourth quarter records for the company.
Revenue in all major geographies improved sequentially.
On a year over year basis, North America organic revenue declined 3% International revenue grew 1% share.
Europe was down 2%.
Similar to Q3, China was a bright spot with 11% growth.
As we've talked about before the operating flexibility that is core to our 80 20 front to back operating system also applies to our cost structure, which was on full display through our operating margin performance in Q4.
We improved operating margin by 170 basis points to $25 four per cent. The second highest margin rate in a quarter in the history of the company.
And like I said grew operating income, 7% to 883 million the highest fourth quarter ever.
The biggest driver of our margin improvement remains our enterprise initiatives as the ITW team executed on projects and activities that contributed 130 basis points in Q4.
The impact was broad based with all segments delivering enterprise initiative benefits in the range of 80 to 170 basis points.
GAAP EPS was $2 on two cents up 2%, but keep in mind that Q4 last year had 11 cents.
One time gains from divestitures.
To exclude those gains EPS was up 7% the same as operating income.
Working capital performance was excellent and free cash flow of 705 million was solid with a conversion rate of 110 per cent of net income.
Finally, finally, the effective tax rate was $22 one per cent down slightly from last year.
In summary, a strong finish to a challenging year and very good momentum as we head into 'twenty 'twenty one.
Let's move to slide five to review fourth quarters recovery and response by segment.
We updated the slide from our last earnings call with Q4 information and you can see that our segments continued to respond effectively to the increase in demand recovery and improved sequentially on both revenue and operating margin.
I would just highlight a few things to illustrate the resilience and adaptability of our businesses.
You can see the rapid recovery in our end markets relative to the Q2 bottom down 27%.
In Q4, three of our segments experienced demand levels that were higher than a year ago. Most pronounced recovery has been in automotive OEM, which has more than doubled since Q2 and grew 8% year over year in Q4 as did construction products.
Polymers and fluids grew 7% while demand in three segments test and measurement and electronics welding and specialty products was only slightly lower year over year.
As you would expect food equipment continues to be impacted by the effects of the pandemic. Although we are seeing some sequential improvement.
Overall, you can see the benefit of having a high quality diversified portfolio.
And the fact that we're back to demand levels of a year ago with total revenue essentially flat year over year. Despite one of our core segments being down organically by 19%.
On the right side of the page you can see the operating flexibility that I, just talked about and how it also applies to our cost structure and ultimately shows up in our operating margin performance at.
At the bottom in Q2, we still deliver solid operating margins of 17, 5% and only two segments were below 20%.
In Q4 were almost 800 basis points higher at 25, 4%. Despite no volume growth year over year and every segment is back above 22%, including food equipment and six out of seven segments achieved record fourth quarter operating margins.
Let's move on to slide six for a closer look at individuals' segment performance, starting with automotive OEM.
The team has continued to execute exceptionally well from a quality and delivery standpoint, and responding to customer demand levels that have more than doubled since Q2.
In Q4 organic growth of 8% year over year was the highest growth rate since the fourth first quarter of 2017.
While North America was flat in Q2, it was more than offset by strong demand in Europe, which grew 10% in China, which grew 20%.
As expected food equipment end markets remained challenged in Q4 organic revenue was down 19%, a little better than the third quarter.
And demand in Q4 was similar to Q3, when you look at it by geography.
And the end markets.
North America was down 20% international down 18%.
<unk> sales were down 20 per cent of the service was down 18%.
Institutional demand was down about 30% with restaurants down a little bit more than that.
And not surprisingly the bright spot throughout the year continue to be retail with organic growth of 8%.
Moving to slide seven for test and measurement and electronics.
Q4, organic revenue declined 3% with test and measurement down 8% against a tough comparison of plus 6% in Q4 19.
And <unk> was up 3%.
And while demand for capital equipment remains sluggish the segment benefited from considerable strength in several end markets, including semiconductor health care and clean room.
As you May have seen on January 19th we announced that we had entered into an agreement with amphenol to acquire MTS test and simulation business.
The test on stimulation business is very complementary to our Instron business, which we highlighted during our 2018 Investor day.
And some of you may have visited our facility outside of Boston.
MTS test and simulation business has similar organic growth potential.
And there are substantial opportunity from margin improvement through the application of the ITW business model.
Pre COVID-19 revenues in fiscal year 2019.
We're 559 million with operating margin of 6%.
We expect to get the business to generate ITW caliber operating margins by the end of year five.
And generate after tax are I see in the high teens by the end of year 10.
As you saw on the announcement, we expect the acquisition to close in the middle of 'twenty and 'twenty one.
We're very much looking forward to welcoming the MTS test and simulation team to the idea of your family.
Moving on please turn to slide eight and.
In welding, where we saw a meaningful pickup in demand as organic revenue improved from being down 10% year over year in Q3.
To only being down 2% in Q4.
Our commercial business, which primarily serves the smaller businesses and individual users and accounts for 35 35 per cent of the revenue in this segment.
<unk> strong and grew 12% year over year.
Our industrial business showed signs of strong recovery from being down 23% in Q3, two down only 5% in Q4.
As customer activity and equipment orders gained strength.
Overall organic revenue for equipment was flat versus prior year and much improved versus a 10 per cent decline in the third quarter.
Polymers <unk> fluids delivered strong organic growth of 7% with fluids up 16% with continued strong demand in end markets related to health care and hygiene.
The automotive aftermarket business benefited from strong retail sales with organic growth of five per cent and polymers grew 4% with solid demand for MRO and automotive applications.
Moving to slide nine.
Construction continued to benefit from strong demand in the home center channel and delivered organic growth of 8% in Q4.
Growth was strong across all geographies with North America up 10% double digit growth in the residential renovation market.
Offset by commercial construction, which represents only about 15% of North America revenue day.
On the 11%.
Europe grew 9% and Australia, New Zealand grew 5% due to strong retail sales.
Specialty organic revenue was down 3% this quarter with North America down, 2% and international revenue growth 4%.
Demand for consumer packaging remains solid, but it was offset by lower demand in the capital equipment businesses.
So that concludes the segment commentary on let's move on to the full year 2020 summary results on slide 10.
And in the face of unprecedented challenges that included temporary customer shutdowns across wide swaths of our end markets. During the year organic revenue was down 10% still we delivered operating income of $2 9 billion.
And highly resilient to operating margin of 22, 9% only down 120 basis points year over year. Despite no major cost takeout initiatives on mandates and with a strong contribution of 120 basis points from our enterprise initiatives.
After tax ROIC was 26, 2% on free cash flow was $2 6 billion.
Throughout the pandemic one of our priorities was to maintain our financial strength liquidity.
And strategic Optionality in it and as you can see we did just that in 'twenty and 'twenty Itw's balance sheet is strong and we have ample liquidity.
We did not have a need to issue any debt on commercial paper on 'twenty 'twenty and we ended the year with total debt to EBITDA leverage of two and a half times, which was only slightly above our two on a quarter times target.
At year end, we had approximately $2 6 billion of cash and cash equivalents on hand.
With Twenty-twenty behind US, let's move to slide 11.
For a discussion of our guidance for 'twenty 'twenty one.
So starting with the caveat that we continue to operate in a fairly uncertain economic environment, we have based our guidance as we always do.
On the current levels of demand in our businesses per.
Our usual process, we are projecting current levels of demand into the future and adjusting them for typical seasonality.
The outcome of that exercise is a forecast of solid broad based organic growth of 7% to 10% at the enterprise level.
Foreign currency at today's exchange rates is favorable and adds two percentage points to revenue.
For total revenue growth forecast of 9% to 12%.
At our typical incremental margins of 35% to 40%, we expect GAAP EPS in the range of 762 to $8 a share up 18% at the midpoint.
We're forecasting operating margin in the range of 24% to 25%.
Which is an improvement of more than 150 basis points year over year at the midpoint.
Enterprise initiatives are key driver of operating margin expansion in 'twenty and 'twenty one as they are expected to contribute approximately 100 basis points.
Restructuring on price costs are expected to be approximately margin neutral year over year.
We're closely monitoring the raw material cost environment and embedded in our 'twenty 'twenty. One guidance are the known raw material cost increases in commodity such as steel resins and chemicals.
Given the differentiated nature of our product offerings across the company, we expect to be able to offset the impact of any incremental raw material cost increases that might arise in 'twenty 'twenty, one with pricing actions on a dollar for dollar basis.
We expect strong free cash flow in 2021, with a conversion rate greater than 100 per cent of net income.
I wanted to provide a brief update on our capital allocation plans for 2021.
Top priority remains internal investments to support our organic growth efforts and sustain our core businesses.
Second we recognize the importance of an attractive dividend to our long term shareholders.
And we view the dividend as a critical component of Itw's total shareholder return model.
Third priority or selective high quality acquisitions that supplement our portfolio and reinforce or further enhance itw's long term organic growth potential.
I should point out that the guidance, we're providing today is for the core business only.
After the MTS test and simulation acquisition closes we will provide you with an update but we do not expect a material impact in 'twenty and 'twenty one.
In line with our capital allocation, we return surplus capital to shareholders and we are reinstating share repurchases with a plan to invest approximately $1 billion in 'twenty and 'twenty one.
We expect our tax rate for the year to be in the range of 23 to 24 per cent.
Finally, when it comes to portfolio management, we have decided to defer any divestiture activity until next year.
And instead focus on time and efforts on the recovery in 'twenty and 'twenty one.
While our view regarding the long term strategic fit of the remaining divestitures hasn't changed we also believe that given their expected performance. This year they will be more valuable in 2022.
Let's turn to slide 12, and the forecast for organic growth by segment.
With the caveat again that the environment remains failure on certain we are providing on organic growth outlook for each segment and.
And based on current levels of demand we are forecasting solid broad based growth as every segment is expected to improve their organic growth rate in 2021.
At the enterprise level, it all adds up to solid organic growth of 7% to 10%.
To wrap it all up ITW finished a challenging year strong as we continued to fully leverage the capabilities and competitive advantages that we've built over the past eight years through the execution of our enterprise strategy.
Our strong operational and financial performance in 2020 provided further evidence that ITW is a company that has both the enduring competitive advantages and resilience necessary to deliver consistent operating performance in any environment.
Looking ahead to 'twenty and 'twenty, one we have good momentum from Q4 heading into the year.
And our solid guidance reflects the fact that we remained focused on delivering strong results, while continuing to execute on our long term strategy to achieve and sustain itw's full potential performance.
With that Karen I'll turn it back to you.
Okay. Thank you Michael Julianne, let's open up the line for questions. Please.
Certainly at this time I would like to remind everyone that asked a question. Please press star followed by the number one on your telephone keypad.
A reminder, we ask that you please limit yourself to one question and one follow up question. Thank you, we'll pause for just a moment to compile the Q&A roster.
Your first question comes from Andrew Kaplowitz from Citi. Please go ahead. Your line is open.
Good morning, guys good execution as usual.
Good morning.
Can you hear me okay.
Yeah, We got you Andy Thank you.
So it's been a couple of years now since your last analyst day. So maybe you could update us on you are at in terms of the goal of finishing the job related to enterprise strategy. It seems like performance on second half from 27% to 10% growth guidance, you've got from 'twenty, one is reflecting full organic growth potential verging on Michael but maybe you can give us some color around that.
And how youre thinking about enterprise strategy coming out of the pandemic do you still see on the basis points of margin improvement per year.
At least 2023.
Well I'd say a couple of things Andy first of all that.
This is Ben.
Process throughout the entire journey, where the where the sort of further we go with it the more opportunity we find to continue to improve on that.
I think the on one of the remarkable things from my perspective is eight years into this I don't see that slowing up any.
And so you know we are we are we are.
Focused on continuing to move forward to get better every year, you know getting a little bit better this year than we were last year.
Within the framework of the strategy that we've laid out on I think there remains ample room to continue on that path for a number of years. We also have some performance goals out there.
You're right. It's been a couple of years, but I think two years ago was when we updated those goals and we remain absolutely on.
Track and committed to delivering on those goals and as we get closer to that we'll figure out what the next step is steps are.
Thanks for that Scott and then is it right to think that generally you should see more margin improvement from your segments with the largest growth projection for 'twenty, one and could you give us I know you talked Michael I know you talked about price versus cost.
It sometimes happens sort of these lags and come on the segments like auto OEM.
Do we get concerned about that at all and any other color on price cost can you give us.
Well I'd say, Andy we based on our bottoms up planning process, we expect.
Every segment to improve on their margin performance in 'twenty and 'twenty, one as Scott said.
You know a little bit better every year as we march towards our full potential.
I think one of the remarkable things when you look at their margin performance by segment is how.
The range has narrowed and we're as we sit here today. The low end is food equipment at 22 and the high end is welding at 29 very different range from when we started this strategy eight years ago.
And I think the fact that we have.
Businesses.
On the delivery margins in the high Twenty's just gives us further confidence in the long term goals that we've laid out for.
For the company.
So the big driver in 'twenty, one remains our enterprise initiatives. Those are broad based in every segment will make progress on 80, 20 and strategic sourcing.
And certainly.
We expect to also have meaningful contribution from from volume leverage as we as.
As we go through the year here, but I wouldnt single any segment out as having more maher.
Margin improvement potential than others, I think we expect all of our segments to continue to make progress towards their full potential.
On the price appreciate it guys.
Andy and I can give you a little bit on on price costs. So certainly like I said, we are closely monitoring the raw material cost environment, we are seeing.
Inflationary pressures in commodities such as steel resins.
Certain chemicals.
By segment.
Automotive construction polymers <unk> fluids.
Probably worse, where we're seeing.
The more significant increases.
In all of our segments.
You know the plan is to offset those cost increases.
On the ones that we know about and the ones that may arise this year with price on a dollar for dollar basis as you know.
In automotive just given the nature of the industry debt is a process that takes a little bit longer but.
We're confident debt.
Over time, you know, we're going to be able to offset any raw material cost increases with price just given the differentiated nature of our product offerings in each one of these segments. So.
<unk>.
Appreciate it guys.
Your next question comes from Nicole the blades from Deutsche Bank. Please go ahead. Your line is open.
Thanks, Good morning, guys.
Good morning.
Can we just start with the outlook.
And when.
When you think about 14% to 18% that you forecasted for 2021, how does that look in the context of some of these semiconductor supply chain issues that we're seeing on I guess.
Some of those hiccups and bad debt in your outlook on that.
Ted if you could talk maybe a little bit about the potential quarterly cadence for the auto business. I know you guys don't give quarterly guidance, but in this case it could be kind of a weird year.
Yeah. So thank you Nicole.
Tell you one thing on the quarterly cadence that Q2 is going to be a lot better this year.
[laughter] Oh, it's all that's one thing I'm all for sure. So I think so I agree with that.
So just on the you know theres a lot of talk about the.
Shortage of semiconductors in the automotive OEM space.
What I can tell you is and this is true across all of our businesses we've not seen.
A slowdown in demand.
And.
Strong momentum going into the year certainly carried through January.
It is possible, though that we may see some production slowdown here in the in Q1 at some of our customers whether that will impact the demand their demand for our products.
I think remains to be seen we view. This right now is more of a timing issue and so certainly.
This could put.
You know a little bit up.
On the auto business here in the first quarter.
But as we sit here today, we would assume that we're going to catch that up in Q2.
Or you know the second half of the year.
In terms of the quarterly cadence for the auto business I think you saw the strong performance here in the fourth quarter up 8%.
Like I said, we've not seen anything to suggest that that demand is slowing down.
When we're looking at the January results.
So we you know we expect GAAP.
Given how we've planned that business too.
It will be off to a pretty good start with positive organic growth and margin improve.
Improvement in the first quarter that typically.
You know sequentially that builds as we go through the year.
Q2 will be as Scott said, the biggest quarter in the second half the comps start to get a little bit more challenging to build numbers are a little bit different but.
That's probably as much as I can give you.
On the on the automotive business and kind of how this might play out by quarter.
Thanks that was actually Super helpful.
Just have a quick follow up when you think about the guidance that you've put together a full company organic growth in 2021.
Going back to last year. When you guys are really talking about opportunities to outgrow as we move into recovery mode.
Third on some of that margin improvement into our sales marketing and market share improvement over peers into the 'twenty and 'twenty one guidance.
Well you know the only way that it's factored in at this point as it is embedded in the impact that those efforts have already made in our current run rates. So we are we are not baking in any further acceleration that doesn't mean that we don't have.
A lot of attention around continuing to.
As we've talked about before be aggressive as the recovery continues to accelerate but from the standpoint of our normal planning practice.
We are or what's embedded in our organic growth forecast is exactly what Michael said earlier the current run rates.
Daily run rates projected through full year 'twenty 'twenty, one with them you know whenever the normal sort of seasonal impacts on a quarter by quarter.
Got it thanks.
Yeah, Okay. Thanks, Nicole.
Your next question comes from Jeff Sprague from vertical research. Please go ahead. Your line is open.
Thank you good day everyone.
Two questions one kind of following up on that last thread.
Fully understand your your methodologies, you're kind of just on a rolling four current trajectory.
But when you look at the segments.
You know are there are there one or two kind of either way positive or negative that Oh, no you're your astute business sense and long history with these businesses would suggest you know are likely to be potentially better or worse.
And then kind of the exit rate here is really as we exit 2020.
Yeah.
Well I'm trying to think about that question.
Obviously, one to point to is food equipment, depending on.
Sort of the pace of vaccine.
Penetration in recovery. That's you know obviously, we're even if debt at that 8% to 12% growth rate per they're well below 2019 levels of demand let alone.
Incremental growth opportunities, we have so that you know from the standpoint of the one with the most.
Upside leverage debt, that's clearly the case.
You know I don't know that there's anything else that I would say it would really stand out I think the capital equipment businesses, you would expect so welding and test <unk> measurement that is as businesses get more comfortable with both the pace and trajectory and sustainability of the recovery that.
Their comfort level with investment.
Wood and our confidence in the future would certainly stimulate more perhaps more demand in those sectors, maybe as I think about your question, but you know I think that would be the two areas that.
Should things continue on in the positive direction. They are that certainly could benefit from a continued.
Broad based on the broad based momentum that we're seeing.
And also thinking about.
No.
Kind of cyclical versus structural growth Scott right. So the.
You know the effort to kind of pivot.
Businesses, the whole ready to grow, but not growing and the ones that were out growing.
Do you think there will be no measurable outgrowth.
Across most of the portfolio.
So like I said, we don't know quite what the world's going to hand us in 'twenty, one, but I just wonder your confidence and visibility on outgrowth, you mentioned new products in food equipment for example, I'm sure there's.
Things in other segments, maybe you could just provide a little additional color there yeah, I think that's where the proof is gotta gotta be in the products I mean, that's what we've been working on and so.
Certainly in.
2020, and 21, I think to try to get any sense of sort of what the market baselines are given the just the overall volatility and all the let's say the corresponding supply chain impacts on demand and inventory levels on all of that stuff.
It's really it's on.
It's impossible to tell but I would I would absolutely expect that our ability to stay focused and aggressive on on the growth agenda through all of this.
I won't say it better pay off but on.
It.
That's what we're all about and that's what we've been what we've been doing all of this stuff for so I won't tell you that every one of our 83 divisions are all the way there but on a year.
Guarantee you that I can say that a good 90% of them are.
And in Great position are doing all the right things have stayed focused on state aggressive through this we're not in the.
We're not using the ready to grow on that growing categories anymore I'll put it that way. It's you know I think we're well past that point.
Great. Thanks for the color good luck this year.
Thank you.
Your next question comes from Ann Duignan from Jpmorgan. Please go ahead. Your line is open.
Hi, good morning, everybody.
And maybe one more.
Maybe you could talk a little bit about true.
For our construction products that might've expected organic growth to have been.
I'll put a little bit more in 'twenty and 'twenty, one, but perhaps it's just on the back of strong renovation in 'twenty and 'twenty, but just some color there in terms of regional and some sectors that would be helpful.
That's exactly what I told our EVP answers.
[laughter].
So what I will tell you and as that.
Obviously.
A strong year for the construction business and.
Finishing Q4 up 8% on a year over year basis.
A lot of strength in the home centers that we've talked about.
Really since there.
The beginning of the pandemic and we expect that to be just given the comps.
The growth in the home centers would be in the in the low single digits.
We there are some encouraging signs around.
Housing starts and then where you know you have a.
You know a a great portfolio of highly differentiated products. So.
You put all of that together.
Our view is we should be able to grow in the mid to high single digits here.
In 2021 and.
As I said, we're a.
We're off to a.
Good start here in January so.
And any differentiation regionally that you'd like to comment on.
No I think it's pretty.
I think the comps are a little bit easier in Europe, maybe than in North America, but we really on a on a global basis. We had we had a good year.
But so that's really all that I would point to.
Okay, and then as my follow up perhaps.
Similar question on welding, just a different customer bases and maybe different regions, where you're seeing per night.
I'll hand it over.
Yeah, So I think welding.
Strong finish to the year good momentum going into 2021.
I would say.
A pretty solid outlook for all end markets, maybe with the exception of the oil and gas piece, which is somewhere in the 15 do.
20% is probably closer to 15% of total revenues.
That is expected to remain.
Soft as we go through the year, but the commercial business has been strong all year.
And no signs of that slowing down the industrial side. So this is what Scott talked about with Capex may be picking up as this recovery path is a little clearer.
We're expecting.
A solid year.
In the welding business with.
You know again.
Continued progress on the margin side, despite the fact that they put up almost.
Almost 29% here in the fourth quarter.
And certainly was impressed okay. Thank you very much on and get back in line. Thank you.
Your next question comes from John inch from Gordon Haskett. Please go ahead. Your line is open.
Thank you good morning, everybody, Hey, John picking up.
Hey, guys and Karen picking up on a.
A couple of the themes.
Asked a few questions to any of the businesses, Scott and Michael stand out based on call. It internal changes they may have pursued in 2020.
Position them in your minds really favorably for 2021 on these could be everything from I don't know like acceleration of enterprise initiatives, new products lineup that they've got ready to kind of tee up here, maybe new customers sort of supply line or excuse me, new customer channel initiatives or anything like that but.
You might call out.
Yeah, I can't really think of anything, particularly given the environment. We're in other other them.
I'll point to what we've been talking about throughout which as we stayed focused on implementing those.
All of it.
Changes strategic changes business by business, along the lines on what you're talking about.
Throughout this entire throughout the entirety of 2020 so.
I think if anything the most.
Significant part of what we comps in 'twenty as we stayed ready we stay prepared we stayed in position.
And we kept moving the ball.
So I don't know that there's any big shifts that I can point to as much as the fact that we stayed in there and and kept moving forward.
While dealing with it.
A pretty unusual set of near term circumstances, and I expect that that will.
Pacing.
Pay significant dividends, particularly if the rate of recovery continues on as we're seeing right now.
Well, Scott how significant.
We think on the next couple of years in recovery or new products or the introduction of new products going to play in terms of the drive to faster growth like was this an opportunity I mean, we don't have a view inside the company right. So because this is an opportunity for yes to do realignment cost cutting and so forth up two other just centralized level, but for the.
Folks to basically say you know what let's push on this initiative or that initiative or launch that as part of kind of your overall emphasis to take share which was David.
Okay.
Yeah.
Products are cord is a core element of our business model customer back innovation, we have been.
Theres been no change in terms of the central nature of that is our strategy.
We are we on we're banging out from it.
A couple of thousand patents a year.
Year on year out that's certainly continued on in 2020 as it always has so I don't know that theres been any inflection.
Or or or or change in terms of our posture. There. It is.
On my view, it's the only way, we outgrow our markets all over the long haul.
We're going to we're going to get some penetration from our service capabilities from our ability to attract new.
And customers, but in the end.
Innovation new products.
New technologies attached storage existing products is the is the key and core driver ultimately of our ability to outgrow our markets consistently over time, that's not a new concept here.
And I would just add financially financially speaking John you know our.
Internal investments.
New products are our top priority from a capital allocation standpoint, if you look at are on.
New products investment in 2020 it was.
The same.
Number as in 2019 as we stayed invested in these projects on strategies to drive above market organic growth historically, we've achieved.
Achieved about a percentage point of organic growth every year from new products.
And that's kind of what were counting on in every segment as we as we move forward.
Makes sense, if I could just sneak in one more you returned to M&A.
The two obvious.
Challenging verticals have been commercial aerospace and oil and gas are theirs.
Are you guys, perhaps thinking you guys are contrarian fingers are possibly going to present opportunities for M&A.
Like would you consider an aerospace deal and in terms of oil and gas would that be off limits, just because of ESG considerations, which you obviously don't have today.
Yeah, I would just go back to our.
There's basically two criteria on one one is that it has.
We have to we're going to make that kind of on investment in terms of not just our capital, but our time effort and energy.
It has to be on something that we have a lot of conviction about can support or further accelerate the company's long term growth potential.
And we have to also have.
Significant potential for margin improvement from 80 20.
You can look at MTS in.
Debt absolutely checks both of those boxes.
So I don't we don't have any anything that it might be was off limits. If those criteria are met.
And.
I'll just leave it at that.
Nor do I, nor what I said, maybe I might be put back on.
I'll also say is nor we lean on and Super hard on one particular sector or another.
I think as we've talked about before we have we have a demonstrated ability to perform.
And execute across.
Seven businesses today so.
It's more a function of the individual characteristics of the asset that we're talking about than it is any sort of sort of outside in view of that.
We want it we need to get growth, you're playing to a certain.
Theory about.
On a long term end market growth.
Yes.
Makes sense. Thank you Paul I appreciate it.
Yes.
Your next question comes from Jamie Cook from Credit Suisse. Please go ahead. Your line is open.
Hi, Good morning, I guess, just two follow ups one.
I know you talked about sort of supply chain and as it relates to the automotive sector. I guess, one do you have anything in your guidance embedded first supply chain potentially higher freight cost or whatever that's that's a you're managing four and I guess my second question.
You know when you first laid out your strategy in 2020 to go after market share during Covid, you talked about potentially you know youre.
<unk> is having issues as demand ramps or even managing through the downturn can you talk about why there were some of the supply chain issues are impacting your competitors.
And whether it's sort of in line with what you thought greater than what you had thought I'm just trying to size that potential opportunity. Thank you.
Yes, so Jamie on your first question.
We are seeing an increase in freight costs it is not.
One of the largest categories when we look at where we are seeing.
Cost pressure, but it is.
Any known increases in terms of freight and logistics our Mb.
Embedded in our in our plan and are in our guidance here today.
I think in terms of market share.
As a result of being able to maintain delivery and quality.
If we were to talk to our segments. They would all be able to come up with lots of examples from their divisions, where where that is the case.
And it's not just in one segment, it's really.
Across the board.
We've been able to pick up share now so I would just say we're not doing this.
With a short term focus that these have to be.
Sustainable market share gains and they have to be at ITW caliber.
Margins for us to be.
And in pursuing them so.
That's probably the best answer I can give you on that one.
Okay. Thank you.
Thank you.
Your next question comes from Julian Mitchell from Barclays. Please go ahead. Your line is open.
Hi, good morning.
Maybe my first question.
Really for Michael.
On the free cash flow outlook.
Capex was down substantially I think almost 30% in 2020.
What slope of recovery do we see there and how much of a working capital headwind should we expect as well I suppose the the endpoint here is to try and understand relative to that $2 6 billion of free cash last year.
You know what the Delta raise this year in the context of the earnings guidance.
Yeah, So julien.
You're right some of the capacity expansions that were planned for 2020, where.
Obviously pushed out as a result of.
The global pandemic.
Not as a result of anybody at corporate saying you can't invest in your businesses. This was really on it.
Our division's deciding to defer these capacity expansion and as the recovery progresses those.
On that Capex spend.
We will return to normal levels, which is the assumption that's embedded for 2021.
We also have in our free cash flow forecast.
An assumption that we will build up some.
Some degree of inventory receivables working capital to.
To support.
Almost.
Double digit growth across the enterprise so we have about.
$125 million of working capital coming in.
And that is included in our numbers here and.
You put it all together we expect two.
Deliver.
Another strong year from a cash flow perspective at 100% plus.
On conversion from net income.
Thanks, and then maybe my follow up on.
On the uses of that good cash flow and the big cash balance at the end of December maybe from.
Scott.
I think Scott it sounded somewhat reticent on.
M&A at the last earnings call.
Today, we see the buyback placeholder.
And HUD Michael's comments around deferring divestments into 2022, so just wondered what your latest thoughts are on the M&A.
Appetite, if you're more or less.
Optimistic on acquisitions today versus a few months ago.
Yes, what we talked about last call was really around the.
The fact that debt what we're interested in is quality assets that we can help.
Good companies that we can help become even better companies.
And the fact is that during times of.
Major disruption that those good companies.
Typically don't want it's not a good time for them to sell their businesses.
So the rest of it the reticence was not ours from a financial perspective. It was just a statement of reality that the kind of assets that we are interested in acquiring are not available.
The.
Our interest in adding quality assets to ITW that fit our strategy and that meet the criteria that I talked about relative.
And my response on one other question.
That doesn't go up and down that debt is always there we have plenty of capacity, whether we have cash on hand, or whether we have what we need to use the balance sheet. That's just a timing issue.
How much cash we have the ability to improve these assets, we buy we generate great returns.
It's just a matter of it.
We're also very disciplined so we find we come across an opportunity that we think fits.
It's not a situation or what.
Is it is it is it the right time or not it's you know we have ample capacity to do it.
But we're not going on just.
Low our standards, because we happen to be set against a cash right now I think that's the best way I can characterize it.
MTS is a compelling yet.
It has.
It has characteristics that are very similar to our <unk> business that we bought back in 2005.
Entry margins are roughly the same I think is trying from a couple of points higher similar similar.
Some of our end market characteristics.
It's a terrific fit.
Matter what time, what year, we were in the cycle or what time of year. It was if we have another MTS like opportunity. We will take full advantage to do our best to take full advantage of it and that's the best way I can.
I think I said and maybe I'll just.
Clarify something Julien I mean, I think given.
On our track record here as we just talked about in terms of consistently generating strong free cash flow.
Given the strong balance sheet.
I don't want you to interpret the fact that the buybacks are coming back as you know we don't have capacity to do M&A because that is certainly not the case I mean, we have ample of liquidity as Scott said, if the right opportunity comes along we're going to be.
Certainly looking closely at things.
So I wouldn't read anything into the.
Buybacks coming back we are in the fortunate position, where when I talked about the four priorities from a capital allocation standpoint for.
For us, it's not a b C or D. It's really we can do all of the above we have the capacity.
The financial strength, the balance sheet to do all of the above.
Great. Thank you both.
Your next question comes from David Raso from Evercore. Please go ahead. Your line is open.
Hi, Good morning, you mentioned cost you would match the higher cost dollar per dollar.
Obviously price cost is not helpful to margin. So on I think of the full year guide.
The organic.
How much of that is actually coming through with no margin.
And a half it sounds like price.
Might cost.
Well so.
We don't.
Really look at it that way David So let me try to answer your question.
Maybe a little bit differently. So.
Think what I heard you say is.
We will offset any material cost increases.
With price on a dollar for dollar basis.
On a clarification that means on incremental from here that doesn't mean necessarily in our plan correct. Yeah. So that's true.
So, yes, so that's where I was going and any incremental cost increases that we may see as we go through the year will be offset with price dollar per dollar obviously is that really reflects the timing products yes.
That's the problem with the lag long term, we will get <unk>.
Catch up and we typically get more than that I think what you were talking about as debt in the debt does mean, if you do the math, which I'm sure you've done that can be slightly dilutive to operating margins.
As we go through the year, but.
That's not.
That's not what's in our planning today and are playing today as.
We are positive price ahead of cost and any cost increases that are coming through will be offset.
<unk> per dollar that can be a slight lag we talked little bit about some of the challenges in automotive.
So that's probably the best I can answer your question.
Okay.
Incrementals are still impressive at 40.
Got it and I was just curious.
They even higher than that.
On a core fashion, because you know say, 2% other revenue growth was coming in it at no incremental rate coming out of price versus cost but.
But overall.
We're saying add it all up we're still gaining 40% incrementals if costs go up from here.
Yes that might be a bit dilutive on the margin just given it might be just price equaling cost.
I'm, just trying to get out of in the 40 silver yeah.
The underlying yes, that's correct David.
When it comes to the M&A pipeline I mean, obviously all the stacks that are out there on the money awash from private equity.
MTS business that you bought.
It seemed like you found something that fits well.
Obviously, the margins arent tremendous side.
Thank you probably got it at one time or less sales.
Are you finding with all those facts out there and so forth.
You can still fine.
As like this that are maybe a little off the radar or it's just going to be.
Yeah, a little more challenging to put the money to work just given maybe people are bidding up assets otherwise wanted just given.
No.
I think.
It's not a matter of finding things that are off the radar that the ultimate advantage we have.
Even in a competitive market as the margin improvement potential.
So that our ability to pay whatever the multiple is there certainly our financial modeling.
I'm not suggesting we can pay any multiple but certainly our ability to pay market multiple and then triple or quadruple the underlying earnings and knowing that we can do that with high degree of certainty.
Over some period of time is ultimately what allows us to be competitive.
So that's that's what we've said all along is we're not going to pay for a fully.
Buying or acquiring a fully margin business non interesting for us because it takes that competitive advantage off the table and from a return standpoint. It makes it makes it all about where you're right about the growth rate 10 years out which is which is a.
Which is a pretty challenging.
Thing to get right. So we.
We can compete on the right circumstances, we just proved it.
I think on.
Sorry.
Go ahead, please just thinking for MTS and I know it's John.
From a framework for hopefully future deals you can do when you think some amortization of the intangibles that are coming in that 6% margin of MTS was on 19 side.
On the margin might have been down.
What's the level set for us when we think of modeling that say from mid year on what's the starting point for all in the margin amortization on the base, we're coming off of and then.
The ramp to the 20% plus over five years, how much is there a step function on the first full year and then it's kind of linear from there.
So David let's close on the deal first and.
Do they do all the accounting and.
And hopefully that'll be mid year, and so when we get on the earnings call.
Hopefully for Q2 will be able to give you.
A lot more detail in terms of.
On the questions that you're asking our current view based on.
What we are what we have modeled is that theres not going to be a material impact.
In year one.
And then just.
The implementation of the business model will take some time, we didn't buy the business obviously for the.
Potentially on your one this is a long term investment and while we're very pleased with.
<unk>.
We see a clear path to get it to.
<unk> margins and returns over the timeframe that we discussed so but if you could.
Wait until we get the deal closed and we will provide all the detail here, but I'll help you with this part if you want which is just figure the margin is steady sequential improvement year on year, just like we run the company there is no big step change.
And so on the path from 6% or whatever the starting point as to the other.
ITW averages.
Divided by five is probably a better model than some.
Hockey stick in the early period.
If that helps.
Your next question comes from Stephen Volkmann from Jefferies. Please go ahead. Your line is open.
Great. Thanks for fitting me in I'll be real quick Scott It gave US a couple of quarters ago. A number that you thought you had won some new contracts because of your when the downturn kind of strategy any update to that kind of for the full year 'twenty 'twenty.
I'll go back to what Michael said that at that point, we can count on because it was we just started a couple of weeks into it and there was some.
Obviously visible.
Specific opportunities that we were aware of at this point, it's far too broad base.
Nothing that we're sort.
Sort of tracking across the company necessarily.
Okay, Alright fair enough.
Given the volume.
Understood and then Michael I think you said P. O S is 50 basis points of headwind in 'twenty, one isn't that kind of what we should consider sort of normal in the run rate for the foreseeable future.
Yes, I think last time, we looked at this at at full potential we had modeled 30 basis points as kind of the ongoing run rate.
So you are pretty close here.
Okay. That's all I had thank you are right.
We modeled 50 here for 2021 Thats correct.
I appreciate it.
Your next.
Comes from Ross Gilardi from Bank of America. Please go ahead. Your line is open.
Thanks for squeezing me in.
Just on the EPS guide I wanted to clarify.
Why wouldn't the low N b $8 plus when you just earned over $2 in the fourth quarter Youre guiding to 10 to 12 net wells.
There isn't a lot of seasonality in your business in a normal year, so why wouldn't $2 at minimum.
Like an appropriate quarterly run rate from.
For EPS in the first half and if that's the case are you baking in a meaningful second half slowdown I mean, any any help you can give us on how your guidance it looks first half versus second half.
Yeah.
Yes, so Phil Ross.
Yeah.
Let me say first I hope you're right.
And second I will just go back to what I said on the prepared remarks and in response to one other questions earlier is debt.
How we have modeled the topline is really using.
Current.
Levels of demand in our.
And what we're seeing in our businesses, we are projecting that into the year.
If you go and look at kind of historically.
A typical year unfolds at ITW in terms of the earnings in the first half versus the second half. It is remarkably consistent so I think thats, probably a good start to.
To help you.
And maybe understand a little bit better how the things might unfold kind of first half second half, but it will be very clear again.
We are not baking into any of our guidance that.
Demand is going to slow in the second half. We're also not baking in that demand is going to accelerate so to the extent you have a more positive view.
In some other segments you can certainly model that and see what what answer you get but we are assuming debt.
As I said the demand stays revenue per day stays where it is.
Adjusted for seasonality projected into <unk>.
2021.
But just on that Michael I mean, if youre, saying Youre just taking current demand I mean, you just you just earned $2 in the fourth quarter.
So yeah, but you have to look at it maybe take this one on offline and I can walk you through how.
The historical trends okay.
Okay, I'm not sure how else to answer your question, so and again I'm not giving you.
Quarterly guidance, we're giving you a full year.
No.
I think there is enough information if you look at the historical trends to figure out how things might play out on a quarterly basis.
Great. Thanks, Michael.
Your last question will come from Joe Ritchie from Goldman Sachs. Please go ahead. Your line is open.
Thanks, Good morning, everybody.
Hey, John.
Two quick ones from me and I know, we'll get more details on MTS later, but just given the pls is.
Part of the framework and equation for you guys like it.
Should we think about MTS is like revenue trajectory will there be some pls you think in the beginning.
And then and then growth from there like how should we think about that.
Yes, yes.
Again.
David earlier, we will provide more of a detail update once the deal has been closed.
But you should assume that pls is a.
Significant.
Component of the overall ITW business model that we will be implementing so happens early first couple of it happens in the first the way its model in the first two to three years or the Pls gets done and then from there on out you should see the accelerated growth rate.
With the higher margin profile that we talked about earlier.
Got it okay that makes sense and then and then maybe my last question.
Actually I can't believe I'm going to ask about it because I don't think I've ever asked the question on polymers and fluids on a conference call, but the but the growth rate has really picked up in the segment in the last couple of quarters and obviously you have a good outlook for 2021.
Maybe talk a little bit about.
How you feel about the either new product introductions or the sustainability of that growth rate.
Just given this segment has gone through several years of CLS and it seems like it's now now seeing a turn on growth.
Yeah I think.
I think you're right I mean, we've done a lot of the team has done a lot of pls over the years.
A big focus on on organic growth.
We continue to see.
Certainly good progress in terms of new products I talked earlier about on.
On average at the company level, we get a percentage point from customer back innovation, we're actually getting.
A rate that's double that in polymers and fluids.
So certainly.
The team has executed well on the organic growth framework and made progress on the strategic sales excellence.
And I think it's certainly helped.
That's some of the end markets were quite favorable in Q4 on the outlook for 'twenty one as is.
<unk> is pretty good in areas, such as health and hygiene.
We're seeing a recovery in MRO up applications.
And the retail side related to automotive aftermarket has been solid too so I.
I will pass on your comments to the polymers and fluids team.
Okay, great. Thank you that'll be thrilled they got a question.
Yeah.
Okay.
At a time.
So I'll just say to everybody. Thanks for joining us this morning, and if you have any follow up just give me a call. Thank you.
Thank you for participating on today's conference call all lines may disconnect at this time.
Okay.
Yes.
Okay.
Yes.
John.
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