Q4 2022 Illinois Tool Works Inc Earnings Call
Good morning, My name is Cheryl and I will be your conference operator today.
At this time I would like to welcome everyone to the I T. W. Fourth quarter earnings Conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you 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 again press star one for those participating in the Q&A you will have an 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.
Thank you Sharon.
Good morning, and welcome to Itw's fourth quarter 2022 conference call.
I'm joined by our Chairman and CEO , Scott, Santi and senior Vice President and CFO Michael Larsen.
During today's call, we will discuss Itw's fourth quarter and full year 2022 financial results and provide guidance for full year 2023.
Slide two is a reminder, that this presentation contains forward looking statements.
We refer you to the company's 2021 Form 10-K, and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations.
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.
Thanks, Karen and good morning, everyone.
As you saw from our release. This morning in Q4, we delivered a strong finish to a year of high quality execution in the face of some pretty unique challenges in the operating environment.
Starting with the topline organic growth was 12% as all segments delivered positive organic growth in.
Five of our seven segments grew double digits led by auto OEM.
20% food equipment up 17%.
Welding up 15% polymers <unk> fluids up 11%.
And test and measurement and electronics up 10%.
Construction products was up 4% in specialty products was up three.
Operating margin expanded 210 basis points to 24, 8%.
With 110 basis point contribution from enterprise initiatives.
And favorable price cost margin impact of 70 basis points.
Which was for the first time in nine quarters, which was favorable for the first time in nine quarters.
Incremental margin was 52% and operating income grew 18%.
GAAP earnings per share increased 53% to a record $2.95.
Including 61 cents of gains from divestitures and 12 cents of negative currency, excluding 61, sorry.
Of divestiture gains in 12 cents of negative currency EPS growth was 27%.
For all of 2022, the company delivered organic growth of 12% for the second year in a row.
Best in class operating margin of 24, 4% and our base business.
After tax return on invested capital of 29, 1%.
And record GAAP EPS of 977, an increase of 15% versus the prior year.
There is no question that our decision to stay invested in our enterprise strategy and then our people throughout the pandemic.
And the quality of our teams execution of our win the recovery focus coming out of it are powering this strong growth and financial performance <unk>.
<unk> is currently delivering.
As a result, we are very pleased with our momentum and positioning heading into 2023.
Turning to our 2023 guidance demand remains solid across the majority of our portfolio.
And we are seeing meaningful improvements in supply chain performance and moderating input cost inflation.
At the same time there is no question that the economic outlook, let's call. It remains certainly dynamic.
As a result of our organic growth projection for 2023 of 3% to 5% and our EPS guidance of $9 60 at the midpoint.
Reflect current levels of demand and a risk adjustment for further slowing.
In certain end markets, Mike will provide more detail on that in just a minute.
I turn it over to Michael I want to again, thank my ITW colleagues around the world for their extraordinary dedication and commitment to serving our customers and executing our strategy with excellence Michael over to you.
Thank you Scott and good morning, everyone.
The demand growth that we've experienced all year continued into the fourth quarter as revenue grew 8% with organic growth of 12%.
On an equal days basis organic growth was 14%.
The fourth quarter. This year had one less shipping day compared to prior year.
We finished the year with strong growth momentum as evidenced by our sequential organic revenue growth of plus 4% from Q3 into Q4.
On a sales per day basis as compared to our historical sequential.
<unk>, 2%.
By geography every major region grew double digit with North America up, 13%, Europe up, 11% and China up 10%.
Foreign currency translation headwind reduced revenue by 5% and the net impact from acquisitions and divestitures was plus 1%.
GAAP EPS grew 53% to $2 95.
And included a 61 cents gain from two divestitures, which I'll provide more detail on.
In a moment.
Excluding those gains.
<unk> increased 21% to $2 34, which included <unk> 12 of EPS headwind from foreign currency translation.
So on an apples to apples basis, eliminating both divestiture gains and currency headwind EPS increased 27%.
On the bottom line operating income grew 18% with strong incremental margin performance of 52%.
And operating margin improved 210 basis points to 24, 8%.
Operating margin in our base business, excluding <unk> was 25, 2%.
In the fourth quarter, we achieved favorable price cost margin impact of 70 basis points and as Scott said this was the first quarter, but the favorable margin impact from price costs since the third quarter of 2020.
Enterprise initiatives contributed 110 basis.
Yeah.
As you saw on the press release, we completed two divestitures in the fourth quarter, resulting in a combined pre tax gain on sale.
Of $197 million recorded in non operating income.
And an EPS impact of <unk> 61.
By utilizing capital loss carryforwards to offset taxes on the divestiture gains the overall tax rate for the company was 19, 1%.
So overall for Q4 excellent operational execution across the board strong financial performance in what remains a pretty uncertain and volatile environment.
Okay. Please turn to slide four starting with our progress on organic growth.
And as you know we've been aggressively executing a very focused growth strategy to build consistent above market organic growth into our core itw's strengths on.
On par with our operational 80, 20 front to back capabilities.
As you can see from the data on the left side of the slide Itw's, 12% organic growth rate for each of the last two years.
<unk> favorably to our proxy peers at about 9% both years.
Suggesting that while we're not there yet in terms of realizing itw's full potential organic growth performance were.
We're making some very solid progress.
Moving onto the segment results starting with automotive OEM.
Which led the way with organic growth of 20% year on year revenue growth was of course helped by supply chain challenges in the industry last year.
North America was up 15% and Europe grew 23%.
China was up 17% with particularly strong growth in electric vehicles.
On a full year basis, ITW auto motive OEM revenues were up 12% versus 6% growth in car builds.
Looking forward, we expect automotive OEM to grow 5% to 7% in 2023 based on a risk adjusted auto build assumption in the low single digits, plus our typical penetration gains of 2% to 3%.
Turning to slide five.
Food equipment delivered another very strong quarter with organic growth of 17%.
North America grew 25% with double digit growth in all major categories and end markets.
Institutional was up more than 40% with strength across the board restaurants were up 30% and retail grew 20%.
International revenue grew 7% with Europe up, 9% and Asia Pacific was flat with some near term softness in China.
The food equipment team also delivered excellent progress on margins with Q4 operating margin of 27, 6%.
An increase of almost 500 basis points year over year.
So obviously strong momentum in this segment and we expect food equipment to grow 8%, 8% to 10% in 2023.
Test and measurement and electronics revenue grew 15% with organic growth of 10%.
Test and measurement grew 12% organic excluding the acquisition of MTS with continued strong demand for capital equipment as evidenced by Instron, which grew 24% electronics was up 7%.
Yeah.
While our semi related businesses, which represent a combined annual revenues of about $550 million or approximately 20% of the segment grew 17% in the quarter. We are beginning to see a slowdown.
And demand after three years of very strong growth.
So embedded in our 2023 organic growth projection of 2% to 4%.
For this segment is anticipated further slowing in semi related end markets.
Moving on to slide six.
Welding delivered strong organic growth of 15% in Q4 with equipment up 17% and consumables up 13%.
Industrial sales remained very strong with organic growth of 25%.
On the commercial side, which is more consumer oriented demand continued to slow and organic growth was down 1%.
On a geographic basis, North America grew 15% and international grew 17% driven by strength in the oil and gas business up 19%.
Operating margin was up 160 basis points to 31, 6%.
A new record for the segment and for the company.
Looking forward, we expect welding to grow 5% to 7% in 2023, which includes some anticipated further slowing on.
On the commercial welding side.
Polymers <unk> fluids delivered organic growth of 11% with the automotive aftermarket business up 13%.
With some seasonal strength and wiper blades.
Polymers grew 11% with continued strength in industrial applications and fluids was up 5%.
North America grew 11% and international was up 10%.
Looking forward, we expect pumps and fluids to grow 3% to 5% in 2023, which is based on current levels of demand.
And anticipated further slowing in the more consumer oriented automotive aftermarket business.
Turning to slide seven.
Overall demand in construction slowed to an organic growth rate of plus 4% North America was still up 9% with residential up 11% and.
In commercial construction was down 6% due to a tough comparison.
Of plus 21% last year.
Europe was up 3% in Australia, and New Zealand.
Was down 4%.
As you know construction is our most interest rate sensitive segment and we are projecting further slowing in 2023.
And a negative organic growth rate of minus five to minus 3%.
Specialty organic growth was 3% as supply chain shortages eased up in Q4, and the equipment businesses had a strong finish to the year with organic growth of 8%.
Consumables were up 2%.
And on a geographic basis, North America grew 1% and international grew 7%.
Looking forward, we expect specialty organic revenue of negative one to plus 1% in 2023, which is based on current levels of demand.
And anticipated for the slowing in the appliance components business.
So, let's turn to slide eight for a recap of our very strong 2022.
As throughout the year, our teams around the world did an exceptional job of delivering for our customers.
Responding quickly and decisively to rapidly rising input costs navigating supply chain disruptions and aggressively executing our win the recovery strategy.
As a result for the full year ITW grew organic revenue by 12% with double digit growth in five of seven segments.
And despite significant price cost margin pressures and thanks in part to 90 basis points contribution from our enterprise initiatives.
Our base business has expanded operating margin by 30 basis points to 24, 4%.
GAAP EPS of 977 was a record for ITW with EPS growth of 15%.
On top of 28% EPS growth in 2021.
Excluding divestiture gains and negative currency translation impact EPS grew 12%.
In 2022 on an apples to apples basis.
In 2022, we also invested more than $700 million to accelerate organic growth and to sustain productivity and our highly profitable core businesses.
Raised our dividend, 7%, marking the 59th year of consecutive increases.
Returned $3 3 billion to shareholders in the form of dividends and share repurchases and made solid progress on the integration of a very high quality acquisition.
And the MTS test and simulation business.
And most importantly, we delivered these results while continuing to make meaningful progress on our path to itw's full potential through the execution of our long term enterprise strategy.
So let's move to slide nine for an update on our full year 2023 guidance.
And while we certainly see some positives in terms of supply chain is easing and moderating input cost inflation. There is also no doubt that the economic outlook.
And demand picture is becoming increasingly uncertain.
On our last Q3 earnings call, we pointed to pockets of slowing demand in approximately 20%.
Of our business portfolio and today, we would add semiconductor related end markets to the mix, bringing the total to about 25%.
Nope Itw's portfolio.
In our view would therefore makes sense to take a more cautious approach to our topline guidance. This year by basing it not just on current levels of demand adjusted for seasonality as we typically do.
But rather anticipating further slowing in end markets related to construction.
Commercial welding auto aftermarket appliances and semiconductor.
As a result, our organic growth rate projection for 2023 of.
3% to 5% is lower than our typical run rate approach.
Operating margin is expected to improve by 100 basis points or more to a range of 24, 5% to $25.
5%.
This includes approximately 100 basis points contribution from enterprise initiatives and positive price cost margin impact based on all known and implemented price and cost actions.
After tax return on invested capital should improve to 30% plus and we expect strong free cash flow.
With conversion greater than net income.
For 2023, we expect GAAP EPS in the range of $9 40 to $9 80, which also includes 15 to 20.
Of higher interest expense on our short term debt.
And 25 of increased income tax expense as our tax rate will revert to a normal approximately 24% versus 22% in 2022, excluding the tax impacts from our divestitures.
In terms of cadence for the year, we're now back to our typical first half second half EPS split of 49 and 51%.
Our capital allocation plans for 2023 are consistent with our long standing disciplined capital allocation framework, our top priority remains internal investments to support our organic growth initiatives and sustain our highly profitable core businesses.
The second priority is an attractive dividend that grows in line with earnings over time, which remains a critical component of Itw's total shareholder return model.
Third selective high quality acquisitions, such as MTS at.
That enhanced itw's long term profitable growth potential that had significant margin improvement potential from the application of our proprietary 890, <unk> tabak methodology and can generate acceptable risk adjusted returns on our shareholders' capital.
And finally as surplus capital will be allocated to an active share repurchase program and.
And we expect to buy back approximately $1 5 billion of our own shares in 2023.
Turning to our last slide slide 10 for our 2023 organic growth projects by segment.
And you can see that we are expecting solid to mid solid mid to high single digit organic growth in four of our seven segments.
Offsetting some lower growth rates in test <unk> measurement, and electronics, which is due to semiconductor.
Demand as.
As well as in construction and specialty resulting in an overall organic growth rate at the enterprise level of 3% to 5%.
Which is on top of 12% organic growth in each of the last two years.
Overall, we're heading into 2023 with strong momentum and we're very well positioned.
To continue to outperform in whatever economic conditions emerge as we move through 2023.
So with that Karen I'll turn it back to you Okay. Thank you Michael.
Cheryl Please open up the lines for questions.
At this time I would like to remind everyone in order to ask a question.
Star then the number one on your telephone keypad will pause for a moment to compile the Q&A roster.
Okay.
Your first question is from Jamie Cook of Credit Suisse. Your line is open.
Good morning, and congrats on a nice quarter.
I guess my first question.
You talked about the 25% of your portfolio where.
Youre starting to see weakness can you talk I know semi to be incremental can you just give a little more color on what youre seeing in semi and then on the 75% and the rest of your portfolio or trends in line with your expectations, a little more positive or negative versus last quarter.
And then I guess just my my follow up question to that.
On price cost in the quarter I think was 70 bps positive I think that's a little better than what you were expected was that driven more by price or wrong going down and then what are your assumptions on the ability to hold price in 2023. Thank you.
Okay that was a that was a lot there Jamie I'll do my best Okay. So I think that the color on semi is really the we're coming off a three year.
Very strong growth cycle with <unk>.
And.
In the high teens or better than that over those three years and we're starting to see a slowdown in the order intake really in Q4.
So it hasnt really showed up in our numbers in a meaningful way yet, but we do expect.
That to continue into 2023, we think it's more of a near term slowdown.
And like you said that is the addition to the.
<unk>.
Portfolio, we've said before 20% of slowing demand is slowing now it's 25% in semi is really the incremental 5% this quarter, but it's important to keep in mind that the balance.
The other 75% of the portfolio is continues to perform at a really high level and I'll just point to the.
The 12% organic we put up in Q4 and for the full year and then if you look at our guidance.
On slide 10.
By segment you can see.
Mid to high single digit growth in automotive OEM food equipment welding mid.
Mid single digit in polymers, <unk> fluids, and then a little bit lower in test and measurement and then of course.
Construction is the one.
That's a little bit.
Yes.
Projected to be down year over year in specialty about flat I'll also say if you just look at from Q3 to Q4, we typically our sales per day go up.
2%, we actually went up 4% so we're more than offsetting.
The slowing that we're seeing in 25% of the portfolio.
So good momentum really well positioned going into next year I think on the price cost side. We were really encouraged we talked about this on the last call.
And an expectation of being positive slightly positive on margins on price cost in in Q4.
This was a little bit better driven by both sides of the equation really price.
And costs, but it was certainly great to see that turn positive for the first time since I think I said the third quarter 2020, So the first time in eight quarters.
So really encouraging heading into 2023.
Thank you.
Thank you.
Your next question comes from the line of Scott Davis Melius Research Your line is open.
Hey, good morning, Scott Michael Guerin.
Congrats on another strong year in 'twenty two.
Thank you. Thank you.
A little bit of a.
But on the 3% to 5%.
'twenty three top line core growth forecast is there any real price in that or you anniversary the big price increases.
Increases that you had in welding and now you are kind of more in the kind of neutral ish to maybe slightly positive versus a bigger number.
Well I think we're certainly lapping some bigger price numbers, there's no doubt about that and I think.
As you know, we don't break out price and volume separately for all the reasons, we've talked about in the past, but there is a.
There is both price and volume in the numbers that we've laid out for 2023 in the 3% to 5% organic.
I'll, just say as a risk adjusted number if you do a pure run rate you end up at a higher number but we just thought given the everything we talked about it was.
Probably reasonable to take a more cautious approach given the given the environment.
Yeah totally makes sense.
What about the inflation assumptions in general when you guys think about the 'twenty three outlook as far as kind of breaking out materials versus labor.
As it is.
Is it fair to assume that labor inflation remains reasonably high but material inflation is more moderated is that a fair assumption in your guide.
Yes, I think thats reasonable I think certainty.
Materials and components.
In that order.
We are seeing.
I wouldn't say prices are coming cost are coming down in a significant way and they're remaining at a fairly elevated level and then I think on.
No our neighbor cost certainly we're experiencing the same.
Labor cost inflation as others.
And but and.
So maybe a little bit higher than typical but nothing really.
That significant we're still expanding margins by 100 basis points or better here than in 2023. So.
Hopefully that answers your question.
Yes. It does thank you and best of luck this year sure. Thank you Scott.
Your next question comes from the line of Tami Zakaria of Jpmorgan. Your line is open.
Hi, good morning, Congrats on the great results.
So I have a couple of quick ones. The first one is how should we think about your EBIT margin.
Progression throughout the year is the 25 to 24 five to <unk> 95, and a half range going to be fairly consistent in all the quarters.
So like I said, we're we're kind of back to our typical cadence here.
I think we said first half 49% of our EPS for the full year second half, 51%, we really if you go back and look in time, we've been remarkably consistent.
Embedded in that is also the fact that Q1 is typically are our lowest quarter in terms of.
Revenue.
And we're expecting somewhere in the mid single digit type growth.
Margins will probably start out.
A little bit lower but still 100 basis points of margin improvement on a year over year basis.
<unk>.
Just to give an additional data point if you run the same data on Q1 contribution to EPS overall, it's somewhere around 23% of the full year and that's a pretty.
The company has become remarkably predictable over the years and so I think thats, probably a pretty good.
Estimate for how the first quarter might play out.
Got it that's fantastic color. Thank you sorry, I'm just going to ask the question I Hope I get Lucky and get a number but can you share what.
Again, it growth is trending quarter to date any segments trending negative right now.
Yeah.
So we just saw the January numbers and everything looks fine everything is tracking.
Yeah.
Really nothing different from what we talked about in the script here. So we're off to.
To start that we thought we would have.
Okay Awesome. Thank you sure. Thank you.
Your next question comes from the line of Andy Kaplowitz of Citigroup. Please your line is open.
Hey, good morning, everyone Hey.
Hey, Andy.
Well when we think about margin expectations for 'twenty three across your segments does the lag in price versus cost slipped the most and auto Oems. So you could see a nice jump in margin in that segment or should we generally think that your segment margin will trend with who has the highest growth forecast versus the weakest growth forecast in 2013.
I think Andy we expect.
All of our planning here at ITW is done bottoms up as I think you know and.
Every one of our segments, including the higher margin ones such as welding.
As well as automotive, which is really dealing with some near term pressures primarily related to price cost.
As well as just.
Volume leverage.
Every one of our seven segments.
Told us that they expect to improve margins year over year.
In 2023, but obviously the ones that have higher growth rates.
I'm going to have more volume leverage and therefore, probably.
A more significant improvement in operating margin, but everybody will get better I would just say on automotive.
It's going to take some time to recover.
The price cost margin impact, which has been significantly higher in automotive than in other segments for all the reasons, we've talked about in the past it takes a little bit longer.
To recover price. So I think our current view is it'll take us maybe two to three years to get back to.
Automotive margins in the in the low to mid Twenty's and so.
That's maybe how I would characterize it.
Very helpful. Michael and then can you give us an update on the longevity of enterprise initiatives ITW continues.
At this point.
I think we might begin to get a little spoiled here.
That it could last indefinitely. So how are you thinking about enterprise strategy do you still see a long runway of initiatives across your segments, and where will the focus of enterprise strategy be across your segments in 'twenty three.
Well.
Go ahead and start okay, well I think.
We're in the 10th year now I think if you add up.
The combined savings, it's approaching $1 $5 billion of structural cost out from <unk>.
<unk> 'twenty and from strategic sourcing and when we rolled up the plans here.
In November and check back in in January and had a chance to review all of the projects and activities that go into delivering.
These 100 basis points, we were really encouraged by what we saw.
And so I know that for a couple of years.
We've been saying I've been saying this is not going to go on forever.
And I went wrong and I was wrong, [laughter], which happens a lot, but I think ultimately look I think if you model ITW long term.
I'd go back to the Tsi model, we've given you, which is 4% plus organic growth incremental margins.
In that 35% to 40% range.
Then operating income grows seven.
You add acquisitions and buybacks on top of that and so EPS grows nine to 10, and then you add an attractive dividend in that two to three range.
2% to 3% range on top of that you've got 11% to 13% over the long term. That's what you should expect us to deliver.
And so.
I think.
I hesitate to give you a definitive answer on enterprise initiatives, because as Scott reminded me I've been wrong for many years, but that's probably how I would think about it Andy.
I would just.
Add in terms of perspective, I think one of the real strengths of our operating methodologies in our business model is its.
Theres no one definition of perfection, there is always room to get better we use the business model as the core tool that are.
84 divisions used to identify and.
And prioritize opportunities to get better and I don't see that stopping.
For quite a while right I think we've said this before I mean the.
This proprietary ITW business model is more powerful than it's ever been as we sit here today its much different from 10 years ago three years ago.
And we are applying it are people, we've all gotten better at applying these methodologies and we're applying it to a much more differentiated portfolio.
And so as long as we continue down that path I think it is.
I agree with Scott I don't think its going to end anytime soon so.
That's that's probably have we have set it up.
I appreciate all the color guys. Thank.
Thank you.
Your next question comes from the line of Andrew <unk> of Bank of America. Your line is open.
Hey, guys you have Sabrina Abrams on for Andrew how are you. Good how are you.
Good.
So first on the margin guide.
70 bps to 170 bps of year over year expansion, yes, it's about 100 bps of enterprise initiatives and then I guess the remainder is a 20 bps sort of price cost at the midpoint I'm just trying to think is this conservative approach should you had 70 bps of benefit in <unk> is there potential upside here.
Well I think maybe what would be helpful. As Sabrina just let me just give you some of the elements here that go into that.
The margin improvement on a year over year basis, and I'm going to use round numbers here. Okay. So if we just ended 2022.
Operating margins of about 24%.
You should expect volume leverage.
Somewhere in the 50 to 100 basis points.
Of positive contribution to margins year over year, the enterprise initiatives, which is sized at about 100.
We're certainly going to make some good progress on price cost of 70 basis points was encouraging in Q4 I think.
If thats the run rate going into 2023, maybe a little bit better than that let's just say price cost adds approximately <unk>.
100 basis points based on what we know today.
And then the offset to some of this is our typical kind of we talked about this a little bit wages and inflation on wages we are bring.
Bringing in.
Some new hires to support our organic growth efforts, we are investing in.
In and driving organic growth, including capacity and so that's typically a headwind of less than.
100 basis points, that's running a little bit higher just given the.
The underlying inflation, that's that's in the system, that's probably running at 150 to 200.
And so you add all that up you get 100 basis points plus of margin improvement on a year over year basis, and I think thats.
I think thats, a pretty good number Sabrina.
Got it. Thank you that's helpful.
And so China, I guess were strong and auto OEM and <unk>.
Just trying to think what's incorporated in your guide for China reopening next year.
Well I think.
As we look at kind of on a geographic basis, including China.
Yeah.
Most of our regions are kind of in that.
Mid single digits for.
For the year.
In China as May be.
A little bit higher than that.
A big driver as you pointed out in China is really the automotive business, where we will continue to.
Yeah.
Make a lot of progress in terms of market share and penetration gains. So thats certainly our largest business and also the biggest driver of our growth in China next year and so.
If the total company is three to five organic China is certainly a little bit higher than that in our current projections as we sit here today. So.
Great. Thank you so much I'll pass it on sure.
Your next question comes from the line of Jeff Sprague of vertical research. Please go ahead. Your line is open.
Thank you and good morning, everyone.
Jeff.
Hey.
Solid results.
Just back to enterprise.
I volkmann kind of thought of it maybe incorrectly.
As.
Reflecting a little bit of a trade off between margin and growth in.
Maybe maybe originally it was more cost oriented but.
Organic growth year recently would suggest.
Not trading growth for margin.
I Wonder if you just kind of comment on that obviously the growth has enjoyed a cyclical lift.
Last couple of years, so I don't want to overstate the point, but.
But it does seem that.
The system has thrown a lot better organic growth than it has.
Pat.
<unk>.
Yes.
Excellent.
Interesting Yeah first first of all Jeff Thank you for noticing.
Yes.
What I would say in terms of just the arc of the last decade. We've been on this is that clearly for the first five years to seven years, we had a lot more work to do inside of the businesses.
Get ourselves in position to grow and what what we're delivering now is much more about businesses that are.
From an operational standpoint, a lot closer to 80% or 90% of their potential.
And so a lot of that which allows a lot of our effort and attention that is too.
To be reallocated to commercial opportunities to grow and Thats ultimately what.
What is showing up that we have a lot more.
Sort of energy collectively being devoted to growth opportunities because we've gotten the internal operational positions of these businesses.
Hiring in.
Sort of a really strong position and so it's.
You can't it can't be great at everything all at once as part of I think what we would reflect on over the last decade and one of the real.
Secrets to the outcomes. We've delivered in my view is that we've been focused on the right things at the right time and have not tried to do too much at any stage, but we're clearly now at a stage where organic growth is the AVR.
What we've got opportunities to do with what we've got to deliver on going forward and I think thats reflective in reflected in the numbers that were currently thrown off.
And wood.
Michael gave you that piece of the bridge wage and growth investment.
Is that number other than kind of the inflationary pressures that you mentioned is.
That shortfall moving higher or can that.
Sort of be funded within the normal incremental margin comps.
Other logos.
Sure.
Thats exactly the way we do it is we are we are self funding our growth investments through our incremental margin contribution.
The 35.
Historical and target run rate that is on that includes that's after those incremental investments.
In growth, we are investing in capacity now.
Significant way in head count in the areas that help us grow and supporting innovation.
And we're still going to deliver a 100 bps.
Thats a margin improvement next year, so that just illustrates the point of these businesses are some profitable every incremental dollar of revenue that we generate organically.
Drives a lot of incremental cash flow and certainly the support that we're going to invest some of that but it doesn't impair our ability to bring a good chunk of it to the bottom line.
Great Thanks for that context.
Your next question is from Stephen Volkmann.
Jefferies. Your line is open.
Yes.
Hi, Good morning, guys. My question has been answered a couple of quick follow ups is there a portion of your portfolio, where you would expect to give back price once the sort of lower energy and transportation and raw material costs kind of work their way through.
Yes.
We have a very small portion of our overall portfolio, where the pricing is indexed to raw materials. If you add it all up it's somewhere around 5% of our total revenue so really an immaterial.
Number where it's an automatic <unk>.
Give back on price I think on everything else we.
Historically command a premium.
Given our the differentiated nature of our products and services.
And the quality of our delivery.
And we expect to maintain that.
Premium as we compete.
And focus on gaining market share so.
That's how I would.
How I would answer your question Steve.
Great I appreciate it pretty minimal then.
Then just sort of maybe the obligatory question on capital deployment relative to your thinking on any sort of further divestiture opportunities our M&A pipeline anything to kind of call out there.
Yes, So I think you saw the two divestitures here in the fourth quarter.
That's part of.
I think we called out a handful of business units about a year ago.
So the first two are done we've got a smaller one that's kind of in the works.
And then we've got.
A more meaningful one that is performing at a really high level right now and I think we're going to kind of assess.
The capital markets and conditions and whether it's the right time to launch sometime this summer.
And that will kind of round out what we talked about about a year ago, So thats kind of where we're at.
Okay.
Okay, great and M&A pipeline sorry.
Well.
Yes.
We get this question every time, we answered the same way I mean I think.
Organic growth is priority number one.
For all the reasons that Scott.
Scott just talked about I think on the we'd certainly be interested in high quality.
Acquisitions that accelerate our long term growth potential of the company, where we can improve margins through the implementation of the business model.
And we can earn a reasonable rate of return on our shareholders' capital and so.
MTS is a good example of an acquisition that checks all the boxes that was a pretty big one that we did a year ago.
And to the extent that other opportunities like that present themselves that check the boxes, we're definitely going to lean in in a big way.
So thats, but maybe just a little color on top of that that's more sort of a topical near term what I would say generally.
Is that we are not looking to acquire broken businesses, we're looking to acquire good businesses.
That would be great businesses.
In environments, where the sort of economic the macros uncertain. Those those good businesses, it's really not a good time to sell so if anything I would say the environment until.
The macro trajectory gets a little bit more clear.
Would expected that the.
<unk> might be a little less than normal this year at least through the first half, but we'll see.
Okay I appreciate the color. Thank you.
Yeah.
Your next question comes from the line of John Joyner of BMO capital markets. Your line is open.
Okay.
Excellent. Thank you.
So the the food equipment business.
<unk> highlighted has definitely been a.
End up for you.
After attending the naphthalene food equipment show yesterday.
So there was a noticeable difference in how the fed.
Doug.
<unk>.
It seems to be presenting itself more cohesively than before.
So we comment on this aspect and also on some of the things that you're doing there with regard to consolidating sales rubs and allocating more investments towards maybe the cooking side, specifically product slate combi ovens, and priors, which are certainly areas that have well known large competitors.
Well I'll take a stab I think we're not really doing anything different than we have over the last.
Five years.
In the food equipment business, we've continued to invest and differentiate it.
Products.
Including the categories that you mentioned.
And we've been putting up the team has been putting up some.
Really great numbers as a result of executing on their strategy and so.
If you add up the organic growth rate here.
Over.
17% coming out of the pandemic, 23% last year. This year high single digit double digit and that's really as a result of us.
Innovating and growing all product categories.
Add to that near term our supply capabilities willingness.
Winning this business, yes, definitely I think this has been an area where kind of back to a when the recovery positioning and the decision to carry.
Enough inventory to service our customers.
With the same level of excellence.
Difficult supply chain on a different supply chain conditions has paid off in a big way and so.
Think if you get the sense that the food equipment team is in a good mood I think thats.
Because they are gaining share in putting up some so.
Really strong numbers, including on the margin side, if you look at that almost 400.
So almost 500 basis points of improvement on a year over year basis. So that business like we said has got a ton of momentum going into.
2023, and we're very bullish on the on the future here.
Okay. Thank you, yes, they were definitely in a good mood.
Got it.
Yes.
Your next question comes from the line of Joe O'dea of Wells Fargo. Your line is open.
Good morning, Thanks for taking my questions sure.
I wanted to start the slide four where you show the 300 bps of outgrowth versus the proxy group over the last couple of years.
When you talk to sort of attribution of that I think obviously, a pricing environment, where are you seeing different trends across different companies. So not sure the degree to which maybe pricing is outpacing.
But the degree to which it is volume.
Is it primarily share gain and just your confidence in the stickiness of those share gains as supply chain corrects.
Yes.
My response would be that there is no way that we can.
Break this apart.
Various pieces, what I can say is that the proof is in the pudding ultimately is in the performance in R&D our ability to consistently.
Perform we're not claiming victory here, we're not we're not we've got a lot of room to go across the company in terms of our ability to consistently deliver the kind of organic growth that we're capable of but.
What we are saying is what we put a couple of years on the board, where we are growing our peers in the aggregate what what percent of that is our market exposures versus theirs or.
Different approaches to pricing.
Supply capability I'd say all of the above in the end it doesn't matter.
As long as we're able to consistently.
Grow our RFP.
Our peers and outgrow our markets and that's really the goal.
And I guess related to that is you're seeing maybe supply chain ease and I don't know if competitors are in the market and a little bit more competitive way, but but any any challenges now that you that you didn't see maybe six or 12 months ago.
I think Joe from the beginning the.
The when the recovery positioning was all about strategic share gains focused primarily on our existing customers.
And we were not interested in opportunistic one time orders.
And so we are we're pretty confident with that direction. These share gains are going to are going to stick I think the pandemic.
The supply chain.
Kind of disruptions, where a great opportunity for ITW to demonstrate how differentiated our supply chain capabilities are.
For those customers that didn't know and so I think.
I think that's been really.
That's what's contributing.
Also to the the outgrowth relative to peers I mean, that's one more element of the equation as you've talked about Scott.
And then I just wanted to clarify on the average daily sales plus two versus seasonal air plus four versus seasonal plus too.
The degree to which that's underlying demand accelerating.
Versus maybe backlog burn I think it's hard to parse given broadly inflated backlogs out there what underlying demand trends look like but any comments on what youre seeing sort of underlying accelerate versus diesel.
Well I think we're not a backlog driven company.
As you know we don't we don't carry a lot of backlog in.
And as you also say, it's hard to parse out what was backlog versus new orders. So I am not sure I can give you a great answer.
What I can tell you is that.
Yes.
Typically our sales per day go up by 2%. If you go back and look in time and they went up by four and so things are definitely not slowing.
And we've got some great momentum going into <unk>.
Q1 in 2023.
Great I appreciate the color.
Sure.
Your next question comes from the line of Julian Mitchell of Barclays. Your line is open.
Okay.
Hi, good morning, and thanks for squeezing me in.
Maybe I just wanted to circle back to the organic sales growth guide and totally understand you Don can elaborate.
Macro gyrations within that.
A very sensible approach, but you've got the 4% growth guide for the year as a whole organically at the midpoint you just stayed low double digit the.
The most recent quarter.
So just trying to understand how do we think about that sort of step down is it a steady deceleration as we go through the year anything in particular, we should bear in mind.
One or two year stacks.
Colorado was really that you could give on how we think about the process for moving through 2023.
It's all in the comparisons year over year Julien so.
Like I said, we expect the year to play out from a revenue standpoint.
In line with our typical cadence and so Q1 starts out a little bit lower and then we kind of.
Improve from there, but theres nothing.
Nothing baked in in terms of.
Big acts.
Acceleration in the back half or deceleration in the back half we've kind of done our best here to model current levels of demand risk adjusted for the areas, where we're seeing some slowing.
And demand and we come up with three to five I think if you run the math Youll see kind of the first half is.
The growth rates are maybe towards the higher end.
Of that three to five in the second half is towards the lower end and Thats, all driven by the comps on a year over year basis.
That's very clear thank you.
And then within.
Construction products.
I don't think we dealt with that one.
Yes, apologies, if you have to repeat anything but that sort of down four.
Alright.
That's probably a bit of price didn't have some of the volumes are down high single digit or something but maybe just help us understand whats embedded within that I think simplistically you have.
Third as resi Newbuild <unk> replacement authorities commercial.
Those three big pieces, how you sort of thinking about those this year.
I mean, the big driver Julien as the housing.
Market, new new housing.
And so the residential side is about 80% of our business here.
North America, and that's where we're seeing some slowing which we've talked about since this summer I think so there's nothing new here.
And.
That's the big driver here of the commercial side is hanging in there.
It was also our strongest business.
In the summer after the right yes.
However, the advantage of the.
Different end market exposures. We have is that we can we can we're always going to have some in the and the tailwind.
And the tailwind mode and some of the headwind mode, but the net mix them at all.
Positive so yes, it's going to be down a little this year, but it's also been business has really performed well for us when other partisans.
The macro had been challenged so.
That makes sense. Thank you.
Thank you.
Thank you for participating in today's conference call all lines may disconnect at this time.
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Okay.
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Okay.