ITT Corporation NEUTRAL ZACKS CONSENSUS ESTIMATES (ITT-NYSE)

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1 January 08, 2015 ITT Corporation Current Recommendation Prior Recommendation Outperform Date of Last Change 10/19/2014 Current Price (01/07/15) $37.66 Target Price $40.00 NEUTRAL (ITT-NYSE) SUMMARY ITT Corporation reported solid third-quarter 2014 results with earnings that significantly surpassed the Zacks Consensus Estimate and year-ago figure. The primary driver was a notable improvement in productivity, driven by diligent operational execution and cost-cutting initiatives. Strength in the company s Motion Technologies segment was another positive. Furthermore, ITT Corporation increased its earnings guidance for the year However, strong competition in the market remains a concern. Also, weak demand in the defense and connectors markets can impact the company s financials, going forward. Hence, we have maintained our Neutral recommendation. SUMMARY DATA 52-Week High $ Week Low $37.13 One-Year Return (%) Beta 1.24 Average Daily Volume (sh) 777,056 Shares Outstanding (mil) 92 Market Capitalization ($mil) $3,465 Short Interest Ratio (days) 1.05 Institutional Ownership (%) 89 Insider Ownership (%) 2 Annual Cash Dividend $0.44 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%) using TTM EPS 15.9 using 2015 Estimate 13.6 using 2016 Estimate 12.8 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Below Avg., Type of Stock Mid-Blend Industry Diversified Ops Zacks Industry Rank * 178 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 609 A 634 A 646 A 2,497 A A 663 A 657 A 659 E 2,654 E E 668 E 693 E 714 E 2,750 E ,810 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.47 A $0.51 A $0.54 A $0.49 A $2.01 A 2014 $0.62 A $0.60 A $0.66 A $0.57 E $2.45 E 2015 $0.69 E $0.67 E $0.71 E $0.69 E $2.76 E 2016 $2.95 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Headquartered in the New York City, ITT Corporation is a global multi-industry leader in high-technology engineering and manufacturing projects. It is engaged in the design, manufacture and sale of a wide range of engineered products and services. The company employs approximately 9,400 people worldwide. For financial reporting purposes, the company organizes its business into four principal segments as follows: Industrial Process Segment (accounts for approximately 44% of total revenues in 2013): Deals in manufacturing engineered fluid process equipments catering to the requirements of diverse industries like oil & gas, mining, power generation and chemical, among others. Through this segment, the company also provides plant optimization and efficiency solutions, and aftermarket services and parts. Motion Technologies Segment (29%): Specializes in manufacturing highly engineered and durable components, consisting of brake pads, shock absorbers and damping technologies for the transportation industry. Motion Technologies consists of two businesses; (i) Friction Technologies and (ii) KONI. Through its Friction Technologies business, the segment provides the automotive market with highperformance, high-quality brake pads. Through its KONI business, the segment provides the transportation industry with shock absorber and damping equipment. Interconnect Solutions Segment (16%): Deals in designs and manufactures a broad range of highly engineered connectors and cable assemblies for critical applications in harsh environments that make it possible to transfer signal and power in an increasingly connected world. The segment primarily caters to customers in the aerospace, oil and gas, medical, handheld electronics, industrial, alternative energy, transportation and defense markets. Control technologies Segment (11%): Specializes in the production of equipments like actuation, valves, switches, custom-energy absorption, vibration isolation and regulators as well for the markets like aerospace, defense and industrial applications. REASONS TO BUY ITT Corporation focuses on highly engineered solutions and has maintained a robust investment in research & development programs. Some of the company s organic investments in the quarter were aimed at the optimization of its Motion Technologies business in order to enhance efficiency and effectiveness. The company has also been focused on improving its auto brake pad manufacturing and aftermarket-reaching capabilities in the Industrial Process business. Such targeted investments allow the company to lay a strong foundation, which is expected to be a key driver for strong organic growth in the long run. ITT Corporation has a diversified business, which is aimed at mitigating operating risks related to economic downturns involved in operating a single sector. The company s business is well distributed across sectors like transportation (43%), industrial (34%) and energy (23%). Additonally, the company has a healthy mix of revenues sourced from different regions 40% from North America, 20% from other developed nations and 32% from emerging markets. In fact, the emerging markets, which are expected to grow far more than developed nations, witnessed overall growth of 13% in the reported quarter. Therefore, we believe that the company has ample scope to ride on growth trajectory, going forward. Equity Research ITT Page 2

3 ITT Corporation, over the past few years, has been achieving operational excellence through its Lean Six Sigma program, restructuring initiatives and global sourcing efforts. The company has been extending its lean program from factories to the enterprise level, in order to optimize operations across the whole-value chain in a comprehensive manner. ITT Corporation s turnaround programs, combined with a diligent operation execution, led to robust organic revenue growth of 45% in its KONI group with a remarkarble 42% surge in organic orders in the reported quarter. Furthermore, with the aid of such efforts, the company realised as much as $26 million of gross savings in the reported quarter, which lead to a yearto-date tally of $81 million. REASONS TO SELL The pump and valve markets of the Industrial Process segment are highly competitive. Primary customer purchase decision drivers include price, delivery times and on-time delivery performance, brand recognition and reputation, perceived quality, breadth of product offerings, commercial terms, technical support and localization. Pricing is typically very competitive for large projects due to increased potential for aftermarket opportunities for the original equipment provider. In the reported quarter, the weakness in the short-cycle base pumps and industrial valves led to a 7% decline in the revenues from the company s chemical and industrial pumps divisions. The company s Interconnect Solutions business has been witnessing sluggishness owing to persistent weakness in defense and handheld device connectors. In the reported quarter, the segment orders also declined 8% year over year. As this segment contributed about 15% to the company s total revenue in the reported quarter, the continuing weakness can significantly weigh down on the company s financials. ITT Corporation develops proprietary technology in the industries in which it operates and relies on intellectual property laws and a number of patents to protect such technology. In doing so, it incurs ongoing costs to enforce and defend its intellectual property. An inability to protect intellectual property could hurt its business. In addition, third parties may claim that it infringes on their intellectual property, which can result in incurring of significant litigation or licensing expenses. RECENT NEWS ITT Corp s KONI to Offer Technology for Indian Transportation Nov. 18, 2014 ITT Corporation announced that its KONI brand, a part of its Motion Technologies Segment will be collaborating with Gabriel India Ltd. The technology license agreement between the two entities will enable them to efficiently meet the suspension requirements of the Indian transportation and industrial equipment markets. Per the contract, KONI will be extending its innovative damper technology to the Gabriel India for the production of original equipment and aftermarket requirements in regions including India, Bangladesh, Sri Lanka, Nepal and Bhutan. The company will also be developing advanced shock absorbers designed for augmenting the performance and ease of the automotives. Equity Research ITT Page 3

4 ITT Corp Designs Advanced Connectors for Defense Market Nov. 10, 2014 ITT Corporation s Cannon brand recently developed the advanced VG95234 connector series in order to offer an alternative to the conventional Cadmium plating. These novel signal and power metal bayonet connectors are designed to meet the requirements of reliability and efficiency for the ground vehicles, while complying with environmental standards in the defense industry. These connectors are plated with zinc cobalt as a substitute for the usual Cadmium plating which enables it to achieve the RoHS and REACH environmental standards. Additionally, these connectors are also designed to meet the specifications of the European Military VG. ITT Corp Designs Advanced Connectors for Medical Devices Nov. 6, 2014 ITT Corporation s Cannon brand set to unveil latest Universal Contact connectors for perpendicular/right angle configurations. The company new technology is designed to cater to the needs of a low-cost, reliable solution for right angle mating in the medical industry. The advanced technology is developed to ensure the smooth linkage between the two printed circuit boards (PCBs) for use in diverse electronic applications. New generation wearable medical devices rely heavily on the connectivity solutions for ease of operations and that too without affecting the circuit boards. The aforementioned connectors utilize a technology for the sliding movement to enable the PCBs to be mated perfectly that too while generating a contact resistance. Additionally these connectors meet the RoHS standards. The company claims that these connectors are capable of handling over 2,000 mating cycles while providing a force of over 1.4N at the time of complete deflection. This ensures a better and consistent interconnect link between the two circuit boards. ITT Corporation Beats Q3 Earnings on Strong Operations Oct 31, 2014 ITT Corporation reported strong third-quarter fiscal 2014 results with adjusted earnings of $0.66 a share, which surpassed the Zacks Consensus Estimate of $0.60 by 10%. Earnings also improved 22.2% compared with the prior-year adjusted figure of $0.54. The increase in earnings was driven by strong operational performance, accelerated business execution and steady progress in implementation of the company s strategies like its Lean transformation initiative. This apart, the company has strategically diversified its portfolio to augment its profitability. Total Revenue Total revenue in the quarter climbed 3.6% year over year to $657.1 million. Organic revenue for the quarter grew 4%. However, revenues missed the Zacks Consensus Estimate of $666 million. The upside in top line primarily reflects strong growth in oil and gas markets, automotive brake pad market share gains and aftermarket expansion. Further, the company reported market share gains across end markets. The emerging markets posted a 14% increase, with 15% growth in energy and 6% growth in transportation markets recording 15% and 6% year-over-year increases, respectively. Equity Research ITT Page 4

5 Segment Results The Industrial Process segment reported revenues of $293 million, reflecting a 3% increase. Revenue growth was driven by strength in oil and gas project pumps in North America, Latin America and the Middle East. However, weakness in chemical and industrial pumps and valves, and mining pumps in Asia and Latin America partially offset the gains. Revenues in the Motion Technologies segment surged 11% to $197 million. The increase was driven by automotive brake pad share gains in China and growth in Europe. This apart, continued strong performance by the shock absorber business in global rail and automotive end markets remained a positive. Interconnect Solutions revenues rose 5% to $98 million in the quarter. The improvement was supported by growth in oil and gas connectors in North America and general industrial connectors. However, continued weakness in defense and communication connectors partially offset the gains. Moreover, an expected decline in non-strategic connectors remained a headwind. In the Control Technologies segment, revenues inched up 1% to $71 million. The increase was driven by growth in demand for general industrial solutions, especially in energy absorption and aerospace components, partially hurt by the impact of a high-margin end-of-life aerospace program and sluggishness in defense. The company s ongoing commercial aerospace program witnessed an improvement of 7% in the quarter. Income and Expenses The company reported operating income of $119.7 million compared with $77 million in the prior-year quarter. The increase was primarily led by higher sales and benefits from re-measurement of the company s asbestos liability. The operating margins surged a robust 230 basis points year over year to 14.4%. The company s selling, general and administrative costs stood at $122.6 million, down from $125.2 million reported in the prior-year quarter. The research and development expenditure increased to $20.1 million from $16.1 million in the year-ago quarter. Balance Sheet & Cash Flow At the end of the quarter, the company had cash and cash equivalents of $522.6 million and shareholders equity of $1.3 billion. For the nine-month period ended Sep 30, 2014, net cash from operating activities totaled $131.9 million, while capital expenditures amounted to $74.4 million. Outlook Encouraged with strong third-quarter earnings, the company raised its earnings guidance for fiscal Adjusted earnings per share from continuing operations are presently expected in the range of $2.42 to $2.47 compared with the prior range of $2.38 to $2.46 per share. The company also revised its guidance for total revenue to the range of 5% to 6% from the earlier projection of 5% to 7%, whereas the organic revenue guidance was reaffirmed at 5% to 6%. Equity Research ITT Page 5

6 VALUATION ITT Corporation s current trailing 12-month earnings multiple is 15.9x compared with the 25.6x average for the peer group and 18.4x for the S&P 500. Over the last five years, the company s shares have traded in a range of 2.2x to 21.8x trailing 12-month earnings. Our long-term Neutral recommendation on the stock indicates that it will perform in line with the broader market. Our target price is $40.00, or 14.5x 2015 EPS, which is well within the historical range. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low ITT Corporation (ITT) Industry Average S&P CRANE Co. (CR) Carlisle Companies Incorporated (CSL) NA Griffon Corporation (GFF) NA NA NA CLARCOR Inc. (CLC) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA ITT Corporation (ITT) Industry Average S&P Equity Research ITT Page 6

7 Earnings Surprise and Estimate Revision History Equity Research ITT Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of ITT. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1105 companies covered: Outperform %, Neutral %, Underperform 5.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research ITT Page 8