(By Mani) ITT Corp.'s (NYSE: ITT) fundamentals and share price upside prospects heading into 2013 look solid, despite the stock's strong performance since last summer. The stock gained 30 percent in the last six months.
In 2013, shares could be driven by several positive margin catalysts include restructuring benefits, aftermarket mix increases, capacity fill-ins at new facilities in China and Korea, productivity benefits from lean initiatives, particularly in the U.S., and shock absorber margins returning to previous levels.
ITT makes engineered industrial products including industrial pumps, shock-absorbers, friction materials for automotive and truck application, electronic connectors, aircraft fueling systems and motion control products. The company derives 60 percent of sales outside North America and roughly 30 percent of revenue from aftermarket applications.
"We believe ITT possesses significant internal opportunities to drive margins and returns meaningfully higher over the coming 2 years despite the sluggish macro economic outlook," Deutsche Bank analyst John Inch wrote in a note to clients.
Over the past year, ITT has injected new management into the Industrial Process, Motion (brake pads), Connectors and Aerospace components businesses. In several cases, the company hired externally from key competitors to expand margins – particularly in connectors.
As part of the planning framework, the company has also reportedly adopted a 5-year strategic planning process which provides an important tool to orient management decision making for long term shareholder benefit.
Meanwhile, ITT has significant opportunities to improve margins through operations streamlining – particularly at Connectors and at the company's primary North American pumps facility in upstate New York. Overall, ITT is spending roughly $12 million on restructuring this year, up from $5 million last year.
"The absence of future restructuring charges should drive up to 10 cents of EPS cost avoidance and at least 10 cents of future recurring annual benefit to EPS," Inch said.
ITT's Interconnect Solutions business once carried double-digit margins. In 2007, the company sold its Switches business to private equity, leaving a significant amount of stranded overhead that subsequently dragged margins lower.
In 2012, ITT has earmarked $7 million of $12 million total ITT planned restructuring charges for the connectors business. Much of this restructuring is focused on European headcount, which should provide a significant cost avoidance benefit in 2013 and beyond.
"Longer term opportunities exist to exit production from Italy, and the U.S. to lower cost centers in Mexico and Eastern Europe, in our opinion. Of ITT's 8 global connector plants, the company likely only requires half that number in the future," Inch noted.
Overall, ITT believes this segment should be able to support a minimum of 15 percent future operating margins.
"Note that an additional 12pp of profit margin on roughly $400mm of connector revenues could equate to roughly 40 cents of incremental EPS upside," Inch noted.
Meanwhile, the pumps segment profit margins should benefit from both moderating orders that should generate more manageable demand volumes coupled with significant internal productivity initiatives that are already reportedly benefiting segment profits and appear set to gain incremental traction as 2013 unfolds.
ITT's $120 million Koni shock-absorber business (70-80 percent rail application) is currently reportedly running at roughly breakeven profit levels – up from previous losses.
"If Koni were to realize 10% OP margins, this could add 10 cents of EPS benefit (as a starting point)," Inch added.