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Remi Cossart

Geoffrey Jordan

ITT AT A GLANCE

P/E ► 15.0   EV/EBITDA ► 10.6   ROA ► 6.7%   ROE ► 15.7%   Debt to Equity ► 2.22   Current Ratio ► 1.57   Interest Coverage Ratio ► 7.78

 

 

 

 

ITT Corporation (NYSE: ITT) is a global manufacturer and top 10 U.S. defense contractor specializing in electronics and fluids. As the largest supplier of pumps and systems in the transport and treatment of water, ITT offers its services to local governments in the U.S. and to the governments of developing nations. ITT also manufactures electronics such as night vision goggles and communication systems for the U.S. military. From 2006 to 2007, ITT reported a 15.3% increase in revenue to $9 billion and a nearly 28% increase in net income to $742.1 million. In the third quarter of 2008, ITT reported an increase in order volume of 13% and an increase in revenue of 32% over the third quarter of 2007.

About 43%^[1] of ITT's revenue ($3.87 billion) is generated by U.S. government contracts, the majority of which are with the U.S. military. Since the September 11, 2001 terrorist attacks, U.S. defense spending has risen over 35%,^[2] reaching $483 billion in 2008.^[3] There remains a high degree of uncertainty, however, in the future of the U.S. defense budget, especially given anticipated U.S. troop withdrawals in Iraq and a new White House administration.

The future of ITT's fluids business depends on the global demand for clean water, especially in developing countries such as China and India. The growth in agriculture, increasingly wealthy populations, and widespread pollution in these developing countries have contributed to the rising demand for clean water. ITT is just one of many competitors working to bring clean water to developing nations.

Company Overview

ITT manufactures defense electronics and systems (through contracts with the U.S. government), manufactures and services fluid pumps and systems (used by municipal communities, oil refineries, and chemical plants), and manufactures specialty components for aerospace, transportation, and industrial markets.

Business and Financial Metrics

ITT Net Income and Revenue from 2004 to 2007 in millions of USD^[4]

Breakdown of Segments by Revenue^[5]

Total revenue for 2007 was $9.0 billion, representing a 15.3% increase over 2006.^[6] During 2006, revenues grew 10.9% to $7.81 billion over the prior year. Both year-over-year increases were primarily attributable to higher sales volumes and prices from existing businesses (“organic growth”) in each of ITT's business segments. Gross margin (as a percent of sales) was higher in 2007 at 28.5% compared to 28.0% in both 2006 and 2005. This increase was driven by ITT's productivity and cost savings initiatives, including continued efforts to improve supply chain productivity and control material costs.^[7] ITT's net profit margin in 2007 was 7.03%.^[8]

ITT's average returns on invested capital were in the 16% percent range from 1999 to 2007.^[9] ITT's balance sheet as of the fourth quarter of 2008 was underleveraged with a long-term debt-to-capital ratio of 0.10.^[9]

3Q08: ITT reported 8% organic growth and an increase in order volume of 13% over the third quarter of 2007. Growth was largely driven by the acquisition of EDO (EDO), a global aerospace and defense company. Adjusted to exclude special items, income from continuing operations for the quarter grew to $205.1 million, or $1.12 per share, up 26 percent compared to the third quarter of 2007. Revenue for the quarter climbed 32 percent over the the third quarter of 2007 to $2.9 billion.^[10] Year-to-date free cash flow reached $759 million, a 127 percent conversion of income from continuing operations.^[10]

Acquisitions

In 2007, ITT spent $2.01 billion in the acquisition of six different companies.^[12] The acquisitions of EDO within ITT's Defense Electronics & Services business segment and IMC within its Motion & Flow Control business segment comprised most of the total spending.^[12]

The purchase of EDO (EDO) for $1.7 billion^[13] in December 2007 is a significant change in the company's product emphasis. EDO specializes in small, light, and intelligent defense equipment such as the Counter Improvised Explosive Device program (C-IED).^[14] The U.S. military has increasingly shifted from spending on conventional military units like tanks to these types of programs to combat Improvised Explosive Devices (IED) and other such weapons used in urban warfare.^[15]

ITT also acquired IMC, a producer of shock absorbers and controls for aviation, for $390.5 million. The addition of IMC into Motion & Flow Control continues the segment's sales of highly engineered key products.^[16]

Business Segments

• Defense Electronics & Services (46% of revenue, 45% of operating income)^[1] Generating $4.1 billion in 2007, Defense Electronics & Services specializes in sensing and surveillance, communications, space, and advanced engineering and integrated services.^[17]
  

  

  ITT Defense Electronics & Services Customer Base ^[18]
  The defense electronics segment manufactures equipment ranging from tactical attack and defense telecommunication systems to night vision goggles.^[19] 98% of 2007 sales^[20] were to government entities and 94% of sales were to the U.S. government.^[20] The following are the subdivisions of Defense Electronics & Services:^[18]
  • Systems (32%)^[21]
  • Aerospace/communications (19% of revenue)^[21]
  • Space systems (14% of revenue)^[21]
  • Advanced Engineering & Sciences (12% of revenue)^[21]
  • Night vision (12% of revenue)^[21]
  • Electronic systems (10% of revenue)^[21]

3Q08 Growth in Defense Electronics & Services:^[10] 9% organic growth, year-over-year revenue growth of 52% to $1.5 billion (driven by acquisition of EDO Corporation, a data analysis contract with ADS-B, and increased shipments to Iraqi and Saudi governments)

• Fluid Technology (39% of revenue, 39% of operating income)^[1] Generating $3.5 billion in revenue in 2007, Fluid Technology specializes in the management, treatment, transport, usage, and purification of water and other fluids.^[17]
  

  

  ITT Fluid Technology Global Revenue Streams ^[22]
  For example, ITT manufactures pumps used by municipal communities to pump sewage and water, by oil refineries to move oil and refined products, and by chemical plants to pump liquid chemicals.^[23] The sector also produces mixers and controls that are used to regulate the quality and flow of the fluid.^[24] ITT owns the Flygt brand which is recognized to have the largest market share for municipal submersible pumps in terms of total sales. The following are the subdivisions of Fluid Technology:^[22]
  • Water & Wastewater (47% of revenue)^[25]
  • Residential & Commercial Water (33% of revenue)^[25]
  • Industrial Process (20% of revenue)^[25]

3Q08 Growth in Fluid Technology:^[10] 8% organic growth, year-over-year revenue growth of 11% to $949 million and operating margin up 100 basis points to 13.9% (driven by strength of municipal markets, desalination in the Middle East, and strength in global agriculture)

• Motion & Flow Control (15% of revenue, 16% of operating income)^[1] Generating $1.4 in revenue in 2007, Motion & Flow Control specializes in interconnect, flow control, motion control, energy absorption, and friction.^[17]
  

  

  ITT Motion & Flow Control Global Revenue Streams ^[26]
  

  

  ITT Motion & Flow Control Market Participation ^[26]
  Motion & Flow Control manufactures products which deal with absorbing or transferring energy such as friction pads used in the braking systems of large trucks and shock absorbers and struts used in airplanes.^[27] The segment's products also deal with controlling the flow of liquids such as jets and pumps used in hot tubs and valves and actuators used in chemical plants.^[28] The following are the subdivisions of Motion & Flow Control:^[26]
  • Interconnect (32% of revenue)^[29]
  • Friction Technologies (29% of revenue)^[29]
  • Flow Control (19%)^[29]
  • Energy Absorption (11% of revenue)^[29]
  • Aerospace Controls (8% of revenue)^[29]
  • Other Controls (1% of revenue)^[29]

3Q08 Growth in Motion & Flow Control:^[10] 6% organic growth, year-over-year revenue growth of 25% to $394 million (driven by strength in Beverage offset by weakness in Marine and Spa)

Key Trends and Forces

ITT relies on a large U.S. defense budget and contracts with the government

ITT's defense segment relies heavily on the U.S. Department of Defense budget related to electronic and network-centric warfare. 94%^[30] of Defense Electronics & Services' revenue comes from contracts with the U.S. government, and 43% of the company's total revenue comes from U.S. military contracts.^[1] Since the September 11, 2001 terrorist attacks, U.S. defense spending has risen over 35%,^[2] reaching $483 billion in 2008.^[3] There remains a high degree of uncertainty in the future of the U.S. defense budget, especially given anticipated U.S. troop withdrawals in Iraq and a new White House administration. The military's share of the federal budget has been restricted by recession, demand for spending in infrastructure, health care, education, and the retirement of the baby boom generation. After the Vietnam War, the defense budge was cut by 31%, and at the end of the Cold War the budget was cut by 36%.^[31] Though Congress has approved the highest defense budget in history for 2009 ($611 billion), the budget in future years is uncertain given the growing demands on the federal budget.^[31]

Rising global demand for clean water drives ITT's fluid technology business

In the U.S., many of the water treatment facilities built after World War II are being replaced, and ITT is the leading supplier of waste water treatment and handling equipment. However, short term shortfalls in municipal spending can delay the replacement of water treatment facilities, and raising taxes or water bills to fund capital improvements is not politically popular. Though federal funding for water projects has been declining since the 1960s, the Council of State Governments projects that population shifts to the semi-arid states of the West and Southeast will increase the overall demand for water. For example, the populations of Florida, California, and Texas are projected to increase by 12 million by 2030.^[32]

Globally, the growth of ITT's fluid technology business is driven by urbanization in developing countries such as China and India. Factors that are contributing to increasing demand for water in developing countries include rocketing agriculture and increasingly wealthy populations. Meanwhile, pollution has reduced the amount of available drinking water. A study by the Asian Development Bank reported that 60% of China’s 669 cities suffer water shortages, and nearly half of the country’s 800 million farmers have no access to safe drinking water.^[33] Moreover, nearly half of China’s cities lacked wastewater treatment facilities in 2005.^[33] While there is a pressing need for water facilities in developing countries, lack of funding to improve the water infrastructure in emerging markets can delay new water projects.

Past and future environment clean-up costs reduce profit margin

As of 2007, ITT was responsible for 90 different sites which need environmental remediation.^[34] The cleanups are associated with ITT's former automotive segment and poorly discharged industrial waste going as far back as 1930.^[35] The company predicts the cost to clean the environmental liabilities to be between $94.6 and $213.3 million. In the past, the company has spent an average of $8 to $12 million on annual environmental liabilities.^[36]

ITT is subject to environmental laws and regulations concerning air emissions, water discharges and waste disposal. In the U.S. these environmental laws and regulations include the Federal Clean Air Act, the Clean Water Act, the Resource, Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act.^[37] Environmental requirements are significant factors affecting ITT's operations.

ITT has faced litigation and penalty fees for improper use of material and information

As of 2007, there were approximately 103,000 claims against ITT for use of asbestos in pumps prior to 1985. The company estimates the pending claims to cost $24.8 million after insurance recoveries.^[38]

In March 2007, ITT failed to comply with International Traffic in Arms Regulations on the sale of night vision goggles and was forced to pay $50 million in fees and fines due to the improper handling of sensitive documents. ITT is not legally permitted to release information about its products used by the U.S. military.^[39] However, from 1980 to 2005, ITT was involved in a "regular pattern of export violations and misrepresentation" to the U.S. government by exporting classified or sensitive technical data to China, Singapore, and Britain without authorization (in violation of the Arms Export Control Act).^[40] ITT transferred this information because laser gear is manufactured more cheaply overseas. ITT's $100 million fine was structured such that $50 million was to be spent by ITT in developing the next-generation night vision system and the remaining $50 million was to be paid in criminal fines, forfeited revenue from a U.S. government contract, and penalty fees to the U.S. State Department.^[40]

Competition

ITT competes with a number of companies for government contracts and private and industrial consumers. Each of the three segments faces a distinct group of competitors, but the following companies are most closely in competition with ITT.

• General Electric Company (GE) is a multinational conglomerate specializing in technology and services. In 2008, GE was the twelfth-largest company in the world by revenue and the second-largest company by market capitalization.^[41] In May 2005, GE announced the launch of an "Ecomagination" program intended to develop, among other green technologies, water purification systems.^[42] GE's water purification and treatment operations compete directly with ITT's fluid technology segment. GE is also a manufacturer of highly engineered parts, competing with ITT's Defense Electronics & Services segment for U.S. military contracts.
• Siemens AG (SI): Siemens is one of the world’s largest companies in the field of electrical engineering and electronics. Siemens Water Technologies competes directly with the fluid technology segment of ITT, while its electronics division competes with ITT's Defense Electronics & Services segment for U.S. military contracts.^[43]
• Pentair (PNR) has a Water Group that manufactures products and systems used in the movement, storage, and treatment of water. It competes directly with ITT's Fluid Technology segment, especially in emerging markets and developing countries.^[44]
• Textron (TXT) is a diversified engineering company which competes with ITT in equipment and electronics for military aircraft and gears and shock absorbers for general aviation.^[45] Unlike ITT, Textron produces aircraft engines and is not involved in fluids.^[46]
• Emerson Electric Company (EMR) has a Process Management segment which competes with ITT's Fluid Technology segment. It produces fluid quality control equipment used in oil refining and pharmaceutical processing.^[47] Emerson also produces residential and commercial air-conditioning units which do not compete with ITT. ^[48]
• Flowserve (FLS) competes with ITT for precision equipment used to regulate fluids through the use of pumps, valves and seals. Flowserve also offers two services that are not offered by ITT: diagnostics and retrofitting of existing plants.^[49]
• 3M Company (MMM) is a diversified technology company that competes with ITT in the development of military telecommunication systems and the manufacture of high friction plates. 3M is much larger and sells a broader range of goods and services than ITT.^[50]
• United Technologies (UTX) provides high-technology products and services to the building systems and aerospace industries. United Technologies owns Pratt & Whitney, Hamilton Sundstrand, and Sikorsky Aircraft, three companies that manufacture military aircraft engines, parts, and space propulsion systems.^[51] United Technologies competes directly with ITT's Defense Electronics & Services segment and also its Motion & Flow Control segment for contracts with the U.S. military.
• Honeywell International (HON) is a diversified technology and manufacturing company, serving customers worldwide with aerospace products and services, automotive products, and process technology for refining petrochemicals.^[52] Honeywell's Aerospace and Automation Control business segment competes with ITT's Defense Electronics & Services segment and also with its Motion & Flow Control segment. Honeywell's process technology segment competes with ITT's Fluid Technology segment.

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4} ITT 10-K 2008 Item 1 "General" p.2
2. ↑ ^{2.0 2.1} The Christian Science Monitor: "Record U.S. Defense Spending, But Future Budgets May Decline" 6 Feb 2008
3. ↑ ^{3.0 3.1} Project on Defense Alternatives: "Is the United States spending too much on defense?"
4. ↑ ITT 10-K 2008 Item 7 "Consolidated Financial Results" p.22
5. ↑ ITT 10-K 2008 Item 7 "Segment Review" p.24
6. ↑ ITT 10-K 2008 Item 7 "Results of Operations" p.22
7. ↑ ^{7.0 7.1} ITT 10-K 2008 Item 7 "Sales and Revenues" p.22
8. ↑ ^{8.0 8.1} Google Finance: ITT Corporation
9. ↑ ^{9.0 9.1} Forbes: ITT Corp. Ratios and Returns
10. ↑ ^{10.0 10.1 10.2 10.3 10.4} "ITT reports strong third quarter earnings of $1.11 per share from continuing operations"
11. ↑ ITT 10-K 2008 "Notes to Consolidated Financial Statements" p.F-38
12. ↑ ^{12.0 12.1} ITT 10-K 2008 Item 7 "Acquisitions" p.30
13. ↑ ITT 10-K 2008 Note 3 "2007 Acquisitions" p.F-12
14. ↑ ITT 10-K 2008 Item 7 "Defense Electronics & Systems" p.21
15. ↑ NATO Transformation Network: "Mission" July 2008
16. ↑ ITT 10-K 2008 Item 7 "Defense Electronics & Systems" p.21
17. ↑ ^{17.0 17.1 17.2} ITT Corporation: About ITT Corporation
18. ↑ ^{18.0 18.1} ITT Corporation: Defense Electronics & Services At a Glance
19. ↑ ITT 10-K 2008 Item 1 "Defense Electronics & Services" p.4
20. ↑ ^{20.0 20.1} ITT 10-K 2008 Item 1 "Defense Electronics & Services" p.5
21. ↑ ^{21.0 21.1 21.2 21.3 21.4 21.5} ITT 10-K 2008 Item 1 "Defense Electronics & Services" p.5
22. ↑ ^{22.0 22.1} ITT Fluid: At a Glance
23. ↑ ITT 10-K 2008 Item 1 "Fluid Technology" p.3
24. ↑ ITT 10-K 2008 Item 1 "Fluid Technology" p.2-3
25. ↑ ^{25.0 25.1 25.2} ITT 10-K 2008 Item 1 "Fluid Technology" p.3
26. ↑ ^{26.0 26.1 26.2} ITT Motion: At a Glance
27. ↑ ITT 10-K 2008 Item 1 "Motion & Flow Control" p.6
28. ↑ ITT 10-K 2008 Item 7 "Motion & Flow Control" p.21
29. ↑ ^{29.0 29.1 29.2 29.3 29.4 29.5} ITT 10-K 2008 Item 1 "Motion & Flow Control" p.7
30. ↑ ITT 10-K 2008 Item 1A "Risk Factors" p.11
31. ↑ ^{31.0 31.1} "Murtha: U.S. Defense Spending Will Dip"
32. ↑ U.S. Water Demand, Supply and Allocation: Trends and Outlook
33. ↑ ^{33.0 33.1} Business Week: Cashing in on China's Demand for Clean Water
34. ↑ ITT 10-K 2008 Item 3 "Environmental" p.12
35. ↑ ITT 10-K 2008 Item 3 "Environmental" p.14
36. ↑ ITT 10-K 2008 Item 3 "Environmental" p.13
37. ↑ ITT 10-K 2008 Item 1 "Environmental Matters" p.9
38. ↑ ITT 10-K 2008 Item 3 "Product Liability and Other Matters" p.14
39. ↑ ITT 10-K 2008 Item 3 "Product Liability and Other Matters" p.15
40. ↑ ^{40.0 40.1} CNNMoney "ITT fined $100 million for illegal exports" 27 March 2007
41. ↑ Fortune Global 500
42. ↑ New York Times, "It's Getting Crowded on the Environmental Bandwagon" 22 Dec. 2005
43. ↑ Siemens Water Technologies: About Us
44. ↑ Reuters: Pentair
45. ↑ TXT 10-K 2007 Item 1, "Bell Segment" p. 1.
46. ↑ TXT 10-K 2007 Item 1, "Industrial Segment" p. 3-4.
47. ↑ EMR 10-K 2007, Item 1:"Process Management" p. 5.
48. ↑ EMR 10-K 2007, Item 1:"Climate Technologies" p. 8.
49. ↑ Google Finance: Flowserve Corporation (FLS)
50. ↑ Reuters Business & Finance: "3M Co"
51. ↑ Google Finance: United Technologies
52. ↑ Google Finance: Honeywell International
53. ↑ Google Finance: General Electric Company
54. ↑ Google Finance: Siemens AG
55. ↑ Google Finance: Pentair
56. ↑ Google Finance: Textron
57. ↑ Google Finance: Emerson Electric Company
58. ↑ Google Finance: Flowserve
59. ↑ Google Finance: 3M Company
60. ↑ Google Finance: United Technologies
61. ↑ Google Finance: Honeywell International