Illinois Tool Works' Q3 2025: Contradictions Emerge on Construction Margins, China Automotive Growth, and Tariff Pricing Strategy

Date of Call: None provided

Financials Results

• Revenue: Total revenue increased >2% in Q3; management stated revenue increased 3% excluding a 1% reduction from strategic PLS (organic growth +1%; favorable FX +2%)
• EPS: GAAP EPS $2.81 per share, up 6% (excluding a prior-year divestiture gain); effective tax rate 21.8% in Q3
• Operating Margin: 27.4%, improved 90 basis points year-over-year; operating income grew 6% to $1.1B

Guidance:

• Organic growth for full-year 2025 expected 0–2%
• Total revenue projected up 1–3% (reflecting current FX)
• Operating margin guidance maintained at 26–27%
• GAAP EPS range narrowed to $10.40–$10.50 (midpoint $10.45)
• Enterprise initiatives expected to contribute ~125 bps to full-year operating margin
• Tariff-related pricing and supply-chain actions expected to more than offset tariff costs
• Full-year tax rate projected at ~23%; Q4 tax rate normalized

Business Commentary:

* Revenue Growth and International Performance: - ITW reported a 3% increase in revenue for Q3, excluding a 1% reduction related to strategic product line simplification efforts. Organic growth was 1%. - Growth was driven by favorable foreign currency translation, contributing 2% to revenue, and strong performance in Asia Pacific, particularly in China with a 7% increase.

• Operational and Financial Excellence:
• ITW achieved record operating income of 1.1 billion, a 6% increase, and improved operating margin by 90 basis points to 27.4%.

• This was supported by enterprise initiatives contributing 140 basis points and effective pricing and supply chain actions more than covering tariff costs.

• Automotive and Construction Segments:

• The automotive OEM segment led with a 7% revenue increase and a 5% organic growth, driven by a 10% growth in China.

• In construction products, the company reported organic revenue declines for the 11th consecutive quarter, yet improved operating margin by 140 basis points to 31.6%.

• Guidance for Full Year 2025:

• ITW narrowed its EPS guidance range to a new range of $10.40 to $10.50, reflecting underlying demand levels and current foreign exchange rates.
• The guidance incorporates a lower projected tax rate of approximately 23% and anticipates that tariff-related pricing and supply chain actions will positively impact both EPS and margins.

Sentiment Analysis:

Overall Tone: Positive

• Management highlighted GAAP EPS of $2.81, operating income up 6% to a record $1.1B, and operating margin improvement of 90 bps to 27.4%. They reiterated confidence in execution, narrowed EPS guidance to $10.40–$10.50, and emphasized enterprise initiatives and customer-backed innovation as drivers of continued margin and growth gains.

Q&A:

• Question from Jeff Sprague (Vertical Research): Construction margins have risen despite 11 quarters of organic declines; what’s driving margin improvement and can margins move higher? Also, you noted visibility on test & measurement improving in Q4—what are you seeing?
  Response: Construction margins reflect operating in the most attractive market segments and disciplined execution; management is confident margins will expand when markets recover. Test & measurement is expected to see a cyclical improvement in Q4 as CapEx and semi demand normalize after tariff-related disruption.

• Question from Andy Kaplowicz (Citi Group): You didn’t change organic growth guide—Q4 needs an uptick; is Q4 improvement driven by pricing or specific businesses? And can auto margins push to low‑mid 20s?
  Response: Q4 should see a modest sequential revenue uptick (~+1 point) led by test & measurement; pricing and other puts/takes are embedded, and management expects auto to achieve low‑to‑mid‑20% operating margins by 2026 driven by enterprise initiatives and customer-backed innovation.

• Question from Jamie Cook (Truist Securities): With FX and lower tax benefits, why is guidance not stronger and what FX/tax assumptions are embedded?
  Response: Management kept guidance measured due to choppy demand; guidance uses current FX rates (Q3 FX benefit ~$0.04) and embeds a lower full‑year tax rate of ~23%, while remaining cautious given near‑term demand volatility.

• Question from Tami Zakaria (JPMorgan): Does onshoring auto production create a net opportunity for ITW? And will the ~1% PLS impact persist?
  Response: Onshoring offers limited net benefit because ITW already produces where customers are; PLS is a bottom‑up, ongoing 80/20 activity that creates value—timing and magnitude are decided by divisions and will continue as part of portfolio discipline.

• Question from Joe Ritchie (Goldman Sachs): Early thoughts on 2026 — growth, margins, and capital allocation/leveraging for M&A?
  Response: While formal 2026 guidance awaits November planning, management expects above‑market organic growth, continued margin improvement and strong incremental margins; balance sheet sits near ~2x EBITDA target, enabling the $1.5B buyback and leaving capacity for attractive M&A.

• Question from Stephen Volkmann (analyst): Are suppliers raising prices and can you fully cover cost increases? Also, what’s driving China strength?
  Response: Tariff‑related cost increases this year were largely offset by pricing and supply‑chain actions (price‑cost was positive in Q3); management is confident it can manage future cost pressures. China strength is driven by EV penetration and customer‑backed innovation, increasing content per vehicle.

• Question from Julian Mitchell (Barclays): How should we think about margin drivers for next year—enterprise initiatives, price/cost, restructuring—and the interaction of CBI vs PLS?
  Response: Enterprise initiatives are the primary margin engine and should continue to outpace price/cost effects; CBI contribution is growing (~2.3–2.5% this year, targeting 3%+ by 2030) while PLS is independent and typically a smaller, maintenance‑level headwind, so net spread should widen.

• Question from Joe O'Dea (Wells Fargo): Tariff math suggested larger pricing earlier—has this eased and what will unlock better demand?
  Response: Tariff impact has been mitigated via pricing and supply‑chain actions and is no longer the main event; a demand unlock depends on cyclical recovery in end markets (e.g., construction, test & measurement) where ITW expects to outperform when cycles turn.

• Question from Nigel Coe (Wolfe Research): The quarter had a strong start then slowed—any unusual customer behavior around tariffs? Also, did restructuring benefits fully show in Q3? And why is welding equipment up while consumables lag?
  Response: Quarter cadence was choppy (strong June/July, slower August, normal September) with some tariff‑related order hesitation; restructuring refers to recurring 80/20 projects (not a one‑off program) with quick paybacks and steady spend. Welding equipment growth is CBI‑driven and industrial‑led, while consumables lag due to more discretionary end‑market exposure.

• Question from Avi Yaroslavovich (UBS): Why leave the revenue range unchanged while narrowing EPS and trending to the lower end—where could upside come from?
  Response: Management narrowed EPS but kept revenue range due to one quarter remaining and choppy demand; Q4 revenue is expected to be ~+1 point vs Q3 led by test & measurement, and upside would come from stronger-than-expected demand or FX moves.

• Question from Mick Dobre (Baird): How reliant are improved incrementals on PLS and could you throttle back PLS to favor organic growth?
  Response: PLS is an integral element of 80/20 but not the sole driver of higher incrementals—portfolio quality, CBI and operating model execution also drive incrementals; PLS varies by segment and cannot be simply turned off without sacrificing long‑term discipline.

Contradiction Point 1

Construction Segment Margins and Growth

It highlights differing perspectives on the construction segment's margin performance and growth expectations, which are crucial for understanding the company's financial health and market positioning.

Given organic revenue delays but rising margins, is there more beyond routine operational factors, and what confidence exists in further margin expansion as revenue growth resumes? - Jeff Sprague(Vertical Research)

2025Q3: The construction margins are driven by the quality of the portfolio, focusing on the most attractive market segments. We are positioned well for future growth when markets recover. - Chris O’Herlihy(CEO)

Can you explain the construction segment's 140-basis-point margin improvement despite a 6% revenue decline? - Stephen Volkmann(Barclays)

2025Q2: The improvement is driven by enterprise initiatives, which were above company average. Our construction business has maintained strong margins in tough end markets due to a focus on the most attractive parts of the market. - Michael Larsen(CFO)

Contradiction Point 2

China Automotive Market Growth

It involves differing statements about the company's growth in the China automotive market, which is a significant focus area for strategic expansion.

What's driving growth in China's automotive sector? - Stephen Volkmann(Barclays)

2025Q3: Growth in China is driven by automotive, particularly in EVs. Significant market share gains and customer-backed innovation are contributing to increased content per vehicle. - Chris O’Herlihy(CEO)

How does your growth in China's automotive sector compare to peers? - Andrew Kaplowitz(Citigroup)

2025Q2: Our growth in China is sustained due to differentiated business models, strong patent protection, long customer partnerships, and experienced leadership. The focus on sustainable differentiation supports our future growth in China. - Chris O’Herlihy(CEO)

Contradiction Point 3

Effect of Tariffs and Pricing Strategy

It involves differing statements on the effectiveness and strategy to manage tariff impacts through pricing, which impacts financial performance and investor expectations.

Are suppliers raising prices due to rising costs? How are you offsetting these? - Stephen Volkmann(Barclays)

2025Q3: Tariffs are largely offset by pricing and supply chain actions. We are back to a normal pricing environment, with confidence in managing future cost increases. - Michael Larsen(CFO)

What are your pricing expectations for this year compared to 2025, and how are you addressing inflationary pressures? - Unidentified Analyst

2025Q1: Our strategy is to offset tariffs with appropriate pricing, leveraging our high-levels of differentiation across businesses. We expect the price cost impacts with tariffs to be EPS neutral or better. - Christopher A. O’Herlihy(CEO)

Contradiction Point 4

Market Demand and Growth Strategy

It involves differing perspectives on the company's approach to managing short-term market demand fluctuations and long-term growth strategy.

Tariffs initially drove higher pricing, but now appear less impactful. What is driving the recovery now? - Joe O’Dea(Wells Fargo)

2025Q3: The current demand issues are temporary, and we are well-positioned in our markets for recovery. - Chris O’Herlihy(CEO)

What contingency plans are you considering for a significant slowdown in demand in 2025? - Unidentified Analyst

2025Q1: Our posture in a short-term recession would be to stay invested in growth initiatives and execute at a high level. We have a flexible cost structure, and we're a long-term focused company with the financial resources to support this. - Christopher A. O’Herlihy(CEO)

Contradiction Point 5

Tax Rate and Financial Guidance

It involves different expectations regarding tax rates and their impact on financial guidance, which are critical for investor projections.

Considering FX and tax rate benefits, why hasn’t the guidance range been updated, and how do you reconcile the puts and takes? - Jamie Cook(Truist Securities)

2025Q3: The tax rate is more neutralized by trending towards the lower end of revenue guidance. - Michael Larsen(CFO)

When do you expect the price cost to be most favorable this year? - Abi Yorosilowicz

2025Q1: We maintain an effective tax rate guidance of 22% to 23% for the full year of 2025. - Michael M. Larsen(CFO)