Dover Corporation (DOV) Earnings Call Transcript & Summary

Good. So thanks, everyone, for coming. Next up, we're very excited to have Dover Corporation, Richard Tobin, President and CEO.

Rich, I think you've been CEO of Dover now since 2018, obviously made some changes already. Maybe talk about how comfortable you are with the operating processes of the company. You recently resegmented the business in late 2019, so that's generated some changes. And yes, I'll leave it there.

Sure, Julian. I think, I don't know comfortable is the word, but I am relatively pleased with the progress we've made after the last couple of years. We tested the management team early in 2018 with a relatively large restructuring of the organization post the spin-off of what is now Apergy, and that was successfully accomplished. We put some margin targets out for some of the businesses that were not comping well against the competitive framework of the industries they participate in. We've reached the one on the Fueling Solutions Group. So we exited at the top end of the margin, so we're pleased with the performance there. This is the big year for refrigeration on that side. So we're hopeful that we've got everything in place to meet that particular target in terms of the resegmentation. We did a lot of work in 2018 and the beginning in '19 to get an understanding of the value gap that we thought that Dover had versus some of its multi-industrial peers. And one of the outcomes is that we thought that providing some more clarity of the pieces of the portfolio would help investors to comp the individual pieces versus their peers. It was a bit of a counterculture move, but I think it was the right thing to do. Because at the end of the day, it's how we run the business. We don't run it as a consolidated group. We measure the performance of the individual pieces against the market structure that they participate in. So, so far so good, but it's a multiyear journey.

And when you think about the operating leadership at the company, there's been some major changes around, the segment head layer being removed. How much more change do you think we get in terms of the personnel at the sort of upper echelons and the operating needs?

I don't expect a lot of change other than kind of just the general churn that you have due to seniority. But I think what's important to understand is we did take a pure management layer out of the business when we are moving into this new segment structure. But we've replaced the cost of that management team by reinvesting into digital activities and into a central team for operations. So I would look at it kind of the -- we run Dover, the corporate head, at the same way that we run the operating companies, meaning that you have to efficiently deploy your capital where you think the returns are the highest. And we believe that we didn't need an excess managerial layer. But we needed to fund our aspirations in both digital and on the upside, and that's pretty much what we've done.

When you look at the -- many companies here at this conference have some kind of operating system or business system that's been moved around and evolved over time. How would you characterize what's in place at Dover today? You had the major SG&A out, now cost of goods sold coming out. But is there a broader system you're trying to put in place for once these major discrete programs have run their course?

There are. I'm not a big proponent of branding systems at the end of the day, whether it's 80-20, or a variety of the other ones that are taken up. Because the bottom line is that the businesses are different in terms of their profiles. So overlaying this so-called business system as it applies to everybody is a bit marketing as opposed to the actual nuts and bolts. So as part of standing up the central operating group, we have a variety of targets that are based on the nature of the business that they operate in. So some of them are very much working capital focused, some are very much cost of goods sold focused. But we have service businesses, we have software businesses that just don't apply across the board. So I don't think that we're ever going to brand something, but you can be sure that a lot of the margin accretion that you've seen over the last 2 years has been the result of us putting some more operational rigor across the portfolio.

And you mentioned some of the reinvestment of that management cost into digital aspirations. Maybe give us some examples of where you think that reinvestment is paying off most clearly, or prior investment is paying off most clearly in changing Dover's business?

I could bifurcate the digital investment into 2 pieces, one being kind of a central investment and one being more product oriented. On the central side, a lot of the businesses that we operate are distribution or your semi-catalog businesses, and all of that can be brought on to the web. So a lot of what we're doing in terms of centralizing back-office operations or offshoring it, the way to facilitate that move is to put on a common platform that you can transact with some of our companies. So we've begun -- I think we have got 5 operating companies that are on our central backbone right now. Our expectation is to bring a significant proportion of the portfolio onto that backbone. So the backbone is common, but the user interface is customized to the operating company, that we believe lowers our transaction costs. It allows us to relocate the back-office operations. But more importantly, I think that the data that we get off these systems, in terms of order patterns and SKU management, is really where we're going to get a lot of productivity out of it. The other side of the digital operations are more product related. And that is we have a central team located in Boston that facilitates what we're doing in terms of digitizing pieces of our business. I think that the most successful place that we've done that so far has been in the Environmental Systems Group (sic) [ Environmental Solutions Group ] in terms of digitizing what we offer our waste management haulers, been the fastest-growing portion of that portfolio based on digital ops. So that's the real -- we've kind of run it split between kind of centralized operations and then more product focused.

And if you think about that, resegmentation, as you said, there was one aspect around more transparency on the business. And that increased light may lead to better operating performance. The second aspect is maybe more directed at people in this room around some kind of valuation, revisiting or recalculation of the value of Dover based on the sum-of-the-parts approach. When you focus on the latter aspect, do you think you're getting that credit? Or there's still a big discrepancy?

Clearly, I don't -- well, I mean, it's hard. Look, we've had a good run over the last 18 months or so. So I think the EV-to-EBITDA gap that we have started off with in 2018, we've done a good job of collapsing a lot of that gap. Now how much I can attribute that to earnings expansion versus productivity gains perceived in the future versus portfolio clarity, I'll leave it up to the audience to kind of split it into pieces. But I think it's helpful, at the end of the day, because I don't think having a marking and coding business co-located with truck bodies was overly efficient in terms of, at least, benchmarking the portfolio. And that's not the way that we run the business and benchmark ourselves internally.

And you mentioned refrigeration maybe running behind some of those initial margin aspirations. Help us understand the challenges there. To what extent do you think they're cyclical versus secular? And then versus, I guess, Dover's portfolio itself, what could have been done differently on its positioning? Or what are you changing now on its position to improve it?

It's not running behind per se in terms of what we control, which is the automation investment that we're making this year to significantly reduce the labor content in the assembly operations of the business. So that stands up at mid-year. And we'll see where we get. I mean I think that we've got a good plan, and we believe that we can execute it, but it's up to us to deliver. But we're not backing away from the margin target that we gave back in 2018, which is an exit margin for '20, so this year. So we're on pace to do it. In terms of the portfolio, I think that we gave an indication of the individual pieces in the portfolio over last September on kind of a return on invested capital basis. If we were to reach our margin targets in refrigeration, our return on invested capital clearly improves significantly. And from a cash flow point of view, or return on invested capital point of view, it literally moves into the middle of the pack in terms of the total portfolio, despite the fact that it is margin dilutive to the total business. So I think we'll look at it as a series of steps. In 2018, we had a choice to make, whether just to exit the business at all cost. We believed that we had an opportunity to intervene on that business to improve its profitability. And so our shareholders would be rewarded with that improvement, and that's what 2020 is all about. At the end of 2020, from a return on invested capital point of view, it does provide a cash engine for the balance of the portfolio. So we can keep it in, or if we want to explore other strategies, at least, we're maximizing our returns.

But the time to do that review would be end of this year, early next, when you see the progress relative to the margin go?

When you all see it, as we make progress on our margin journey. So it's not going to be us. We're all going to see it together.

And in terms of the customer spending or the top line aspect of that, some consolidated customers and some nascent ones around the smaller-format stores for refrigeration, where do you think we are along that customer spending cycle? And how comfortable -- aside from the margin goal in 10 months' time, how comfortable do you feel with longer-term industry growth dynamics?

Well, I mean, you can see what our forecasts are for this year. I think we're being relatively prudent in terms of what we think that where we are in the demand cycle. And our margin targets and our business sizing do not incorporate some significant increase in the demand of the cycle because we believe that the build-out of the infrastructure for food retail is largely done. Now small format is growing significantly, but large format has been relatively stuck as we -- as they figure out what's happening to the marketplace in terms of delivery services and a variety of other things. So we're not betting on the return of a significant step-up in greenfield investment in terms of food retail going forward from here. But we believe that we have got a significantly large installed base. So it's largely driven by a replacement market, and that's what we've sized our structure and our margin targets to accommodate.

And in terms of just the growth, longer term, I guess, will be driven mostly by replacement. And you think that's reasonably attractive?

I mean if it grows 2% to 3%, and we can -- and then we can get and realize our margin targets, then the returns that we've modeled like that are quite good, and its cash flow is significant. So that's -- would we expand off of that and reinvest in capacity expansion? Highly doubtful.

Looking more broadly at Dover. There's been, now and again, the last several years, some manufacturing inefficiencies that tend to crop up, yes, some in fluids, not too long ago. How do you assess the state of the degree of automation, the degree of planned productivity across the company right now?

Well, I mean, that's -- there's a question of what we think about the capital asset base, and then there's a question of how do I feel about our ability to execute. So let's deal with the ability to execute. I feel better about it. I think that we made a significant amount of changes in terms of the operations personnel, and I already mentioned that we've basically stood up some central resources to allow these smaller companies to be more efficient in terms of facility and footprint consolidations and the like. So I feel better today sitting here than I did back in May of 2018 at the end of the day. So do we do -- do I expect anything into the future? No, right? At the end of the day, if you were getting the benefit of some footprint consolidation rolling into 2020, so that's part of the $50 million in terms of target savings that we've come out with for this particular year. Would I expect to grind those type of savings out year-over-year? Yes, that's our expectation.

And since you became CEO, you had gross savings on SG&A, $130 million-something, $50 million net costs out this year that you just referenced. Yes, that's a lot done in just over 2 years. When you look around Dover with the existing portfolio, do you see a lot of runway left for further cost out medium term? Or is it more about incremental margins in that 30-something range?

Yes. I mean, look, at the end of the day, the -- either the SG&A takeout as a one-trick pony, and after that, you've got to grind it out over time. But there's -- other than the sum-of-parts valuation, the rationale for resegmenting it was from an operating point of view, probably more than from an external point of view. And the operating point of view is you get those business in a collection of common nodes. I think that capital deployment and capacity utilization should improve over time because the amount of intercompany elimination in Dover is next to 0. Meaning that, despite the fact that we have got a lot of common businesses that do a lot of common practices, historically, none of them did it for each other. They were all run as standard businesses. And I think that there's a lot to be had by gathering them into kind of common types of businesses, where, where they may be heavy on machining, that there should be a lot more of asset base utilization should -- which should manifest itself in better use of capital deployment going forward, which should roll into margins if we do it effectively.

And assuming that the manufacturing base is upscaled with that higher CapEx that you're putting in right now, what type of operating leverage through cycle, if you like, do you think people should expect at Dover?