Dover Corporation (DOV) Earnings Call Transcript & Summary

Good morning and welcome to day 2 of Morgan Stanley's Laguna Conference. I'm Joshua Pokrzywinski, the firm's U.S. multi-industry analyst. With me this morning is Dover Chairman and CEO, Rich Tobin. Just before we get started, I need to read a quick disclaimer. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you're a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Rich, welcome. Always a pleasure. Appreciate you taking the time this morning.

I'm glad to be here, Josh.

If you wouldn't just mind, I know you had the Biopharma Analyst Day on Monday, which we were talking about before we kicked off, kind of an interesting format and a good highlight on the business. But maybe just zooming out, what you're seeing at the Dover level, what you're focused on, and any kind of near-term trends that we should be aware about there in the marketplace?

Sure. I'd be happy to. And thanks for letting us lead off the day here. We like to get up early to start the day, so let's kick it off. As we talked about at the -- at our conference the other day, demand conditions are improving across the wider portfolio, but they're not back to normal, per se. Our order trends are continuing in an upward trajectory relative to the second quarter. If you remember at the end of the second quarter, we said that June was a very important month to Dover because that was going to be a proxy for what we had embedded in our forecast for Q3. And we're actually at a pace that's better than June right now. So based on our order books and based on the quarter-to-date trajectory that we're on, we are feeling quite confident about the full year guidance that we've given. So we are on track to -- and trending towards the upper end of that guidance. We'll give more color around that when we close Q3. So that really helps us out for any doubt or dislocation that could happen in Q4. We're going to go into the quarter with a bit of a buffer as it relates to what we had embedded in our forecast. So election, turmoil aside, I think that we're in pretty good shape. Trends continue to vary by market, so our longer-cycle businesses continue to perform as expected. So a lot of what we had embedded in our forecast was to turn a lot of that backlog that we had carried into the first half of the year, was to commercialize it, and we're in pretty good shape there. We've got robust activity in above-ground retail fueling, heat exchangers, can-making, biopharma that we highlighted earlier this week and constructor trading conditions in marking and coding, food retail and vehicle aftermarket. So margin management remains robust. And we expect to close the year favorably to our targets for decremental margins.

That's great. And then I guess just on the markets themselves, I mean I think a lot of Dover's businesses, as much as they fit into the broader economy, are not really like an IP-sensitive market. They're a little nichier than that. Is that how you would describe kind of what's working? Is that some of these nichier markets are just kind of getting back to business versus really seeing evidence of a strong recovery yet in the portfolio?

I think that's fair. I mean we have certain end markets that are particularly strong for some reasons, like retail fueling, and then we've got a couple of markets where their end exposures are particularly difficult, like digital textile printing and food equipment. So on average, though, I think that we are a component supplier. We don't see a lot of like stocking going on through our distribution network. It's -- we're pretty much -- our numbers are a reflection of kind of the constant uptick in demand after bottoming in Q2.

Got it. And then on the margin side, you said coming in favorably relative to the decremental targets. How should we think about temporary cost add-backs and kind of a target or incremental margin on the way out? Can that still kind of hit what you would consider to be those normal levels in the 20s and 30s as demand recovers?

Yes. I mean that's the expectation here. I think that there's a question that everybody is going to try to solve between now and the end of the year is there's been a lot of temporary costs out, especially around T&E and things like that, that everybody in the industry has taken down because of the COVID pandemic and everything else. The question is, what happens in a more proactive demand environment? And I don't think we're ready to size it yet, but the bottom line is, our expectation is, is that our SG&A does not come back to 2019 levels no matter what happens in terms of the demand environment. So there's going to be a roll-forward benefit of SG&A. But having said that, I mean we're going to have to build up bonus accruals and a variety of other things, so I don't think you can hold the pace beyond this year. Our intention is, like every other year, that we would like to have cost takeout, either permanent cost takeout or productivity-based, that neutralizes inflationary input costs, so on raw materials and labor, thus that each individual business will convert as close to gross margin mix aside as possible. So our expectation that our incremental margins next year, assuming that the demand environment is better, would be reflective of that.

Got it. And then I guess just on maybe one specific productivity initiative that's gotten a lot of attention, the automation project in refrigeration. I think this just kicked off in July. How has that gone so far? And just as the market has evolved over the last couple of quarters, any scope changes or investment criteria changes in that business?

We are a bit behind because, as you can imagine, getting contractor access for a big project like that was difficult in the first half of the year. But we are going into production as we sit here today, so we're getting beta units off and everything else. So that will sequentially ramp between now and the end of the year, but the bottom line is, I mean I think we gave some color about the fact that we expected that particular business to have better margin performance relative to the second half of 2019. And as part of that estimate, there wasn't a huge benefit from the automation, quite frankly, because we knew we'd have some start-up-related costs, we're on pace to deliver our expectation there.

Got it. So more of a 20/20/20 -- I'm sorry, 2021 phenomenon regardless?

Yes, regardless.

And then I guess just taking a step-back on some of the broader initiatives that you've had over the past couple of years. I mean I guess most of the savings, and correct me if this is a mischaracterization, appear to be removing layers of cost and better centralizing G&A across some of the portfolios. You mentioned having a lot of sales force accounts I think a couple of years ago. One area that I haven't heard as much about is on the supply chain. Is that still an opportunity? Does it run fairly well? Is it just not as big of a cost-burden on the company? How does that factor?

Look, I think that supply chain has been run relatively well in Dover for some time. So when we're talking about commodity group buying and centralization, that's been done before. A lot of what we're working on is SKU management. So product complexity in terms of the amount of SKUs that each of the businesses sell. And part of the reason that we're spending so much time and money on digitizing the front end is that's a way that you get the data to allow to do SKU-management rationalization to do dynamic pricing and a variety of other things. So our expectation is less on supply chain, kind of the traditional "let's aggregate all of the steel purchases across Dover and try to leverage that benefit." It's more a matter of, by digitizing the front end, can we mine the data that allows us to be more efficient in managing a number of SKUs so it's complexity-reduction, which also has a knock-on effect and better working capital management.

Which I think the complexity reduction was something you called out as being a particularly big opportunity in refrigeration. Is that right?

That is correct, and that's part and parcel to this issue of, if you're going to take something that was a very manual process and automate it, by its nature, you have to reduce the number of SKUs just because of the fact that you're running a continuous process.

And I guess, looking across the portfolio, what we can see in segment margins, it doesn't look like there are a lot of other areas that are quite as ripe as refrigeration was. But there -- is there another area that we should look at and say, "Gosh, there's a lot of custom work where it's hard to get a return on that or something analogous to the phenomenon that you had in refrigeration?

Well, I mean I think it's part and parcel to the reason that we did at Investor Day this week, highlighting smaller pieces or smaller platforms within the portfolio. So let's talk about a different one for a moment. If we look at printing and ID, for example, the margin performance in printing and ID year-to-date this year has been excellent because the bigger portion of that business, which is the more of the traditional market, and much of the business has done a fantastic job in terms of rationalizing their cost, which has driven the margins up. And so despite the fact that our digital printing business has suffered greatly in '20, and will probably continue to do so between now and the end of the year, the incremental margin, if we get some amount of snapback on the textile side, should be significant, both the margin and in terms of the absolute profit. So there's plenty of opportunity because we've -- not every segment has flown through this COVID-related problem that we had, for lack of better words. So we've got a lot of operating companies that have potential upside going into '21. And think about automotive aftermarket, I mean just got killed in the second quarter with the shutdowns and the fact that we are levered towards Italian production. We are really feeling good at the trajectory that we'll exit this year and what we can expect next year.

And I guess, just on that same line of thinking, the Biopharma Analyst Day, I think for folks who aren't as close to the business, biopharma and Dover are classic word association. But there are some real gems in the portfolio. I think that business is $300 million, give or take. If you had to call out some other kind of similarly well-positioned businesses that maybe fall below the water line in terms of people's awareness, how big is that? And maybe talk about a couple of the examples that are maybe particularly overlooked.

Well, I don't think that our digital -- taking '20 out of the equation for a moment, I don't think that our digital textile printing is well understood, for example. And I think that, that's an area that we would highlight. And believe it or not, I don't think that our waste management business, our environmental services group, is well understood either. That is not -- I think that, that is looked at externally. When people look at our ESP business, it's material to the portfolio. And you got to go out there and look at comps that are out there, and the comps -- or publicly traded comps in that business are vertically integrated industrial companies. And I would argue that our business has transformed itself substantially, that it shouldn't be looked at as we're not just purely a metal-bender down there making compact as there's a significant portion of that portfolio that is reoccurring in nature and productivity and software-related. So I could wax poetic for a while, but I can tell you that based on the feedback that we've got from doing a more concentrated look at sub-platforms as an Investor Day rather than tour de force of the entire portfolio, we're going to keep that up. So we've already -- we'll be scheduling one to happen in the fourth quarter of this year and then I would expect we'd have that same kind of cadence going into next year.