Dover Corporation (DOV) Earnings Call Transcript & Summary

Hi, everyone. Next up, we're excited to have Dover's President and CEO, Rich Tobin. Rich, I know that you have a few prepared comments to kick us off, so I'll turn it over to you, and then we'll get into the Q&A.

Here you go.

All right. So Rich, I'm not sure if you heard my segue over to you, but we're excited to have Rich Tobin, President and CEO of Dover. I know you've got some prepared comments. So I'm going to turn it over to you, and then we'll go from there.

Thanks, Joe. I hope you can see the slides. My opening comments will be brief. So why don't you move forward to Slide 3, please, whoever has got control of the deck. There we go. Look, Q1 was a good quarter overall. I won't read all the bullet points here. I think the important ones are clearly on the top line growth. But more importantly, how we converted that growth into margin expansion at 310 basis points for the quarter. That has been driven by margin mix and structural cost takeout from prior periods rolling over into '21. Free cash flow was better than we would have expected, and that's just the velocity of the inventory turning over so a little bit of a different seasonality in the portfolio than we generally tend to build inventory in Q1, but we were shipping it out the door as fast as we were bringing it in. So the velocity of this was the free cash flow numbers look comparatively some pretty heady figures there at 309%. I think probably at this stage now that April is closed and we're a week into May is exiting Q1, if you look at the top right-hand side of the screen, our backlog is up 39% year-over-year, which portends well for meeting our updated guidance numbers, which are down in the quarter, which I'm sure Joe is going to ask questions about going forward. I'm not going to read all these. These are for anybody else's reference, but it's the repeat of the slide on the business trends and the outlook across the 5 segments of the portfolio, with very few exceptions. Most of the companies in the portfolio are growing well at good accretive margin performance. More one more slide. Again, briefly, what we've done based on the backlog performance in Q1 and the backlogs that we carry into the balance of the year, we have changed our full year guidance to double-digit top line growth for the year, and you can see what that translates into EPS and accretion. I'm sure we'll pick that apart in terms of incremental margin and the like and what segments are driving it. And then finally, my last slide, which is probably the most important messaging slide that we could put out there is, is that we've been trying to convince the capital markets that the portfolio is different here at Dover than it maybe had been historically in the past. We're incredibly proud of the performance in '20, which we were able to hold on to our top line I think better than most, and I think the way that, more importantly, we increased margins in '20 despite having the revenue decline. So there we see a lot of reports out there that go back 20 years and look at the cyclicality of the portfolio and a variety of other things. We're just trying to make the argument that, that historical data is probably less relevant, more useful, quite frankly. So we prepare -- so we tend to look at it this way with the portfolio that we have today and what our aspirations are in terms of the performance of the portfolio, and you can see from the adjusted earnings per share trajectory that we've had here since 2018, that is a combination of managing the portfolio and underappreciated top line opportunity and structural cost takeout that we've been executing for the last 3-plus years. So those are my opening comments. And go to the Q&A. Joe?

Yes. Thanks, Rich. And brief, as always. But maybe just starting off on that last comment, right? You talked about the portfolio. We've had this conversation before around like how underappreciated your portfolio is and the mid- single-digit growth that you've put up over the past decade across most of your businesses. I think -- why do you think that is? And how do you think that portfolio is going to perform coming out of this cyclical downturn that we saw due to the pandemic?

I can only speculate that it is, is because you have to deal with history. I think it is -- as a multi-industrial, it's a difficult portfolio to understand. We touch a variety of different end markets with a variety of different competitive sets. So it's a combination of 2 that we are dragging around history. We're dragging around the history of the electronics exposure, the oil and gas exposure, which tended to wag the dog to a certain extent, both up and down. And I think that, again, that it is a complex portfolio. I think that we've tried to make it clear to investors when we went and resegmented a couple years ago in terms of the individual pieces. But the bottom line is, despite clocking at mid-single-digit top line growth, when we look at the outer years, we don't get that modeled in to our price. So I guess we're just going to have to continue to take that track record that I showed you on that last slide and continue to execute. And then I think at some point, we'll probably get the credit for it.

So as you think about the go-forward, right, and when we caught up in March, I think you were pretty adamant that myself and other sellside analysts were mismodeling the growth opportunity for the portfolio. Given what you were seeing in your end market today, I don't know how you expect it to recover. So maybe how do you expect this recovery to look like then across the portfolio and broader?

Look, as I mentioned, and I'm sure we're getting the questions about the individual business, the vast majority of our portfolio, as you would expect in an upturn, is doing quite well. So in discussing the performance with the management team now, they really have 2 things to manage, which is unlike in a kind of a non-upturn year. The demand is there, you can see it in our backlog. So it's purely a question of execution. Let's get the product out the door, and let's keep a close eye on input cost and price and manage that issue over the next 8 months or so, which is great news because I think that we have developed the muscle to do that. I think our performance over the last couple years has shown when we have top line growth that our conversion is healthy. I don't believe that consolidated conversion is a relative -- is an important number for Dover. Look, it comes out in the math at the end of the day, but we don't operate the business that way. We operate the business by individual business or at least the segment. So we've got some expectations for accretion based on the different mix within the portfolio. So we don't measure them all equally at the end of the day. And because we've got such a robust backlog, and because we can synthesize the instructions that we give to our businesses now, it's freed up a lot of time for the executive management and some of the bigger operating groups that we have to start working on '22 now, right? So we're not chasing revenue. We're going to be -- I think that we're going to have the backlog that we need to meet our top line aspirations. And I think that we've been rewarded with kind of good execution going into this, that we've got plenty of time to work on a variety of different projects that kind of rolls the ball forward in terms of margin accretion in '22 and '23. So look, I'm happy about the market conditions. The demand's there because, out of the 3 legs of the stool of what needs to be managed, 1 of them we have, and we've got the demand, and that's great.

Yes. No, that's great to hear. And you guys called out the $2.2 billion in backlog that I think it was almost a 40% increase year-over-year. I'm curious, I know it doesn't seem like that long, but you were one of the first multis that reported about 3 weeks ago. And in this environment, it feels like a lot can happen in 3 weeks. Just any update that you'd like to kind of give us on the margin on demand trends? Maybe we'll just start with demand trends first, and then I'll ask the follow-ons.

Yes, when you get to go first, you get to get in the newspaper, too, I found out, so I'm going to have to make guarded comments, I guess, or maybe move back in line for Q2, we'll see. But look, any of the comments that I made in the opening, I can tell you that nothing has dramatically changed. We've closed April already. We're already at the -- now we've only, believe it or not, got 7 weeks to go before we're doing this all over again. Our backlogs remain healthy. So everything that good was happening when we closed the quarter has continued, and everything that we've been concerned about has continued. So backlogs are good across the vast majority of the portfolio. We are booking in certain businesses into Q4 now, which is terrific because it helps us manage basically the execution. But the warning signs are still there in terms of what we need to manage. So logistic costs and constraints continue to be a challenge. Raw material prices continue to be a challenge. I think that we're managing them well. I stand by the comments that we made at the end of Q1 that price cost should be neutral, and that's -- that is under an estimate that raw materials do not come down in Q4. That's our view right now, which is unlike the view of the Fed, apparently. So I mean, we're managing well. Backlog and revenue solves a lot of problems. And as long as we can keep on that trajectory, I think that we are on the front foot on pricing. What remains to be seen, what net pricing looks like because that's a trailing figure, and a lot of that is held -- is in inventory and coming through the system. But based on the signs that we can see right now, we're in good shape.

Yes. That's helpful. And I know you guys have managed both the supply chain issues, price cost issues, I mean, very well so far. So like you said, we're halfway through the quarter. For this quarter specifically, I mean, is there any increased headwinds that we should expect at least for 2Q? Or do you feel like it's very manageable just based on what you're seeing today?

I think that there's an overestimation of the market, and this is not a Dover comment solely, about incremental margins in Q2. Everybody knows that the comps -- the numbers that are going to come out are going to be incredibly messy. We're going to see growth rates in certain portions of the business that are reflective of the fact that we basically had to shut down certain businesses in Q2 last year. So we're going to see those numbers, and our numbers are going to look great because everybody's numbers are going to look great on a comp basis. But I think that there's this -- that the issue that, I think, needs to be understood, is everybody is looking at incremental margins in Q1 and then taking the same incremental margins and taking that same revenue growth and say, well, you know what, they're easy to expand further. Then we need to be careful about that because there was a lot of support given to the industrial sector in Q2 last year with legislation about recognizing labor costs and layoffs and a variety of other things both in North America and Europe. So decremental margins in Q2, if you go back and look, weren't as dire as they should have been when you looked at the top [indiscernible]. So Q2 is just going to be reflective of that. And I'm not talking down Dover's incremental margin or backing off anything here. I'm just saying that I think that just we need to be a little bit careful about Q2 in terms of the pretty messy top line numbers and extrapolating that into earnings forecasts. But look -- but ours, as you know, we'll take a look at our full year guidance at the end of Q2. But right now, we're tracking where we thought we'd be when we increased guidance seemingly 3 weeks ago.

Yes. And in the context of all of that, just for the folks that are listening that aren't as aware, you also stated that 2Q EPS should sequentially be better than 1Q. Correct?

Yes.

Okay. Just putting all that into context. Okay. No, great. Talking about some of your businesses. I think your point in the beginning, it's funny that you bring up [ Comtech ] and oil and gas. I just haven't thought about those businesses for you guys in a long time, but I'm sure that is probably part of it. But if you think about like the rest of the portfolio, it is pretty complex, right? There are pieces of your short-cycle businesses. You've got some long-cycle businesses. I guess, maybe let's talk about both. Let's try to bifurcate both and seeing -- what are you seeing on the longer-cycle pieces of your businesses like the Belvac components of the world? And then also, when we get through that, I'd like to hear on the early cycle industrial indicators, what you're seeing specifically there, too?

Well, we don't have a lot of long-cycle exposure. At the end of the day, Belvac, be very popular within the portfolio all of a sudden, but at the end of the day -- and that's why we separated the backlog out of that particular segment because there was a lot of confusion, I think, in terms of what part of that is Belvac and what part is kind of retail refrigeration. So if you go back and look at our Q1 disclosures in term of backlog, now you can tell what's happening there. And look, it's a good story overall. So Belvac is booking into '22 at this point because we think that there's structural tailwinds on aluminum cans. And so you can go take a look at any of the publicly traded can manufacturers, the amount of CapEx that's been announced, and it's a multiyear cycle that goes out into '23 and '24. We are just a beneficiary of that. So that's a long-cycle business that's following a structural change in the marketplace with this transition between plastic and aluminum because of ESG and recyclability. The other longer cycle business that we have is Maag, which is in Pumps & Process Solutions, which again just builds up backlog over time, and then it gets bled down over. I mean, so overall, we like the fact that we've got a combination of both because you're not -- you're not trading with short cycling. You're not trading with long cycle. You get a good balance between the 2. And as long as they're both successful in the marketplace, you can kind of mine out the more volatile trends, whether they're long-cycle or short-cycle trends. On the short-cycle side, it's just a matter of economic activity. So economic activity around the world post-pandemic is accelerating. If you see that, that's what's driving commodity prices up and causing all these issues, logistics costs and constraints and everything else. And so we're just a beneficiary on the broader portfolio on that. We've got a couple businesses that are still behind so digital printing and the textile. That marketplace is still kind of in recovery mode, to a certain extent. Food equipment is still in recovery mode and is beginning to get better, but it's coming out of it. But if I anticipate the majority of the portfolio, it's all benefiting from kind of economic activity in total.

Yes. You mentioned, I guess, in our pre- getting on this publicly webcast conversation, we talked a little bit about the fact that you've just been in Oklahoma, right, to see the Tulsa winch business. I think of that business as being kind of like one of your tip-of-the-spear type businesses. Maybe I'm wrong in thinking that. But like, I guess, like any -- on the early cycle indicators that you see across industrials, are you starting to see a pickup in North America? Because that's one area that we've seen across the multi-industry group that you hadn't really seen much of a pickup really in the first quarter results. And so just any thoughts around that?

Yes, I would put TWG into long cycle rather than short cycle because -- let's compare and contrast a little bit. I mean, in Pumps & Process Solutions on the industrial pump side, it's more of a short-cycle business because it's CapEx related, and it's got a distribution inventory cycle care associated with it, meaning, under economic uncertainty, the end user cuts CapEx, which makes the distribution deplete inventory and then the market comes down. And when it reaccelerates, the end user comes back, and then the distribution prepares based on that trajectory, stocking levels, so you actually get a compounding effect under that type of business model. TWG, because it's far more of an OEM business, is an indicator of kind of the restart of longer-cycle business, so crane manufacturing, bulldozers, those types of things. That's where that market ends up. Now that's a much longer transition because you're starting a far bigger engine just to get supply chains moving and everything else. So that tends to be a little bit of a longer-cycle business. So conversations we were having at that business yesterday was, it's up to you to call the cycle to a certain extent. And do we lay in inventory now because we think it's inflecting. And what are the signals you're getting from the OEMs. On the other side of the business, because you've got end-user demand and distributor demand, you're just basically capturing all of the funnel that you can. And it's a question of, can you operate to grab market share or not?

That makes a ton of sense. Maybe switching gears, and we'll get into some of the segments specifically in a minute. But just switching gears to the margin opportunity. Rich, since you joined, you've done a great job of really improving the profitability across the portfolio. So kudos on the work that's been done already. Constantly get the question from investors like what's left. And I know you've highlighted several different areas where you think that there is opportunity. Just how are you guys thinking about it internally and what the entitlement is across the portfolio?

Yes. We have some centrally led pillars that we believe will allow us to take structural costs out over a multiyear period from here. I think this view that there was a lot of low-hanging fruit and they mopped it up, and now it's done, I think, is not true. And I think even during the pandemic, we had a net $70 million plus of structural cost takeout despite all the other things that we are working on at the time. I think I'll go back to my comments before about when we have backlog. In a strange way, running the business is actually easier because you're not trying to find revenue. All you're really is moving into execution, and now that allows our management teams to work on these projects to continue to become more efficient into future years. So I'm absolutely confident that we've always put a line in the sand of $50 million of structural cost takeout. I think that, that's doable over a multiyear period. But if you go and take a look at our Q1 results, look sure, you get margin accretion because of top line and absorption. But the vast majority of that is margin mix. So the unknown, the untold story, I thought we tried yesterday by doing -- yesterday, last year by doing specific presentations on portions of the business line is, it's not just a volume play. So our margins expand when the volumes go up, and we take some structural cost takeout. We've been -- the management teams here have been working very hard in terms of mix enhancement on the product lines. And if you look at Pumps & Process Solutions, that is in a quarter, which I think surprised everybody. That's not just a top line phenomenon. That is a mix phenomenon. And I think that we can continue to do that across a lot of pieces of the portfolio.

So just to kind of restate what you just said, it sounds to me like there is $50 million or so in structural. There's mix improvement that's occurring with the portfolio and then whatever volumes do, you're going to lever on that?

Yes.

Okay.

You said it brilliantly.

Just summarizing you.

Yes.

All right. So I won't hold you to a target, but that gives us a good framework going forward. You mentioned Pumps & Process...

We're going to get to 20% and based on our performance this year, we're probably going to get to 20% earlier than we had modeled back when we did the resegmentation in 2019.

Okay. Great. I wasn't going to hold you to it, but there you go. This is -- you mentioned Pumps & Process. I'm glad it surprised you. It surprised me. I surprised us. It surprised everybody, and that was an area where you did talk about mix last year. We had that Investor Day. I think it was in September, if I recall correctly, on hygienic and biopharma. So small business for you guys, relatively small business for you guys today, right? I think it was a $200 million business back then, or at least the biopharma component was. How -- what are you seeing in that business? How fast is it growing? Are there M&A opportunities to potentially grow that business going forward?

The trajectory of that business, I think that when we make a presentation last year, I think the top line CAGR was about 17%. It's higher than that now. The mix is significantly accretive. It has been driven through a combination of organic expansion and M&A, so both. So we greenfielded a brand-new plant for our colder products company in Minneapolis. I think the timing, knock wood, was perfect. That would allow us to capture market share as that business inflected, we are -- we think that, that end market is decently fragmented that gives us opportunity for continued inorganic investment, and we are continuing to invest organically behind it in terms of both clean room expansion and automation to increase our capacity.

Okay. Great. Look, 30% type operating margins in that segment. As analysts, we just kind of want to like put a stake in the ground and say, going forward, 30% is a good number, probably not the right thing to do. But what are your thoughts on the sustainability of that margin? And then moving forward, where the margins could go?

Look, I mean, they're best-in-class margins now. So if you take some pure-play pump comps out there, it benchmarks top quartile if not top 8. So we think that it is undervalued in terms of the sum of parts, in terms of the portfolio, for sure, #1. We have no intention of having the margins decrease. It may -- to use a popular word, it may be transitory, if we do some inorganic investment, but we think that we -- the intention would be to bring it to kind of core consolidated margins. I think that every operating company within that segment has improved margins dramatically over the last 3 years. And as of note, our compression business is still not fully recovered from the pandemic. So these results have all been posted despite the fact, I want to say a little bit less than 1/4 of the revenue is still underperforming. And we've got absolute confidence when that market turns, which it should, based on economic activity alone that we're going to get good volume leverage in that particular piece of the portfolio.

Got it. So let me ask it specifically then. 30%, I mean, so it should be 30% margins then in this business going forward?

I don't want to give out -- I already -- without you even asking gave me the 20% target within a shorter period of time, which is a portion of the entire portfolio. We don't have intentions of bringing those margins down.

Got it. Got it. No, that's clear.

That's based on seasonality and inorganic investment, but we think that this margin is durable.

That's awesome. Switching gears maybe to Refrigeration & Food. So food retail backlog, I think, the highest level since 2014. Just talk us through a little bit what's driving that? Or like is it the grocers just being really strong financially, some pushouts from the pandemic? Like what's your sense on what's driving the backlog there?

I mean, the business shrunk for 4 years. And it was kind of a two-pronged function of -- there wasn't a lot of capacity added to the marketplace. I mean, what drove the last expansion was Walmart entering into the food retail business, which was greenfield expansion that we wouldn't expect to see again. So we think that the market is fully served in North America now from a big box retailer point of view. But that big box retail went through a sustained period of time where CapEx was deployed to e-commerce as opposed to footprint, and we would have expected the business to grow last year just based on normal cyclicality for maintenance repair, but then the pandemic hit, and you couldn't get into the stores anyway, and the stores were crowded because you couldn't get into restaurants and everything else. So it actually extended kind of, let's call it, normal cyclicality, an extra year. So now we come to the other side of it. There is a large installed base that's had a significant amount of foot traffic in it over a prolonged period of time, and these stores compete on fresh food and what the store looks like in a variety of other things. So that's why we strongly believe we're in a multiyear cycle, where CapEx will be deployed to kind of refurbishment and repair, and we're kind of riding that to a certain extent. Additionally, we think that fresh and prepared food for big box retail is becoming increasingly important, right? So as kind of canned food and paper towels may go find their way into e-commerce, that was expanding significantly as fresh food and frozen food, which because of reasons everybody knows, it's hard to go to an e-commerce model to a certain extent. So that's driving demand on the Refrigeration side. And I think that what is new this year is legislation around refrigerants, which have been introduced in California. We think that we've got a very good position in CO2 technology, which is also driving a portion of our backlog right now. So again, it's execution for us. I think that we've got them. We're booking into Q4 now. So we would expect to see some meaningful margin -- comparable margin accretion from here going forward.

Congrats. Like, this has been a journey, right? And you guys have -- you made a lot of investments in this business. You're seeing the fruits of your labor. I mean, this is as bullish as I've heard you on the food retail business.

Well, when you have the backlog, it's -- you know what I mean? It's -- look, in the past, it was like waiting and waiting and waiting. And like I said, we closed '19 feeling good about '20, and all the indications were we were going to get an upturn, and what we got was the opposite for reasons everybody can understand. So I think that kudos to the management team. This is a market that has shrunk for many years. And so pricing power was -- there wasn't any, I guess, is the best way to be kind about it. And we are managing that price cost element quite well, and it's quite the shock to our customers, quite frankly, but I think that the team so far should be congratulated on that.

That's great. I have to ask you the mid-teens margin question for food retail. So clearly, the pandemic slowed that down. But you're back up to double-digit margins across the portfolio. Any renewed discussion around when you'll be able to achieve that?

We'll be in the teens in Q2 and Q3.

Okay. That's awesome. That's great. And then I know we're going to be kind of bumping up on time in a couple minutes. So I want to -- I know several questions I want to ask you, but I want to maybe focus on just M&A for a minute. You've done a few acquisitions recently in DFS. It seems like part of the strategy there is diversifying away from the dispensing units. I'm just thinking through how are you thinking about M&A specifically within DFS and then also beyond that across the rest of the portfolio?

Yes. I mean, we get it, and we're not denying this issue about EV penetrations and everything else. We made a big presentation about it. We believe that the scenario about what it means to revenue and earnings is overcooked, quite frankly. I mean, we love the market structure in this business. We love the margin opportunity in this business. It's not all about electric versus combustion engine. That's a piece of it, for sure, but we believe this is a business that we can do quite well in for the next 10 to 15 years. So we've got diversification opportunity, and we've done some of that recently, inorganically. And we believe that with the market structure as it is with rational competitors that there is a need there, a multiyear need, and the margins are actually very good. So this -- we see kind of the moving around of some of parts and just an overhang of ESG thematics. We're not -- we get it. But at the end of the day, we're here to make a profit, and we believe that this particular segment is not going to be a drag neither to our top -- top line or bottom line for the foreseeable future.

Yes. And maybe just sticking on that for a second. So when you think about your strategy to do M&A within DFS, it seems to me like probably a lot of it is going to be more on the software system side, point of sale. You're not interested in owning EV charging stations or anything like that, right?

Look, we've got meaningful partnerships on EV charging stations. The EV charging market, the vast majority of the volume doesn't go to our customers because of parking garages. And that's what we -- our strategy is tailored to what our customers want to do with their retail operations. And I think that we've got a very clear-eyed view what they want to do with their retail operations. And we think that we can add in products and services to augment that fact. So I mean that's why we got into carwash in a bigger way. That's why we've been investing into software in bigger way. So it's kind of aligning ourselves, but the big retail players in the market want to do over time. So anybody who's interested in terms of what our strategy is, I would just go tell you to go look at either the pure-play retail operators or the vertically integrated oil companies and what their strategy is in terms of CapEx deployment and monetizing the assets that they have.

Okay. One last one for you. So going back to the 20% number that you threw out earlier, if you are a kind of 20% type margin business longer term and probably nearer term than longer term, what does that mean for free cash flow? Does free cash flow margins -- do we be like -- think Dover is more like a mid-teens type free cash flow margin business if you can get to 20-plus percent op margins?

I'm going to have to bring Brad on camera here to do this one. We struggle with the variety of different ways to measure cash flow around here and the creativity that's used in the market to determine the number. So we keep falling back its cash flow as a percentage of revenue, and I think that somehow we get penalized for that. Look, it's 2-pronged at the end of the day. We continue to work on working capital management. I think that Dover Business Solutions, by centralizing accounts payable and accounts receivable, we'll grind out cash flow year-over-year, but the biggest thing that's going to drive cash flow expansion, whatever the deviser is over time, is going to be the margin expansion.

Yes.

Makes sense. Rich, Brad, we can't see you. Brad, Jack, thank you for being with us today. Hope you guys have a great rest of your week, and really appreciate you attending the conference.

Thanks, Joe.