Dover Corporation (DOV) Earnings Call Transcript & Summary

All right. Good morning, everyone. Thank you for joining us. My name is Mig Dobre. I'm the Baird analyst covering diversified industrials and machinery. It is my pleasure to introduce to you today Dover. As you probably know, Dover is a premier diversified global manufacturer. Joining us with an update on the company, we have Rich Tobin, Chief Executive Officer. Rich, I know you have a couple of slides and some quick prepared remarks. I'm going to turn it over to you, and then we'll do a lot of Q&A.

Thanks, Mig. Good morning. I'm starting on Slide 3. Is that echoing?

It is echoing a little bit. Can you try it again, Rich? I'm afraid we can't hear you now. Yes, I don't believe we can hear you, Rich.

You want to test it now?

Yes. There's absolutely no echo now. So I think we're good.

Okay.

All right. What I'm going to do before I resume the broadcast, I'm just going to put the last slide back up. All right, I'll give you a countdown to go in live, all right?

Okay.

We'll resume broadcast in 5, 4, 3, 2...

Okay. Well, let's try this the second time. Hopefully, this time that it works. Are you there, Rich?

I'm here, Mig. Let's try it again. I'm on Slide 3. So briefly, if you know the story, as Mig mentioned, Dover is a multi-industrial with premium franchises. You can see some of the stats from the period of 2018 through 2021 estimated. So we're compounding at 4% despite the COVID impact in '20. You can see the EPS CAGR. Our margins were actually up in '20. And I think that, that was a unique opportunity to demonstrate the strength of the portfolio. So our margin performance -- I think we were the only one in the space that margins that increased during '20. And what that means is in terms of the compound annual growth with expanding margins and dividends has resulted in 19% annualized return for shareholders. So moving to the next slide. Q3 highlights I'm sure everybody knows. We had a pretty good quarter despite all of the challenges with the supply chain and labor and the like. I think most importantly, the organic bookings you can see in the cash flow. So despite the challenges that we had getting product out the door, our bookings are up substantially, up 79% year-over-year. And being through margin expansion and some pretty healthy mix and a lot of the work that we've done on the working capital side, you can see that our free cash flow is up 18% year-over-year. As a result of Q3, we raised our EPS guidance at the end of the quarter to $7.45 to $7.50 per share. That's adjusted EPS, by the way. And look, at the end of the day, I can just give you an update on where we are right now before we get into Q&A. Things are still difficult. They're not getting more difficult. I guess that's a positive, but they are, and we would expect them to remain difficult in terms of supply chain challenges. The labor is getting a little bit better than it was, but we've been raising rates quite aggressively to continue to attract labor. But the good news is that in terms of our backlog, that continues to build. So we fully expect now to exit 2021 with a very robust backlog, which portends to a pretty good outlook for '22 despite all the challenges. So -- and then finally, we know that we were acquired. Let's move on to the next slide. Our pipeline remains quite active. There's not a lot of big deals that we've done during the time frame, but these are niche technologies that we use the power of our network to expand over time. It's the -- if we take a look at the list here, it's becoming meaningful to our year-over-year EPS accretion is driven by a lot of small acquisitions, and we expect that trend to continue going forward. So I will close off my opening remarks, Mig, there, and then we can go to the Q&A.

Yes. Sounds good. Thank you, Rich. And a reminder to everyone that you can submit questions via the system itself or you can e-mail me at [email protected]. So appreciate the updates that you provided here, Rich. You kind of anticipated where I was going to go with my first question right out of the gate. Your orders have been very good, and you have very solid backlogs. I'm curious, as you think about 2022, one of the big questions that we've had is sustainability of demand, right? What portions of your business do you feel most comfortable with in their ability to grow in 2022 given that we're above pre-COVID levels pretty much everywhere?

Look, I don't think there's a piece of our portfolio that we expect to shrink in 2022 based on what we can see from, not only the backlog, but from all the activity we have on the customer side. So you understand that we've got some short cycle businesses, some long cycle businesses. So some of the longer cycle businesses, that backlog just books out. And when you've got companies like Belvac, which we expect to be booked for the year, at the end of this year, and then we've got a lot of short cycle businesses where backlog is being influenced by a lot of solid customer demand and -- but let's make no mistake, the backlog is increasing because with all the supply constraints, everybody is trying to get in line and secure capacity. So we believe that the portfolio is set up to grow healthily into '22. I would expect in '22 that there's going to be a panic as backlogs -- total backlog begins to shrink, but that's not a negative. That's actually a positive because that means that the supply chain challenges are beginning to unwind and we can go back to more normal order patterns where you don't have to order things 6 months in advance. So we're going to have to manage the optics of that as we get into the year, but it's actually a positive in some of our short cycle businesses, and the backlogs begin to decrease as we go out through the year. So that's the big debate in industrial world, translating backlog into revenue. And I've seen everybody try to do the mathematical extrapolations of that. Look, at the end of the day, it's good. But the bigger the backlog that we have, the more effectively we can plan on the production side to maximize our profitability. So I've got line of sight. I know what to order. I know how to plan it in production. So having a good backlog is fine. On the other hand, backlogs were to shrink in the second half of the second year, I don't think anybody should panic because it's not a reflection of the revenue projection going into '23.

Yes. And I think you made this point before, and it certainly resonated with me. The question perhaps is less so on backlog, but rather the orders themselves and how those are progressing, right? I mean those are maybe more informative. And maybe to what you were saying earlier, customers are, to some degree, panicked, and they are ordering ahead. Is there a way to better understand this dynamic in terms of how that might play out? Like, say, for instance, normalization of order patterns, what kind of a natural headwind would that generate?

Yes. Well, I mean there's 2 parts to the equation. We're an OEM in portions of our portfolio where we're selling our goods to end users. And then we've got a big portion of the portfolio that runs through distribution. So you manage that dynamic a little bit differently. When you're an OEM, you're talking directly to the customer. And in those cases, it's a relatively easy conversation. If you put the orders in and we're going to order the raw materials and the components, so you're going to take the order, right? We don't take call-offs when we act as an OEM. The distribution is a little bit more challenging, right, because you've got an inventory position at distribution between the end user and yourself. But we've done a lot of work here to get a really good visibility into distribution and our ability to kind of look at channel checking, whether there's inventory that's piling up in the distribution side. Right now, because of all the challenges in the marketplace, there's very little inventory in distribution. So as we move into '22, we'll keep an eye on that dynamic. If we see inventory building in distribution, then we'll know that there's a little bit of a headwind coming. But right now, everything that we ship goes almost on a pass-through basis through distribution to the end user.

If I'm to maybe then ask this question differently, when you're sort of looking at the duration of your shipments, right -- if, say, for instance, you've got normal orders that you would normally ship in 6 or 8 weeks, and now you're looking at orders that maybe are 3 to 6 months out, is there a way to understand what percentage of backlog or orders are associated with these kind of like out shipments rather than what you would consider to be normal business? I don't know if the question makes sense. I'm just sort of trying to understand...

I understand what you're saying. Look, at the end of the day, we do have an understanding of it. And I just -- this worrying that somehow there's over-ordering going on, right, is we just don't see it, right? We don't -- so at the end of the day, if you order the goods from us, if we're acting as an OEM, we're shipping in the goods and billing. If you're a distributor and you're ordering it, we're going to ship it to you and then you're going to pay for it. Now it may end up in the distribution channel, but that's what I was talking about before. Right now, we don't see any inventory being built at the distribution level of any quantum.

Understood. Let me move on from this topic and talk a little bit about backlog is one of the risks that all of us are seeing with backlogs building is this whole price-cost dynamic, right? You do have visibility in how you manufacture, but not always on the cost side. So what's the risk in your backlog? And how do you manage that?

Well, I mean you saw some of that play out in Q3, right? So we entered -- we exited '20 with a pretty good backlog. We've built a lot of it in Q1. We had priced it based on raw material curves that we could see at the time, but you're chasing it to a certain extent, right, because the time between us or in raw materials, us building the product and it's cycling through inventory, if you're chasing inflation, your backlog -- the margin pressure on the older portion of your backlog needs to be dealt with. And you saw some of that in Q3, built into our forecast of Q4. We're going to see some of that again. Now having said that, we're repricing and repricing. So you're basically catching up as you're winding out. Even though your total backlog does not shrink, you're basically -- your pricing is catching up with that backlog, right, because it's almost first in, first out from an order point of view. So we believe as long as we don't go into another inflationary environment into '22, that we'll actually roll over and be positive shortly into '22.

I see, I see. Which sort of brings the point of margin expansion. You talked about it in your slides. And look, I mean, I agree. I think your performance has been really good in 2020. And considering how tough '21 has been, it's been good as well. So what's next? In terms of initiatives, in terms of the earnings power of the business, how would you frame this for investors?

Look, I've been here since 2018, and we have never had a year where we've hit on all cylinders. And there's 2 ways to look at that, meaning it's a positive -- it's a negative that we haven't had the portfolio that all of the segments were operating at peak, I guess, is the bad news. The good news is we've never had -- the power of having a diversified portfolio is that you take some of the cyclicality out because we've got such a wide geographic and end market footprint. So our capital goods type businesses have suffered this year because of everything that we've talked about with the raw materials and the labor and the logistics costs and everything else, but we carry that as a benefit going into '22. I think -- I don't believe that we're going to see raw material prices go up from where they are today. Actually, if you look at metals, they're poised to go down, if you believe what the futures look like. So that's a positive for us. And the logistics side, it's going to solve itself over time, I believe. So we've got a portion of the portfolio that's had some headwinds that we believe is going to recover next year, which is positive, and then we've got other portions of the portfolio of sales right through, some of which we've been investing heavily behind that have some significant mix impacts. So if you look at our comps and process solutions business and the margin expansion there, that is 100% mix-driven, right, from products that we've invested behind in the past that are now kind of hitting their stride. So we don't believe that, that margin performance is driven by something that goes away moving into '22 and '23. We're actually continuing to invest behind it. So we've got some catch-up from some of the capital goods portions of the portfolio going into '22, and we've got some real good tailwinds in mix where we've been doing a lot of work.

That's good color. Getting into segments a little bit, and there's a question from the audience here. And perhaps not surprisingly, this person is -- wants to talk about EVs. Do you get a sense that EVs are going to be at risk for the fueling segment in the near future? I guess the way I would augment this question is to sort of ask you to talk a little bit about some of the things that you're doing on a charging side. I know you've got partnerships with ABB and others and how you sort of see this portion of the business evolve.

Okay. In the short term, no. And I would ask any investor that's got a question, we made a presentation on this segment in 2020 where we laid out what we think the penetration rates are going to be with EVs and everything else, and we think that it's absolutely manageable. And at the time, we had given a revenue forecast for that segment for '21, which we are actually beating handily as we sit here today despite EVs and EMV and every other acronym that seems to chase that business around. So when we made that presentation, 40% of our revenue was in dispensing units. So when you look at that segment, I think that there's a misunderstanding that somehow everybody is under the impression that it's all gas station pumps, far from it. 40% of the revenue stream is gas station pumps. I would expect by the end of '22, that will be materially smaller just through diversification efforts on our part. So what we're going to end up having is a legacy business where the market structure is super attractive because of its concentration with a massive installed base that we were going to use to fund the diversification, whether that is into EVs or a variety of other components-like businesses. So we think it's entirely manageable.

So on that follow-up, though, maybe talk a little bit about LIQAL. Hopefully, I'm pronouncing you correctly, your recent acquisition in hydrogen fueling. And again, I know that in the past, you talked about charging as an opportunity for Dover, right? So how do you see that play out? And does the infrastructure build, for instance, help in any way accelerate this trend?

Okay. Look, we have agreements with charging companies to manage the installation in spare parts administration, and we've got a variety of different form factor cooperation agreements because at the end of the day, you need to have the credit card reader and a variety of other things. I mean -- but the fact of the matter is there's not a massive margin opportunity in building the chargers themselves, especially at retail gas station units. As you know, the vast majority of EV chargers are going to be in home or in parking lots or in fixed infrastructure, not on the side of the road in a retail operation. So -- in the grand scheme of things. So we'll get that revenue stream. But as we've laid out in the past, we are not a gas station components company. We control the ecosystem of our retail operators from everything from point of sale to inventory management to carwash to a variety of other things. So our customers are the sheets and the marathons and everybody else. And I would like -- I call your attention to taking a look about what they say about their CapEx plans into the future. It's actually quite robust. And so as they consolidate very, very fragmented -- a very, very fragmented industry, there's a huge opportunity for us to follow them along. The days of the mom-and-pop gas station with One Island and Coke machine are going to be over in the next 10 years. If you go take a look at what's being built today, the size and complexity of these retail operations are massively different than what they've been before. And as those stations are built out and this consolidation takes place, there's a huge opportunity for us to fulfill those needs.

Another question from the audience. This one is on your pumps business, and it goes to demand sustainability in the biopharma component of the business. And maybe parsing out if there was any bump from COVID and how that might play into '22.

Undoubtedly, there has been a bump from COVID, but what is more important than kind of the raw demand from vaccine manufacturing is a structural change of the development of these drugs from large vats that have been used before now to skin production. So skin production, if you know anything about what Sartorius, Thermo Fisher is doing, is small batch size, a lot of single-use components where everyone is investing behind. And we -- and what we do is sell subcomponents that go into those systems. So yes, there's been a demand spike because of COVID, but we believe that the marketplace has structurally changed where single use is kind of the wave of the future as opposed to big bioreactor production, which has been done in the past.

Maybe a capital allocation question here. You talked about the singles and doubles in terms of the M&A that you've done thus far, and it seems like that's essentially where you're focusing investors, saying that this is kind of the road map going forward. But in terms of your own portfolio, Unified Brands is now gone. I remember you sold Tipper Tie a little while back. Brings the question as to the remaining portion of your RF&E portfolio, how that fits in longer term. And look, I mean, is there an argument that now that both these businesses, I should say Belvac, as well as refrigeration, have seen a bit of an investment cycle that this is sort of a time to think about it in terms of potentially monetizing this portion of your business?

Well, I don't see any need to monetize Belvac. I'll go back to refrigeration since we've discussed it for years. Belvac that we believe is in -- because of ESG concerns around plastic use in the beverage industry is a structural grower for the foreseeable future. So we'll put that one aside. And there really is no natural buyer for that business because the market for can-shaping equipment is very concentrated. There is only a couple of global suppliers that are even out there in the first place. On the refrigeration side, as we mentioned, as I commented on before, we believe we're in a multiyear demand cycle. We are going to exit this year with a larger backlog that we entered into '21. Right now, we are struggling on the supply chain side. So we're unhappy with the margin performance, but we're absolutely pleased in terms of not only the demand dynamic that we see, but we also believe that we are carving out a leadership position in CO2 technology for refrigeration. So '21 should have been the year where we prove -- where we were given the opportunity to prove the profit potential of that business. Unfortunately, component shortages and the like are not going to allow that to happen this year, but we are going to enter '22 with a backlog that I believe is going to be the year where we hit our longer-term targets they've established back in 2018 from a margin point of view, in a business that's substantially larger than it was in 2018. So in terms of total profit, materially different.

Understood. And since we only have 2 minutes left, maybe I'll close by asking you this. Your stock has done well. I guess I'm curious, given the questions you normally get from investors, do you think that there is still something about Dover's growth and earnings growth algorithm that might not be fully appreciated by the market or investors at this point?

I would call any investors' attention to the growth outlook for Dover outside of the forecast year when we -- so let me answer it differently. In February, we were going to come out with our full year results, and I'm going to give a forecast for '22, and everybody is going to put it in their model and then everybody is going to put 4% growth in '23 despite the fact that we've been growing here substantially higher than that over the last 4 years. So it's an absolute fact that the growth rate of -- potential of this portfolio is misunderstood. Now I'm not saying that it needs to be top quartile, but there's absolutely no rationale for it to be bottom quartile.

Well, I guess I need to reexamine my model, Rich. So thank you for that closing, and thank you for participating in the Baird conference. This was a really good conversation.

Good to see you, Mig.

Nice to see you, too. Take care.