Dover Corporation (DOV) Earnings Call Transcript & Summary

Great. Well, I think we're ready to get underway. It's my pleasure to have here President and CEO, Richard Tobin, of Dover Corporation. I think, Rich, you have a couple of prepared remarks and then we'll go into Q&A after that.

Nothing really prepared, Julian. I think that we have a couple of slides here for anybody here that's new to our story just in terms of the market exposures that we have, I think you can go forward from here. That is the results for both Q4 and for '21, so despite the difficult operating environment, whether that's COVID-related or supply chain, which I'm sure we'll deal with in the Q&A, I think that we were able to post some pretty strong results, and you can see that from the revenue growth and the margin accretion on a full year basis. Next one. We are an acquirer, so we've begun to ramp up activity recently. So we did 2 rather large material deals in Q4 where we recognized marginal revenues in '21 so we'll be -- we expect those 2 deals to be EPS accretive into '22. And the next one. These are the 2 deals that we did. I'm sure I don't want to get in front of the Q&A, but we're happy with the 2 deals. We think that we're investing behind secular growth, and we think that it diversifies our portfolio into some areas that we were underexposed. And I think this is the final slide and this is what it adds up to be. I think that in terms of the performance since 2018, we can be quite proud. You can see the guidance that -- or the bar chart that implies our guidance, so we're looking again at some pretty good EPS accretion built into our guidance. So we're here carrying some pretty large backlogs, which I know is going to be part of your Q&A. And to the extent that we're beyond Omicron and that some of the headwinds we had in supply chain were to dissipate, we're looking to improve profits meaningfully into '22.

Perfect. Well, thanks very much, Rich, for that introduction. Maybe start off as you just mentioned, the sort of -- I think a lot of people in this room are not used to looking at Dover as a big kind of backlog business but that's what global supply chain constraints and strong demand have led to. I think you've been more forthright than most other CEOs in sort of highlighting, please don't expect monster bookings growth to persist wherever, and that obviously carries some backlog implications with it. So maybe just give us some updated thoughts on how has the year started out on orders and backlogs. And when you're sort of cautioning us on bookings growth dissipating? Shouldn't shock people, but any context around that.

Sure. We would have liked to have shipped more of our backlog in Q4, but because of supply constraints and labor availability and absenteeism, which was driven by the last wave of COVID, we actually carried more of our '21 backlog into '22. So that further exasperates the size of the backlog relative to kind of more normalized periods. The negative with -- the good news is we have got a very large backlog and I'll get back to that. The negative is, is that we would have liked to flush some of our older-dated backlog out in Q4 because we're really counting on price/cost to flip positive in some of our segments. Into '22, we've baked that all into our full year estimates so we're tracking pretty much where we thought we were going to. And look, and the backlog, we're a multi-industrial. We've got a mix of both long-cycle and short-cycle businesses so we run those differently and we evaluate the backlog differently. The longer cycle businesses, the backlog is actually a good sign because it just extends the duration of the demand cycle is going to be, and we can touch on maybe that in some of the Q&A. We talk about things like Belvac for aluminum can making equipment. [ Firstly ], we think it's entering a secular growth on the back of some pretty large capacity expansions that are multiyear projects. So that's a good sign. I think that the part that has concerned market participants is this notion of, is there over-ordering. We don't see any indication of that. Our channel checks indicate that our businesses that we sell through distribution are not building their own backlog, so you've got almost like this double counting going on. But clearly, there's an amount of trying to source goods with longer lead times than is normal, and that's just a function of the supply chain, meaning I want products like refrigeration cases that in, let's call it, normal supply chain environment we'd be taking orders inter-quarter and shipping. Right now, we are booked through October, and that is just a reflection of our clients want to do the work. They're concerned about supply chain so they're trying to get in line until that normalizes over time. So there's no easy answer to it because we've got different types of businesses. But at the end of the day, I would not be overly concerned about aggregate backlog or order rates dropping in the second half of the year because a lot of that could be explained by the fact that supply chains are normalizing. And there's no need -- the demand is still there. It's not a function of future demand. It's just a function of, I just don't need to order that far in advance because I can get the product.

And as you said, your impression from the [ disciplined ] markets that Dover's in, but whether it's OEMs or distributor channel partners, no evidence really of elevated [indiscernible].

Not from what we can see from channel checks and the most appropriate way if I look at that, one of the OEMs that we sell to for -- because we're largely a -- a lot of our businesses are subcomponents that find their way into finished products of the OEMs we talk to. Look, we deal with them in terms of the forecast of their demand and their backlog. The businesses that we sell through distribution, we've got a good view of where they are in terms of their own inventory because we're doing channel checks frequently.

And you mentioned that the year started out pretty much as you thought on the top line. When you look at operating leverage, I think guiding for that 25%, 35% range for the year is -- it's a pretty good number, I think, versus most multi-industry companies. So maybe flesh out how is the seasonality of that through the year and the conviction in putting that relatively high number out there.

Well, they are forecasts at the end of the day, but I think that the good news about this issue of our backlog, at least this gives us some visibility in terms of what we have to make into the future and better than we would have seen 2 or 3 years ago at the end of the day. In terms of the margin, I think that we were overly clear, I think, as we closed the year about cautioning about Q1 because we were still in the midst of Omicron, so absenteeism on the factory floor, which we had seen in December, was rolling into January, and then that supply chain was still sticky, for lack of a better word. So a lot of what we endured in the second half of the year, we would carry some of that. And as I mentioned before, we are going to carry some of that longer-dated backlog into Q1, where there's price/cost is not catching up as much as we would like. Now having said all that, that's been factored into our full year guidance. The demand across the portfolio remains robust. The absenteeism that was created by Omicron has dissipated. Supply chain is still sticky. Raw materials need to be flushed through inventory. But based on all those factors, I think that we are setting ourselves up that it will be back-end loaded because of everything that we talked about, but I don't think it's insurmountable in terms of what we can expect in terms of margin accretion. I would ask you to look at it this way. If I take you back to the slide that shows our full year results, it's absolutely clear that Pumps & Process Solutions carried the day. So our capital goods like businesses are those businesses that we have that have a material exposure to raw materials or assembly labor, suffered for all the reasons that you all understand after talking about it for a year. So as we roll into next year, that the -- what we need is for those businesses that suffered into '21 to repair themselves back to kind of historical profit margin that we're not counting on another year for Pumps & Process Solutions to carry the day. So it's not insurmountable. Those are margins that we've delivered in the past, and I think that we've got the demand, which is the hardest part. So it's just up to us to execute at the industrial level from here.

So if we think about those points you mentioned demand, absenteeism, supply chain and raw materials. Across those 4, it sounds like the absenteeism is less of a headwind than it had been and the other 3 are about the same as [ as we execute the costs ].

Well, the raw materials, you can see on the curves, right? So we expect the raw materials, and we don't expect a dramatic improvement nor a decline in terms of forward purchases of raw materials. We actually think it's a credit. And as you know, we priced based on '21 raw material costs, so you've got an inherent built-in spread there. I think that the one that we'd like to see some better improvement is on supply chain and logistics. I think that the good news that I can tell you is capacity is expanding globally based on recovery from COVID. So at the beginning of the issues, what we saw in midyear of '21, it was a capacity ramp problem. That capacity is now largely on stream. We're still suffering a bit on the logistics side. So hopefully, that progressively recovers. And I think that there are some early signs that, that is beginning to recover in terms of logistics.

And when we look at that 30% midpoint operating leverage number for the year, is it fair to assume that if in 2023, cost inflation is more normal, that number should be higher theoretically because of the price/cost anyways?

Well, it's going to be until when we get into '23. It's going to be robust this year because of the decremental margins and the recovery and everything that we talked about, right? So you're going to get the flip on the other side. I think that when we get into '23, it is going to be more mix-related than anything else, and I think it's a bit early to be predicting revenue mix into '23 right now. But I think what is not well understood in terms of Dover's performance since 2018, it's looked at as a cost-cutting story. I mean that was 2018, arguably 2019. The fact of the matter is the majority of the margin expansion through from 2021 has been driven by product mix and an underestimated potential for revenue growth. So I expect that to be the theme for '23 as opposed to COVID's over. So here comes another round of cost cutting. I think we're beyond that.

And you mentioned Dover Pumps & Process Solutions. As you said, I think it was the majority of the earnings growth late in the year for you last year. I think there's -- maybe investors have questions around kind of the business mix of that and how much was sort of COVID/vaccine boost. So any sort of perspective or color on that business [indiscernible]?

Yes. Look, I mean, at the end of the day, it's very difficult for us to be a proxy for biopharmaceutical production. We are a rounding error in the TAM of that particular market. So anybody that's curious about what's going on and there's a lot of bellwethers in the industry that you pointed, but I can point to a couple of issues. We had signaled back in early '20, we made an actual special presentation on what our intentions were in terms of biopharma exposure. We announced the greenfielding of a brand-new plant, which is, I think, the first one that Dover has done in a very long time. And that has been quite successful, but it's not -- COVID aside and vaccine development aside, which is in the factor across the entire scheme. We believe that we've got unique component parts that provide productivity to our customers. And those products are single-use base, meaning that they are tied to absolute production, not to production assets -- or the number of production assets. So when you think about things like tube welding, which is the technology for joining tubular products that go around skin production, so there's a technique that's called tube welding. What we basically have introduced a product that we believe is entirely more efficient from a cost and productivity point than tube welding, so that is the nature. So it's replacement, not just an aggregate. Scale benefit is there's a lot of existing productive assets where we replace the product.

And I think one area in that division, DPPS, where maybe you did signal, look, don't expect the past to just copy paste. The '22 is sort of caution around the margin expansion sloping. It did look from the outside, at least, as if there was a healthy mix tailwind there already. How do you think about that mix this year playing out in DPPS?

I mean I think that where we were trying to be a little bit cautious on the growth rate for all the reasons that we've talked about. I mean we don't believe that we're over-earning. So we don't -- and we don't believe that we're going to go negative in terms of growth rate. But that segment is made up of 4 to 5 different business lines in between. There's an industrial pumps business in there that's performing very, very well, that we've expanded margins materially. There's plastics processing systems. Again, that's performing very well. It's a long-cycle business, so it's part and parcel to some of the backlog that we see there, where we've expanded margins materially and entered into recycling where we think that there's some secular growth there. So there's a variety of other exposures within there, all of which have contributed to the 700 basis points of margin improvement. And look, and if you go back to the slide that I showed you before, from an inorganic point of view, I think that we've been opportunistic of buying small companies that have single technologies that we believe that we can weave into our product offering and use the network effect of the scale of Dover to accelerate their growth rates, and knock on wood, that's been a successful endeavor over the past 3 years.

Then clean energy and fueling [indiscernible] sort of direct peers sort of said some things in recent days. Now how do you assess the sort of the growth outlook medium term? This year, you've been very clear on your medium term, you got some interesting things in your portfolio, it's quite different perhaps versus some of your peers in the industry. What do you think a reasonable medium-term organic growth assumption for that [indiscernible].

Well, I don't think we give out our growth rates by segment. I think that we gave you a consolidated one, but I can just tell you that it's part of the overall growth rate, we expect that segment to grow despite some of the negativity around EMV and ICE exposure and a variety of other things. I think that we were -- part and parcel to the reason that we did the special presentation at the time that we made those 2 acquisitions is to kind of show our investors the different components of the revenue streams. And I think that if you step back, our exposure to ICE at the end of the day is manageable over time. And I think that we're big believers in subcomponents into the gas industry, where we get a free option on hydrogen, which is, we believe, at least the amount of capital going into hydrogen to tell you that there's going to be secular demand there. And again, it's subcomponents where switching costs are high, that there's regulatory regimes covering it. So Dover-like businesses that we believe we know how to run.

So the point would be, you've reshaped it such that we shouldn't have some cliff a year from now?

We worry about everything, Julian, but I think that we don't -- we're not running this off a cliff at the end of the day. So what's built into our expectations into '22 accommodates some decline in terms of EMV. But it's no different than when we did the presentation back in '20 where we gave a 3-year outlook. I think the management team that runs the business for us hit that number dead on for '21. So I have absolutely no fear that they're going to be more right than wrong about how '22 and '23 develops.

And then Climate & Sustainability Technologies, very good revenue progress to date and market share with the backlog. Margins, a lot of pressure, probably temporary. So in aggregate, sort of how satisfied are you with the margin path of that business? And do you think it can get to a place 18 months from now where people would stop asking what is [indiscernible]?

Yes. I mean we're generally not in the satisfaction business. We're more in the kind of move-the-bar business. I would tell you that we are very encouraged by the secular growth in can-making equipment. So it's a niche of a niche. But at the end of the day, if you were to go take a look at the aggregate amount of capacity expansion announced by the aluminum can-making industry, you'd find it to be very interesting with a quite a long duration. We believe that there is an ESG tailwind behind this as PET becomes less attractive from a recycling point of view. So as you take a look at the recycling rates between PET and aluminum, there's a massive disparity between the two. So we were an early investor -- not early -- putting capital behind it from a capacity point of view. We started expanding capacity there in the latter half of 2019 and continue to do so. So in terms of our ability for market capture, I think that we're in a good position. We are a material participant in the heat exchanger market. That has been a very nice grower for us, particularly in Europe on heat pump technology. We believe that heat pump technology will be adopted globally progressively. And as such, we, over the past 24 months and through '22 into the beginning of '23, we are expanding production capacity in Asia, North America and Europe proactively based on our view of the demand cycle there. So that leaves Refrigeration, which between raw materials and a high -- low margins, raw material exposure and a lot of assembly labor, gets the trifecta of all of the headwinds of '21. Good news is it's a short-cycle business, that because of those constraints has turned into a medium-cycle business, where we at least have visibility. We believe we are sold out from a production capacity point of view through October, which is unprecedented. We believe that this is, at minimum, a 3-year cycle based on business models and refurbishment schedules that our customers are talking about. We've had a target out there of 15% margin for that business. And we touched on it in Q3 of '20, I think that we were all set up to do it in '21. It's been a dream deferred. We've got everything in place. I think when we get beyond Q1, we're looking for a material change in profitability in that particular business. I think it's important to understand that business is looked at as a supplier solely of refrigeration cases that you see in the supermarket. That's about a little bit less than half of the revenue stream. The balance of it or a proportion of it is CO2 systems, so the main systems. We are a market leader in CO2 systems in Europe through a company that we own in Denmark called Advansor. That technology has now been mandated for all new builds for the state of California. And we believe that, that is a precursor for greater adoption moving to '22, '23 into the future. It's our fastest-growing portion of that business right now is CO2 systems.

Perfect. And then if we think about acquisitions, you mentioned that there is acquisitive sort of approach of the company. You did a couple of fairly substantial deals in December. Should we look at Dover for this year is sort of digesting those? Or you think absolutely not, you can keep doing a lot of M&A over the rest of the year?

[indiscernible]. Both of those acquisitions were done with cash on hand or short-term funding. So we've got all of our balance sheet firepower that we had at the beginning of '21, we carried into '22. Those businesses are material, but those -- the integration of those businesses will be handled by the acquiring company and/or segment, so that does not preclude us from being opportunistic inorganically in '22. Actually, it's our intention.

I think that there's a big enough funnel of accepted price deals like those. [indiscernible]

The funnel's big, the valuation is always the difficult part. Bad news is that equity markets are re-rating with a threat of interest rates. If we can take any good news from that, then asset prices may react to that and that we can be -- we can take advantage of our balance sheet going forward.

Just a reminder, please take a few seconds to do our audience response survey if you have time. If I look at the sort of evaluation of the company and people have different views on some of the parts analysis and so on, how do you assess what Dover is today relative to that? And depending on your views on that, what does that mean for any sort of appetite for share buybacks versus M&A?

Well, every CEO says we're undervalued, right -- or overvalued. At the end of the day, we clearly do not trade at the EBITDA multiple of our best-in-class peers. We've been entirely focused on closing the margin gap from those peers. So our expectation is, over time, that, that's reachable. But at the end of the day, earnings growth at whatever multiple translates into value creation over time. And so we're not going to -- I'm not going to sit up here and squawk about relative valuation. That's up to the capital markets to decide. We'd like to be an acquirer. I think that if you were to go take a look at average valuation that we've paid inorganically, I think on average, it's been less than our own trading multiple despite the fact that the vast majority have been EPS accretive in the year of the acquisition. So I think that we will be remained disciplined in terms of what we do. But that's not to say that we won't take interesting bets on interesting technologies as long as the scale of those acquisitions are manageable and we're not betting the balance sheet.

And when you think about the sort of the business improvement aspect, you mentioned it earlier on where sort of group cost cutting was 2 to 3 years ago and seems to have evolved since. So when you think about areas like IT infrastructure, Dover business services, where are we in sort of squeezing that lemon for savings? Or is it just part of the run rate. So look, there's X percent continuous productivity now every year they're starting to get great [indiscernible].

On the IT infrastructure, we're probably in the seventh inning, so a lot of the productivity has been by mopping up a very disparate amounts of systems and using the scale to be able to do it. On the digital front ending, I think, is probably the biggest opportunity that we have. A significant proportion of our revenue is sold through distribution, so I don't want to be -- our management teams get mad when I call them catalog businesses, but it's the only simplistic way I can describe them. And to the extent that you can lower your transaction cost by putting them on the web, I think that we've -- I think we've done all the heavy lifting to build the know-how and the infrastructure going from here. While the hope is that the adoption rate of what we've built accelerates, and we think that we've got some real interesting opportunity of lowering our transaction costs and to put in centralized pricing, a variety of different things that you can imagine from moving things onto a centralized platform. And so sort of all in, that 20% segment margin while that's [indiscernible] we would hope that we meet it or beat it in this coming year, and then when we get there, we'll consider revisiting the grand tour de force presentation that we did back in 2018 and set some more targets from there. My expectation is that's not going to be the case. We've moved now where we're going to go and now that COVID, knock on wood, has passed, we'll probably start doing individual segment presentations because I think that listening to me to do a 6-hour dirge about the portfolio, I don't want to do it and you don't want to listen to it. So I think it's a better way for market participants to understand what we're doing, is to do it by segment by segment, and I think you can expect that to start again in '22.

Perfect. Well, we'll look forward to that. Thanks very much, Rich, for your time with us today. Thank you.

Thanks, Julian.

Thanks a lot.