Dover Corporation (DOV) Earnings Call Transcript & Summary

Again, good morning, everyone. Andy Kaplowitz, cover multi-industry and E&C. We are really excited to have Rich Tobin with us again, back in person, President and CEO of Dover. Rich has been President and CEO for several years now and prior to joining Dover was part of CNH.

Rich, maybe I'll just start with a simple question. Your backlog was up 84% year-over-year last quarter. Demand is obviously quite strong. Maybe you could just highlight anything -- any changes that you've seen here over the last month? I know that we'll -- I'll ask you about geopolitics, but just anything that you've seen in the short term, and then we'll get to some more interesting questions.

Like it's early days, so not really. I mean, we don't -- it's not as if we're not taking orders year-to-date. We're actually -- book-to-bill looks reasonably good. So it's the same as where we exited last year that we've got some interesting long-cycle businesses that are building significant backlogs and short-cycle demand seems to be holding up, and we're weathering the last vestiges of Omicron and so supply chain, but that at least on the Omicron absenteeism front has improved materially between January and February. So that will result in satisfactory production performance. So, so far so good.

That's good. And then let's just get geopolitics out of the way, exposure to sort of the issues in rest of Ukraine. And then how are you thinking about sort of the European business overall for the year?

Our direct exposure to sales in Russia are not material at all to the group. Look, it's concerning. I mean, early days, whether this has a dramatic impact on the demand function in Europe, I think it's a little bit too early to tell, quite frankly.

And the U.S. actually has been very strong for you. And you've talked about watching policy decisions, regulatory environment a little bit. So maybe sort of expound on sort of what you're worried about here or the demand momentum here and how you think about it for '22?

Look, I think the biggest concern that we and a variety of different market participants have is what's going to happen with inflation, right? I think, to this point, everybody has been a little bit too sanguine about well -- on pricing for it to a certain extent. Well, that becomes an argument of how long is a piece of string. So this initial wave of inflation on input and labor has been priced in the market. Whether we can absorb another round of that without having an effect on demand into the future remains to be seen. So to the extent that we can get a handle on inflation, I think that's very important. Our view is that inflation on labor is sticky. So we do not expect to get any relief on that front going forward. We do expect, based on forward curves outside of macro political risk that metals pricing looks like it's stabilizing and coming down based on futures. And we'd like to see some relief on logistics and supply chain, both on the cost front and getting this friction out of the system where there's unreliability in terms of delivery, both inbound and outbound.

So Rich, you've been pretty good, I think, about sort of trying to -- you talked about inflation early versus some of the other -- some of your peers. So when you look at this year, 25% to 35% is still your incremental margin guide, how difficult is it in this environment? Have you seen sort of a peak in logistics and freight? So you can kind of dial it in a little bit more. And what are you doing on the pricing side to try to stay ahead?

Well, look, I mean, if we roll back forward after COVID reopening, the initial issue that everybody dealt with was the capacity ramp of componentry for lack of better word. But that was further exasperated by supply chain issues. We're reasonably confident that the capacity has been built. We're now still struggling with the remaining vestiges of the logistics side. In terms of the pricing element, we can price for and have been pricing for input cost inflation on the raw material side. In certain cases, we can price for logistics, but not on supply chain interruption. So on the raw cost of logistics, we can do our best to mop that up. But on the cost of supply chain interruption, there's no way to price for that, and that's why you saw in certain parts of our capital goods businesses last year where we had to take supply -- take plants down because of supply interruption you can't price for that. That's just lost fixed cost absorption at the end of the day.

So Rich, I mean, you've got a growth outlook of 79%, and you've got the backlog we talked about. Do you need anything in terms of supply chain to leave you to deliver that kind of revenue? Or is that sort of assuming that supply chain doesn't get much better?

Our assumption is that we do not have to take plants down again in '22 because of supply chain. But it incorporates the cost of the elevated pricing of logistics into the forecast.

So I want to ask you about one more region about China, a little bit smaller portion of your business, but you did see strong growth there, but it's been kind of like on off there. So in Olympics this quarter, obviously, maybe a little bit of weird headwind. But overall, what are you seeing in that region?

It's been choppy for several years. I think that a significant portion of our portfolio is sold or driven by changes in the regulatory environment. So because of that, the revenue line could be choppy. So we went through a period of doing underground tanks that we recognize the revenue and profit, but when that regulatory regime rolls over, then it looks like we're having a problem in China, so to speak. I think that we did reasonably well last year. It was coming off a lower base because I think the previous 2 years because of COVID related, we had shrunk. But I don't think that we're over reliant on China demand, and we're very much with other than the longer-cycle businesses make for China in China at this point?

So it's a good -- talking about EMV for 1 question only and hopefully never again hope but -- so your peer actually talked about China still being weak in 2022 for them on the retail fueling side. You seem to do better, I would say. Any sort of thoughts on 22? And then when you think about EMV, they gave us a '23 forecast. That was a pretty big drop off. So what's the outlook for Dover as you go out -- EMV?

Look, the EMV adoption is a North American phenomenon presently, right? So which is ground that's been plowed over a variety of times and then there was all these questions about the length and duration of the EMV adoption tail and everything else. Look, all I can say is that I think it's probably still on our website. We did a presentation, a detailed presentation in 2020, what our thoughts were on EMV. And in the 2 years since then, we've nailed the number on the button both times. So what's in our forecast for '22 and '23 incorporate those estimates. There's big differences in terms of geographic exposure between the competitors. There's big differences in margin. I will say that we've been preparing for this EV roll off for years. And if you look at the presentation that we did when we made our most recent acquisitions into clean energy, you'll see our exposure to aboveground gas station pumps for a lack of better word, has been meaningfully reduced in our portfolio. So I think that we're well positioned to handle whatever the estimates are of between 22% and 23% for the end of the EMV-driven demand.

So we should still think, Rich, about low single-digit growth as a decent possibility longer term?

All of our segments are poised to grow top line in '22.

Right. Okay. So maybe in Clean Energy. You obviously have been pretty active on the M&A front. So I know it's just been a very short amount of time since you closed on RegO and Acme. So maybe talk about how they're doing in the very short term? And then what are you trying to do there? Can you establish a much bigger presence in that area?

Look, this cryogenic fittings has been something that Dover has been looking at for many years. It's got a right to play in that space because we do a variety of different products that are aligned to the total fueling complex. So I think that we are opportunistic with the 2 acquisitions that we made. They fit what is in kind of Dover's wheelhouse of companies that we like, that they're engineered components or some components that have a regulatory aspect to them, where switching costs are high. I think that the foray into Acme is an option that we have on the capital going in, potentially going into the hydrogen complex. But we are attacking that particular sector in a variety of ways, both through our compressor component business through our aboveground fueling and now through fittings and fitments.

So Rich, I should step back and ask you, I think you and I have sat here before a few years ago and you said to me like I need to sort of get the DNA of the company ready to buy acquisitions. So clearly you think you're there, but maybe let me just ask you about that because I think there's no question that operationally, you've done a good job. So the question now is about capital allocation. Is the company ready to take on this kind of activity or even ramp up activity from here?

Yes. I mean I think that we described and we talked about in years past about earning the right to do acquisitions. I think that the management team has earned that right because if you look at all of the work that's been done in terms of expanding margins in the portfolio, we've delivered on the commitments that we laid out back and over delivered, quite frankly, what we laid out back in 2018, I'm highly confident in the -- not only in the management team in terms of the execution. But I think that we've built a muscle at Dover to extract synergy value expeditiously. And I'm not talking about shutting down plants and cutting labor. I'm talking about modernizing IT systems by modernizing back-office systems to reduce costs. We've got all of those muscles built that we're highly confident that if we can find products that are sold into areas of secular growth that we've got an operating philosophy and a management team that can execute.

So as you know, we're well past the Famous 50. But when you step back and think about sort of the next most interesting points of structural improvement for Dover, sort of what are they? And I will say further, like you and I have talked about digitization, which seems really interesting to me because it's overused for a lot of companies, but for you guys, it seems like it can lead to a lot more profitability. So that's my opinion to maybe...

Yes. Yes, look, without getting into portfolio questions, we can probably finish up with that. Yes. I mean, I think that the most interesting Dover project that we've been working on for several years now is preparing the company for digitizing the front end of our businesses. Some people look at that as -- well, it reduces transaction costs. It does for sure. But more importantly, it makes it easier to do business with. It makes it easier for us to do SKU management, it makes it easier for us to do pricing on a global scale. So the ancillary benefits up and down from the supply chain through the factory floor are significant. And I think that we've -- our digital team has spent several years building up an infrastructure that can accommodate that transition. So we're looking to make some real progress on that front. Over the next 3 years, I mean, in 2018, we had marginal dollars sold through digital interfaces. We closed $1 billion of transactions in '21. Our goal is to get to $2 billion by the end of this coming year. Quite frankly, I think that we can beat that again. And clearly, I think a significant portion of our revenue can be accommodated that over the next 3 years or so.

And when you think about -- because we all obviously want to quantify everything. So when you think about that, does it just make it easier to deliver those 25% to 35% incrementals, does it actually add on to that? Is it multiples of the Famous 50? Like...

Look, I think that it's part and parcel to our goal to convert at gross margin. You never really get there because there's always a variety of factors and additional costs that get attracted with business growth. But simplistically, when we sit down with our operating teams is the nirvana for an industrial component company is, you basically have a very slick SG&A business operating philosophy that allows you to convert at gross margin and that's our target.

Got it. So I mean, you talked, Rich, about sort of front-end automation. If you may now let's talk about sort of back end or at least manufacturing. So a lot of projects, obviously, across multiple segments. So how do we think about those projects layering in? I think you've said to me before, it's really about '23 and beyond for ESG or VSG? How are they going? Is it harder to do these projects during the supply chain craziness that's out here?

Look, I'm proud of the work that we did during the whole COVID period where everybody was strapped to their desk in their office. So we did make a lot of progress there. Getting some of the work down to the factory floor because of the ability to deploy personnel and everything else. Some of that work was deferred. I think that we have some footprint projects that we would have liked to have done over the previous 2 years, and we're unable -- we're unable to do so for obvious reasons. So I don't want to go back to the days of 2018, where I think it was important at that time to put some real stakes in the ground in terms of cost reduction targets. From here on in, it's a grind out. I think that we're clearly spending the capital to get this done. So it's not a wish list that we're putting a lot of money behind it. But I think it's going to be very hard for an investor to parse that away from the impact of product mix because a lot of what has been expanding our margins over the past 2 years has been the impact of new product introduction and the richness of the mix, a lot of which has been driven by organic investment or organic capital investment and then that's been further enhanced by inorganic investment.

So it's a good segue to talk about pumps and process in the sense that when I get some investor pushback, it's like, wow, Dover's over-earning in pumps and process. I'm sure you hear that 12x in the last 2...

My favorite term over earn -- everybody should over earn.

It's actually pretty good to over -- I should do that more often. Anyway, so if I think about sort of your growth outlook for pumps and process, right, you got the high single digits to low double digits. Maybe remind us how big is the sort of exposure to COVID because it seems kind of small, number one. And number two, when you talk about sort of your capacity expansions, like how enduring is this business?

Yes. I've tried a variety of ways to answer this question. Look, let's step back for a moment. The Pumps & Process Solutions business is 4 businesses arguably, right? All 4 of those businesses have expanded margins meaningfully between 2018 and 2022. So I think that there's this notion that our biopharma business that we highlighted back at the beginning of '20, I believe, is the sole driver of revenue growth and margin expansion. And if that was the case, and you did the math and the implied margin of that business is 80% or 90% is just unrealistic. So we've done very well in that business. We are really, really proud of the management team that is -- has developed the products that proactively expanded capacity in front before anybody knew about COVID, quite frankly. And that was on the leading foot of technology trends in terms of biopharmaceuticals production. I can't sit here and wax poetic about the biopharmaceutical industry. We are a sub supplier of single-use components into that. There are plenty of market participants. They are a lot smarter than we are about what the plans are for big pharma in terms of drug development and vaccines. We are a rounding error into the industry, but I think that, again, we've basically carved out a niche that has been very successful. And if there's a worry about over-earning. We are expanding capacity in that particular segment today as we sit here. So either we've got it wrong about the durability of the demand or somebody is worried about something that's not to be worried about. And so I'm not -- clearly, the growth rate as that business gets larger by the law of small numbers is going to come down. But I'm not particularly concerned about the operating margin of the segment going forward from here.

So maybe you can talk about the other 3 businesses that -- so you've got industrial applications business, plastic polymers and oil and gas. So maybe talk about where those businesses are versus pre-pandemic levels and where they could go?

They've all grown and they've all expanded margins with the -- on the growth side with the exception of Precision Components, not oil and gas. They've all done very well, I think that we've done a lot of heavy lifting on the cost basis across that portfolio. I think that we've been advantaged because we are a proximity supplier, particularly on the industrial pump business. The plastics and polymer processing business has a long cycle business has been very successful. That's an industry that we like a lot because of its market structure and what we believe the long-term demand is there. The only business that has suffered at all and not meaningfully is the Precision Components business. We think that's a great business that just went through a little bit of a cycle, and it actually expanded margins during the last 2 years despite having a relatively flat top line.

And are you seeing Precision Components now with $100 oil really starting to move?

Yes. Well, let's see how much capital goes back into that part of the sector. Like I said before, I mean, we are a big believer in gas as a fuel source. So natural gas, LNG, CNG, propane, we think that the demand for those types of fuel sources is going to remain durable. Our Precision Components business also supplies components into the wind industry. So it's not as if we're not got fingers in the pie of alternative sources of energy. And as I said before, we stood up a rather large R&D investment in our Houston production facility for compressor testing as pipelines are prepared to convert from potentially natural gas to CO2.

So you mentioned resilient margins in pumps and process. Maybe we talk kind of sort of same question in Clean Energy & Fueling in the sense that I think you -- this Investor Day that you had, you talked about 20 basis points of adjusted margin runway, obviously, ex RegO and Acme, how is that going in this environment? Do you still believe in that sort of margin improvement in the core business?

This is before the Clean Energy side?

Yes.

Yes. Look, I think that the -- that business is not well understood. I would call any investors' attention to the bar stack of the sources of revenue that we disclosed. I think that we've -- we recognize that this issue of ice exposure somehow become thematic negative in a way. And at the time, we had set out some goals in terms of diversifying the portfolio to reduce that direct exposure, our expectation is our exposure there is going to be not overly meaningful 2 years from now. I'll tell you that the acquisitions, it's early days, of course, but the acquisitions that we closed in December, which brings approximately $300 million of incremental revenue to the group and to that segment in '22 are performing very well. And we are very pleased with the management team that came along with it.

So I should ask you a bit about vehicle wash. And I think you've got vehicle wash, systems and software, 2 other businesses within the clean energy. Like obviously, you and your competitor both brought into that business. How do you see it sort of moving forward? Is that also an above GDP business? And do you want to add more to vehicle wash?

It's become quite popular since we made the purchase in 2018. Now having said that, Dover was -- has been in vehicle wash for some time. So it's attracted a lot of capital. I guess the bad news is it's driving up asset pricing there. The good news is, I think that we are right in terms of the secular growth because it's attracting a lot of capital. Look, at the end of the day, our view is unchanged. I think that we were early in our investment there. I think that we're going to have both an in-bay and a tunnel product with the software for operations and payments that it's going to be a compelling product offering to what our traditional retail customers, where profit margins for our customers are actually quite high in vehicle wash and because of that, we think it's got a lot of secular growth behind it.

So moving on to Engineered Products. It's the 1 segment where it seems like it's been harder to turn the corner on margin. You talked about price versus cost turning positive in Q2 while everybody else sort of turns positive in Q1. So maybe talk about the challenge there and the visibility you have. I know it's a lot of businesses. So -- but how do you look at that business and some of your bigger businesses there, backlog businesses, so you should have at least some visibility in that sense.

Look, at the end of the day, there's 2 large businesses in that segment, both ESG and VSG, which are capital goods businesses at the end of the day. So they got the full brunt of with our COVID derivative or however you want to describe it between the chips in availability for the chassis to build -- to do the body building, which is kind of the initial shot fired across the bow. Then here comes raw material price inflation and then here comes COVID because these are big assembly operations, so you deal with the absenteeism and all that. We threw it all, our backlog has remained robust. So the markets are not impaired. It's the industry's ability to serve those markets. Economically, I'm fully confident that if we point back to kind of pre-COVID profit margins, we have everything in place to get back there. And at those margins, they're far better than average in terms of capital to capital goods space. So I think the management team has done a terrific job of protecting profits because, as you know, shutting down capital goods plants and the fixed cost absorption penalty you pay for it can be quite severe sometimes. So not only were we able to buffer that at the same time, we were able to manage our working capital that we're not completely out of sorts. So the only way I can put it is that when we look into '22, as opposed to '21, this goes back to your question about over this notion of over-earning, the biggest contributors to profit expansion '22 versus '21 are going to come from the businesses that suffered the most in '21. And I think that, that is a reflection of the overall strength of the portfolio. I mean, at the end of the day, despite everything that happened last year, we expanded margins and grew the top line.

So it's interesting. I mean, you tell me if you agree, but Imaging and ID doesn't get as many questions as the other side maybe because it just kind of does its thing, right? So when you think about it, maybe just the question I have for you is, what's the biggest opportunity in Imaging and ID to sort of grow versus where it is today?

I think that you need to get into adjacencies. I mean, I think that the core business, as you know, is very consolidated globally. So there's really not a lot of room there. There's a lot you can do in terms of internal R&D and developing both the equipment and on the consumable side to deliver productivity to our customers. So that just is an ongoing issue. We've had some forays into ancillary positions there, primarily on software management because if you think about what you're doing, you're putting barcodes on things and track and trace becomes important to clients and a variety of other things. It's an area that we would like to invest for -- if you do look at some parts valuation of the Dover portfolio, it's meaningful because of the stability of the revenue stream and the profit and the operating margins are there. So it's not through a lack of trying in terms of deploying inorganic capital, but it's an industry where between consolidation and asset valuation, you've got to be deliberate.

As textile printing started to come back in a faster way? Or is it still kind of slow without a goal?

I think that the textile industry is finding its footing post-COVID. So I think that it will be better in '22, but I don't think it's going to inflect significantly.

So maybe moving on to climate. A lot going on there, right? Maybe just talk about the sort of core refrigeration business and sort of what you're seeing there. Is this the year maybe towards the second half of the year in '23, we're going to start to see the real margins from the automation project. Like what do you think about that?

Well, I mean, I think that we were positioned to do it last year and for everything that we've beaten to death here, I mean, we just got knocked about, right? The hardest thing in any business is having demand. And that's a short-cycle business, and we are sold out through October. I think we're probably taking orders for beyond that at this point. So the hardest part of the equation is having the demand in the short-cycle businesses that we have it. So we need to get beyond some of these supply chain issues, again, a lot of assembly labor in there that we kind of weathered through January. So we knew when we put out our estimates this year, like first quarter would be difficult, and then we ramped from there. Look, I feel good about this is the year that we deliver on the margin side on the refrigeration. That business is looked at as it's the part that everybody knows, which is when they walk into a retail operator. They see the cases with the frozen foods in it. That is a material portion of the business, but it's not, a, all of the business; and b, the fastest-growing part of the business is actually the systems portion of the business based on CO2 technology that where we're a leader in Europe, and we're bringing that to North America because of the regulatory changes that have now gone on to California, and we believe we'll deliberately spread across the U.S., and that is accretive in terms of margin to the case business. So if we look back at 2018, when we're putting these targets out there, it was all about case because it was disproportionately larger in the portfolio. That's not the case anymore. So we actually have a margin tailwind or let's call it an opportunity that we didn't have then. So we feel good, I think. And this is the year that I'm confident that we can deliver on it.

I think, Rich, you believe that it was a multiyear cycle before CO2 really started to become more important. So how do -- is there a way for us to think about the opportunity for you guys on the system side with CO2 and the longevity of this cycle in refrigeration? What are your customers telling you?

It's early days, right? So the only place that the -- this is -- just talking about North America. It's early days. The only regulatory aspect of that business right now is in the state of California as it applies to new builds of a certain scale. Now if you believe that California from a regulatory point of view is a precursor of what happens across North America. We've seen it before, especially around things related to CARB, which we've got some experience with. What the pace of that adoption is going to be from a regulatory point of view, it's too early to tell. But if you consider that our customers also are being driven by ESG concerns at the same time that are not really driven by regulatory but by -- driven by emissions targets and a variety of other things that there is an interest in that technology that is not solely regulatory driven. So -- like I said, it's early days. We've made some investments on preparing capacity for that into the future. It was the fastest-growing portion of the portfolio in '21. And I would expect it's likely to be the same for 2020.

Got it. And then historically, in covering Dover for a while, I think of Belvac and heat exchangers is kind of small, but growing fast, kind of small. When did they become -- because you're adding capacity, right? So when do they become kind of bigger to think about and still growing fast?

Well, I mean, there's different drivers there at the end of the day. Let's take Belvac first. Between COVID driving demand for less restaurant consumption of beverages, a lot of that move to the home, the demand on can makers was significant. So you had that initial demand and then you see things like energy drinks and a variety of other things. You've got -- so that -- if you go take a look at capacity plans for the bigger can makers, these are billion-dollar projects. So these are 3- or 4-year projects. Virtually every major can makers is expanded capacity simultaneously. So there is a cycle there. That we are capacitizing ourselves appropriately to win as much of that without getting over our [ SKUs ] because in theory, it could be finite. It's also being driven by recycle rates between aluminum and PET. And what happens there is really what is going to affect the long-term duration of this transfer to aluminum potentially. But we are attacking it from 2 different ways. So look, we'll take as much on the can businesses we can get, and we're partnering with all of the major companies worldwide that run canning operations. But at the same time, through Maag, which is the plastics and polymer business, which is in DPPS, we are attacking it from the PET side from the recycling because we think that -- because of ESG and recycling rates that, that is -- which has been historically not a profitable business that, in theory, there will be incentives, whether they're monetary incentives or other types of incentives that we believe that, that is going to be a secular growth opportunity for us. into the future, so we're kind of going at it from both ends. SWEP has been a steady Eddie for us. We love the market structure that we participate in. I think that the management team over the past several years has done a terrific job in terms of moving up the scale and size of the heat exchanges to accommodate this transition to heat pump technology. That has been the driver of growth for that business over the past 2 to 3 years. We are in the process of expanding our capacity in 3 geographies now to accommodate what we believe is going to be a secular growth trends, and we can point to Europe where heat pump technology is the technology of choice for lack of better word. And we believe that both North America and Asia are -- will seize upon that for the productivity benefits and the CO2 benefits associated with it.

So I've only got a minute, so I'll ask you a very quick question. So M&A, we already talked about a little bit. Do you expect the activity in '22 to be similar to '21 given, I mean, it's definitely more volatile this year. So does that help or hurt when you talking to...

Look, I hope so. I think that we've been deliberate, I think that we stuck to our guns in terms of valuation. We never talk about the deals that we don't do, but we looked at a lot last year. I think I'm pleased that we transacted. And I think at appropriate valuation, I find it difficult to believe that we will not make portfolio moves in '22.

We can leave it at that. Thank you very much, Rich. Appreciate you being here.