Dover Corporation (DOV) Earnings Call Transcript & Summary

So with that, we kick off the next session. So really excited to have Dover's President and CEO, Rich Tobin. Rich, thank you for being here, and he had some prepared comments. So why don't I kick it over to you, and we'll get to Q&A after.

Sure. Thanks, Joe. I'm not going to spend a lot of time here. This is the first slide of our Q1 performance. So I mean, the takeaways here is, we didn't change guidance for the full year and the top line growth and the amount of our backlog is up 54%. So in terms of the demand function, right now, we're seeing good things. This gives you a historical perspective in terms of the performance of the company since 2018. I will call them to attention to anybody that's beginning to worry about a recessionary environment in the future. If you take a look at '20, which is the COVID year, which is a proxy of demand decline, you can see that we actually increased margins during that period. And I think that puts us as an outlier in the industrial space. And you can see the CAGR in terms of earnings per share that we're projecting through '22. We think we have a business model that this -- that type of performance can continue in the future. My models will just take this one head on since it seems to be the grand debate in the multi-industrial space between book-to-bill and order rates and backlog. I think that we've been relatively forthright for some period of time about the post-COVID demand increase in terms of the backlog, which was further exasperated due to supply chain constraints that naturally that the backlog would have to come down, which would be reflected in order rates over time, but for whatever reason, people have a difficulty understanding it. I think I would call your attention to, if you look historically between revenue and bookings that they're very closely correlated. So if that was to continue into '22, then that would basically say we're going to do $9 billion plus in revenue, which is well outside of our guidance. So we've not been trying to massage these numbers at all. The fact of the matter is that lead times for a variety of difficulties, the acceleration of the demand coming out of '20 and the supply chain has built up significant backlogs, right, that over time should normalize, and that's a healthy thing because that means that supply chains are normalizing, that lead times are beginning to come down, and then we go back to a more normal book-to-bill that we've seen historically. So I'm a little bit confused while somehow people are latching on in terms of the decline in orders. We're not a distribution company that we're shipping all of our products out of our warehouse. We've got a combination of both short-cycle and long-cycle businesses in the portfolio, so the dynamics of taking a look at just orders or taking a look at just backlog without comparing the two, I would argue, is laziness. I will tell you that you see the backlog strength continues to build. So as we get beyond Omicron and we begin to see supply chains not quite normalizing yet, but they're getting better than what we had seen in Q4 and at the early in Q1, our backlog still remains healthy, and anecdotally, we're just closing April now, and that remains the case today. Part of our strategy is to continue to invest inorganically. This is a slide we give out often in terms of where we've been deploying our capital. And I think let's go to this one, and we announced, if you did not see it last evening, the acquisition of a company in the biopharma space, which we report in the Pumps & Process Solutions business that has seen significant growth and margin expansion over the last several years in a company called Malema. I would call your attention to the space, I would call your attention to the patents, which is incredibly important, which is reflected in the valuation. This has been a privately incubated deal. I think it took us 2 years to close it. So there's a lot of hard work behind it, but we're really happy to bring this into the portfolio, and it is a component that fits into what we're already supplying into the biopharma production space. Speaking of which, here's the recent history of what we've done in terms of building a platform within Dover. And you can see historically, the time line of the acquisitions that have been made. And if you take a look at the bottom left-hand corner, there's a grand debate of this COVID demand and overearning and everything else. We'll just give you an idea. I know that Joe's upset that we didn't put the actual numbers on the chart on the bottom left, but that gives you an idea of the sizing of the CAGR that we've seen since 2020. We believe that -- we clearly recognize that COVID did push demand quite a bit. But more importantly, we believe if you take a look at the investments that are going into mRNA production for broader pharma outside of COVID, it is significant, and we are hoping to be a participant in that going into the future. So Joe, that is my opening comments, so we can go to Q&A.

No, that's great. Why don't we just start with backlog since that's where you started. So I agree with you. I think that the market is overly fixated on decelerating growth. I like that slide that showed that you had about 38% of your revenue number in your backlog in 2021. Just maybe just talk about the visibility that you have to your growth number this year? And then also how that then plays out beyond this year? I know it's hard to talk about 2023 already.

Sure. Well, I mean it says already at the top of the slide to the extent that we have visibility. And when you're a manufacturing company, the more that you can see into the future you can be more efficient on the production floor as opposed to filling orders and dealing with changes in mix, month after month. As you can see, because of the size of our backlog, the majority of our portfolio right now is sold out or covered from a production point of view for the balance of the year. So it's just purely a question of producing the product and getting it out the door. And despite having some Omicron issues in Q1 and we've dealt with the whole Russia issue, and now we're dealing with China and everything else, I don't think that those are, I guess, manageable as compared to what we've been through in the previous 2 years, quite frankly. So unless you want to make an argument that it gets worse from here, we've got line of sight in terms of our revenue and the implied profitability through the balance of the year.

Yes, that's an important distinction as well. I think that there's been a lot of discussion just given the kind of hyperinflationary environment that we've been in, the pricing that's coming through on the backlog. So again, maybe just kind of parse out for us how you feel about the confidence in the pricing that's going to be coming through?

Well, we spent a significant amount of time of it. And if you look at the back half of our performance last year when commodity prices accelerated and we ran into all the problems with the supply chain, I mean, it was dilutive to certain portions of our business. And unfortunately, because we were coming out of COVID, you had a backlog that was significantly higher than normal that had already been priced. Now we did not aggressively reprice backlog. So it takes a rolling period before you produce that older backlog as you're raising prices into it. I can tell you anecdotally that we were positive in Q1, slightly so. We'll be more positive in Q2 and then will be significantly more positive in Q2 and Q3. And they will be in the areas, if you go take a look at sequential performance last year, where we suffered the most in this back half of '21 is where the accretion will manifest itself.

Which would be in like the Engineered Products business, the sustainable climate and sustainable technologies business, i.e., refrigeration, which is your longer-cycle backlog? Correct?

Correct.

And then I think that there's the implied incremental margins are, I don't know, 45%, 50% in the second half of the year. But again, going back to the second half of last year, there was some deterioration in those businesses because of the pricing mechanism and so you're just lapping?

Yes.

Okay. cool. All right. So we dug right into it, but let's take a step back.

Sure.

You're the first to report? Right? A lot's happened in 2.5 weeks.

Yes.

So maybe just provide an update? How is 2Q progressing? Any of the key topics that you want to highlight, I'm sure we'll dig into all of them, but...

Look, it's -- forget the equity markets for a moment. It's a volatile macro environment. So generally speaking, what we do is we give out full year EPS guidance and revenue guidance and EPS guidance and then we refine over time in normal years. Unfortunately, we really haven't had a normal year around here since 2020. And so because of that, as we gave out the full year guidance, we were pretty explicit about Q1 that at the time, we said it would be a reflection of the performance of Q4, but sequentially better in terms of margin. And quite frankly, we hit the number, whether anybody liked the number or not, it's the number that we basically guided to. And so because of everything that's going on today, that we did pretty much the same when we reported Q1 that we said that Q1 would look in terms of absolute profit like Q2 would like Q2 of last year in terms of absolute profit, recognizing that absolute profit was at its peak in last year, right, because of the fact that the seasonality got inverted between post-COVID versus a normal seasonality. So just to try to manage expectations here. And I get it that it basically says, well, the squeeze on the backhand loading and all the concerns of -- is anybody just delaying the inevitable? No, we're not delaying the evitable I think that we've gone through why. We believe that we lap on easier comps. We go significantly positive on an existing backlog, and we don't have to find the orders in terms of price cost that allows us that we're not overly concerned about this notion of squeeze into the back end.

Makes sense. China, so just -- can you just level set how big China is for Dover? When you guys reported, I don't think you quantified a potential impact or how you see that playing out, either this quarter or for the rest of the year?

It's 7% or 8% of our revenue. We did not quantify it in order to give any comments how it's going to play out because we don't know how it's going to play out, quite frankly. We had production stoppages. We just got our printing and ID plant in Shanghai started a week ago. And let's hope it starts and doesn't stop from here. But I can't tell you really what's going to happen there. So I mean, we'll manage it from our own domestic demand point of view because part of that 7% to 8% is not produced in China itself. So it's the revenues recognized in China. So some of that is products that have shipped either from North America or from Europe into China. And we'll see. I think it's the more concerning part in terms of the Chinese shutdowns is on the supply chain side because virtually all electronic components that any industrial company buys likely are coming out of China. So we're going to have to continue to deal with that.

Yes. So maybe just touching on the supply chain then for a second. I think you guys are seeing probably some of the more acute pressure in your Engineered Products business, the fueling business, maybe the imaging business as well. How much of this is mostly chips versus are you dealing with extra labor costs on installation installing, Just want to understand that a little bit better?

Yes. I mean, it manifests itself in clean energy and fueling and printing and ID, mostly to a certain extent on the refrigeration side, but it's much more manageable than it was last year, not so much on engineered products. I mean, I think for the most part, we can -- that was more of a raw material issue as opposed to subcomponents coming out of China. And now we're beyond that, both in terms of supply and price stability from there. I think we'll muddle through, but it will make results that you won't see because their inter-month is a little choppy. So we get -- we build up units, we wait from motherboards, and then we install the motherboards, and they go out. So it makes inventory fluctuate quite a bit and it makes us race around at the end of the quarter to get that whip shipped out. I think it's manageable, and I think it's built into our forecast for the balance of the year.

Okay. You touched on pricing a little bit more. So I think the comment you made at the quarter was that you're going to squeeze price cost in Q2. Does that mean you're going to be turning breakeven or turn positive in 2Q?

Well, we were slightly positive in Q1. It will be more than slightly positive in Q2. And then in the back half, it actually becomes material because that's in engineered products where we had the big lag because of the steel cost and everything else. So I mean, I think the good news is, we're not over reliant on the 2 segments of the business that allowed us to meet expectations in '20. We don't need another year of that again, and so this notion of the COVID demand and what's going to happen to Pumps & Process Solutions. And when I said something to the extent of 30% as the new normal, remember that we increased margins by 790 basis points in '20. And at the time, we're getting questions about when is it going to go back to 25% again. So somehow staying north of 30% being an unacceptable result is, I don't want to say unfair, because nothing is not fair. But -- so I think that we're in good shape that we're not over-reliant on portions of the portfolio that have done well in the previous 2 years.

We'll get to that 30% comment in a second. It definitely caused some consternation. Just sticking with pricing for a second. I thought it was interesting commentary on your point around surcharges from here. So I'm just curious, like, are you starting to get any pushback? I mean obviously, the pricing discussions are never fun with your customers, but like are you getting more pushback from your customers on price receptivity?

Look, no one likes free to raise prices, that's a fact. But I think that there's a general recognition that prices across the broad swath of the economies are going up, and the demand function remains very strong. So there's almost a see-through. It's more important for me to get the product than to worry about what I'm paying for it. That just can't go on forever. I mean let's be realistic. So we're trying to manage a variety of different things. Do you want to force demand destruction, clearly. And you're trying to set up '23, where you don't have volatility in terms of demand because of people waiting for pricing to either come up or move down. So from here, where, like I said, we go into the back half of the year that we move into a credit position in terms of price cost, which is great. Let's not get over our skis where we think that we could do that again in '23. I think we need to manage the top line for '23.

Yes. If we get into an environment where commodity costs start to come down, inflation is better, maybe deflation, that would be nice. Do you feel like there's a portion of your pricing that you might have to give back?

Part of it, if it's surcharge for sure, right? I mean that's just the nature of the surcharge. It's going up because of an underlining tied to a, let's just say, a metal price and then it would unwind based on futures and there's timing difference and everything else, but that's the nature of it. I mean, in very -- I mean, it's interesting, right? I mean we tried to get in front of this issue about backlogs and order rates. And apparently, I must have been yelling into the wind over the last year. If we run into a situation that pricing begins to moderate, right, then that is going to be to the detriment to the top line in '23 and everybody is going to panic. And they shouldn't really because at the end of the day, if you're price-cost neutral in an environment where you're raising prices a lot, that's to the detriment of margins. So you could envision a scenario, a low-growth scenario in '23, where the top line is moderated negatively as opposed to positively, like you see in everybody reporting now, but margins going up. I'm not calling it right now, but I'm just trying to caution there's a variety of people that latch on to individual metrics and declare victory. That is a plausible scenario.

Okay. That's -- it's a fair scenario. And look, for what it's worth, I think a lot of the investment community gives you kudos for being front footed on this stuff.

Only my children can admire me, I'm fine.

All right. Let's move on to the Pumps & Process business.

Sure.

I'm most reluctant to bring up the comment as you -- but I'm going to bring it up anyway. You mentioned air pocket on the quarter. So just step through what you mean by the transition from COVID to non-COVID type therapies in your biopharma business?

Well, we -- I think that we all understood that there was a significant amount of demand in terms of -- across the pharma complex to deal with demand for vaccine therapies. So -- as, thank God, we're kind of getting on the other side of this, the demand function is going to decline over time, and we've understood that for a period of time. Having said that, we've actually expanded capacity during that time period, not necessarily to chase COVID. Now we were a winner during COVID, for sure. But we knew that there would be a transition period coming up that would be reflected in the order rates that you've actually seen in Q1. And you may see in Q2, although I think the April stats are actually quite good in terms of the order rates right there. But stepping back from a moment, what we're more interested in is the production aspect of these types of therapies that are outside of COVID. And you need to -- I would point to 2 things. I think there's a significant amount of research around mNRA (sic) [ mRNA ] that has not been applied to vaccine therapies that its applications are widely diverse number one. And I would point to, we are a subcomponent supplier into systems. So our customers are the system suppliers and if you go take a look at what they've announced in terms of their own capital spending, we're just following into that. So forgive me for saying, what was the word?

Air pockets.

I already -- never say it again. So I forgot, I'll never say air pocket again. That was just the transition time for everybody to reposition themselves away from COVID production into this production. So is it going to be detrimental to the top line and to the mix of DPPS in '22, yes, right? But that has always been factored into our full year outlook in terms of EPS and revenue.

You got to stay away from high watermark, too.

Yes. I'm going to carry it on a 3x5 card with things you can't say.

All right. The other kind of area, consternation, 30-plus percent margins still incredibly good. And to your point, a year ago, folks wouldn't have thought it was even doable, right? So they're great on one hand, but you've gotten to 32%. So the consternation is like we're expecting then a step down in margins in the business in the near term because the mix of the business is actually changing?

Well, the actual margin performance of the business, if we're talking about the biopharma business, is not going to come down. But the mix effect on the segment because of the participation of the weighting comes down, so it's detrimental to the segment. Having said that -- and remember, there are portions of that segment that are not at plus 30%. And to the extent that those portions of the segment grow, let's talk about precision components for a moment, then that is going to be negative to the consolidated segment results. So latching on to this notion that it was all biopharma and then somehow that the biopharma margin comes back down, that's just not correct that the biopharma revenue is going to come down in '22, not meaningfully, but I think that we can -- I think it's on the chart here without putting the numbers, I'm sure we'll get a sexton out and try to measure what it means there. But we recognize that, that portion of it is kind of shrink over time to be replaced by further demand once we make this transition period, and to the extent that something like precision components, which is levered towards natural gas transportation spending. So you're thinking about compressor components for pipelines and everything else, the amount of CapEx after a 3-year period of virtually no CapEx going to that segment for all the reasons we can understand now the CapEx is going there, so we'd expect over time the revenue of that particular business to increase, which is great. Unfortunately, it is dilutive to the consolidated margins. But in absolute profit, which we're all working on improving, it's a positive.

Super helpful. I'm going to open it up to the audience in one minute. Just I'll ask you the question on M&A since you didn't announce the Malema deal, am I pronouncing it correct?

That's correct.

So you guys have been super active over the years. I think you have another chart that shows how active you've been. Just talk to us about like some of the more recent acquisitions that you've done because you've done some stuff in the fueling business, which I think gives you some cryogenic LNG exposure. You're now increasing your precision components on the biopharma business. How does the pipeline look? Talk to me about these deals and why you're excited about them?

Yes. Look, I think we're really excited about the acquisitions that we did in what the renamed Clean Energy segment. which is RegO and Acme, both Dover like companies, subcomponents, super great brand names, really good margin. Acme is a free option on what's going to happen in hydrogen. So we think that, that's got some really interesting growth prospects in the future. And in terms of margin contribution, both of them are accretive to the consolidated segment. So real earnings with real -- with margins, with secular growth behind them. And we don't think that we're done in terms of exploring in that space as we gain confidence in terms of having that exposure there. On the biotech side, I think we've talked about enough. We -- that is a platform that's been built underneath what was an industrial platform over time. It is significantly larger, as I showed, which is on the chart there than it was when we kind of introduced it a couple of years ago in terms of -- when we did a -- it's doubled, it's got 50% CAGR, so it has doubled in sized over that period, we would like to continue to build around there. You have to be -- these are high growth, pretty expensive assets. So you have to be really creative to find them. That's why I mentioned, it took us 2 years to close Malema. Overall, the pipeline remains good. And I guess you're going to ask the question of, are valuations coming down reflected of the equity markets, not yet. I think that's probably going to take some time for that to happen, but there are some companies that are introducing new technologies that really don't have the cash flow that would have been able to raise equity in the past. That's probably less likely now. So that makes some of those niche. We like to buy a lot of -- what we do is to buy a product, not by the company itself, and that Dosatech and MTEC and Quantex, the ones that we see in DPPS are very small companies but have some really interesting IP that we believe that we can give the network effect just coming into a bigger company. So overall, damn the torpedoes, I mean I think that when we haven't been that active between 2018 and 2019, '20. As COVID '21, we actually came back into the marketplace. I think that '22, we've got a lot of interesting things in our pipeline.

Let pause for a second, turn it to the audience to see if there are any questions.

Thank you. Earlier, you made some cautiously optimistic comments around the supply chain. Do you attribute that more to your own self-help efforts in broadening out the supplier base or reengineering products? Or is it more a broader t**g out of some of the logistics and labor constraints?

More of a broader comment, but we have, like everybody was forced to do, do a lot of work in terms of diversifying the supply base. I think clearly that we, generally speaking, we're a proximity company, meaning that we source our subcomponents within region. But I think the entire industry in certain product sectors have gotten complacent. So -- but broadly speaking, it's -- if you take a look at container freight rates and trucking freight rates and a variety of other things that are coming down, we're not dealing with the backup lead times that we saw in the Port of Los Angeles a year ago from now, are beginning to improve quite a bit. So it's a general commentary. We're not dealing with -- we're not shutting plants down, in the second half of last year we were curtailing production in a meaningful way in certain parts of the portfolio. We're not -- we haven't been doing -- outside of January, which was more COVID-related, we haven't been doing that over the last 3 or 4 months.

Any other questions from the audience? Back left.

Could you speak a little bit about how you're managing backlog and the situation with surplus demand that we find ourselves in? I mean, is there anything you're doing in terms of, I guess, creating more firmness in those orders, prepayment conventions. I mean just anything you're doing a little bit differently there?

Yes. I mean all the positives of having a big backlog is the visibility and you can kind of arguably plan better if supply chains are working normally. That's all great. But I think that we take a look at backlog, too, in terms of, is it real. This whole notion of overordering, right? I can tell you in the long cycle businesses, those are bespoke-built-up products. So you really can't -- they've got deposits in a lot of cases and things like that. In the areas of the portfolio where it is more short cycle, we're continually pinging reconfirmations on the order, meaning, I know you ordered this 6 months ago, but now we're within 90 days. If you don't reconfirm, we're throwing you out of the production schedule, right, to manage if -- we're not seeing a lot of that, but clearly, with backlogs the size they are, we're doing a lot of different things to make sure that we're not just getting -- being complacent in terms of managing that backlog to maximize profitability into the future. And it becomes increasingly important as we start to try to get a view of what's going to happen in terms of the demand function of '23. I think I mentioned earlier. Right now, April is just coming in, and our backlogs are not depleting. So we're pulling it apart, operating company by operating company, but just like any other question I answered about Dover because the variety of different types of businesses that we have, any answer I give doesn't apply to all of them. So they are uniquely looked at depending on long cycle, short cycle.

Are there questions? Guess, I'm going to have to ask you an EMV question. Just maybe...

This will be the last year. Okay. Go ahead.

Okay. So it will be the last year. How are you thinking about the headwind for your business in this year since it will be the last year. And then also just not related to -- or maybe related to the dispensing units, like just your confidence in shipping the backlog through the end of the year, given that, that's been -- assuming supply chain doesn't get worse from here? Maybe touch on those 2 things.

Our forecasts accommodates EMV roll off. I think that we were right last year in terms of what that was in terms of revenue and profits. I have no reason to believe that we're not right again this year in terms of what we factored in there. I would just tell you that the vast majority of the volume was shipped in the first half of the year. So from a comp point of view, Q2 will be really the last EMV shipment material shipment in terms of volume and mix. And look, we've got a -- I think that was not well understood, and we probably could have communicated better without getting into this issue of amortization on margins in the Clean Energy segment, which we will endeavor to get that cleaned up when we get to Q2, so everybody does not have a heart attack about amortization of intangibles. Well, we failed to communicate appropriately, I think, it was on the Clean Energy businesses that we brought in, that the lowest profit margin quarter of those businesses is Q1. So we write all your orders for that business in Q1 and then you begin shipping over the balance of the year. So while those 2 businesses are accretive to profits on a full year basis or accretive to the segment on a full year basis, they were actually dilutive in Q1. So we got this big slug of revenue that was dilutive to the comp period. You had EMV, which is accretive. And then we had this amortization thing, and then everybody -- that's a bit of a footfall. And obviously, I got worried about Clean Energy's margin profile for the balance of the year. I can tell you that it's -- we're -- I think that we're going to end up being very pleased with the performance of that business, both the legacy business and what we brought into it in terms of revenue growth and margin. On the dispensing side, yes, it's a big pain in the neck. So whether that makes the results lumpy or not, it's hard to say. But like I said, you've got such a tailwind coming on the clean energy side, I think it will mop up any issues that we have dealing with subcomponents on the dispensers.

And Rich, I mean, obviously, the follow-on question there is you think we're through it in 2Q on the EMV side, your frontiers out there saying that there's a cliff in 2023 for their business. Just curious, like, I'm sure you guys have done the comparison, like, why do you guys get through it much earlier than they do?

Yes. Cliff should be put in the same category with air pocket apparently.

Sorry, sunset, they used sunset.

Look, I'm not going to sit up here and talk about what another company says. I just think we have a handle on it.

Okay. Fair enough. Just on the Climate and Sustainable Technologies business, so Belvac has been a great story last couple of years growing over, I think, 40% was the number, heat exchangers up in the 20s, just talk us through some of the dynamics that are impacting those businesses right now?

Well, I mean I would -- on the Belvac side, I would just point to the big can makers and what they've announced for their capacity expansion plans when we are a supplier into that capital spend, we are part of that capital spend. The drivers are a lot of -- during COVID, less restaurant supply of drinks, more individual cans. That's coupled with the ESG PET versus aluminum, which is coupled with a lot of different new shapes that you see in terms of energy drinks and everything else, which makes you spend on capital every time you change the shape of the individual unit. We think it's a secular growth story. We're capacitizing ourselves not as if it's going to grow forever because it's been up by 40% over the last couple of years because of these drivers, but we think that there's been a step change in terms of the demand function on aluminum cans. And you have to recall that once the installed base is there, we have a steady stream of spare parts that follows it out. So we're kind of in the -- right now, we're shipping the units, we would expect to convert a lot of that to spare parts going from there. On SWEP and the heat exchanges, we are expanding capacity in all 3 -- or 3 out of our 4 factories around the world, largely on the back of this transition to heat pump technology in the HVAC world, again. Rather than being waxing poetic about it, I would point to the big HVAC players in terms of what they're seeing. It has been a robust demand market in Europe during this transition. We expect that to continue for at least 2 or 3 more years. It is nascent in North America, but there's a belief that it's coming. So we're investing capacity on the come. So I was just out in Tulsa, Oklahoma, last week and approving all the capital to get that going. So we -- I think that SWEP can kind of look like Belvac over the next 3 years or so.

That's interesting. Any parting thoughts for us?

No. I mean I think that we touched on everything. I mean I'd be very careful about individual metrics and latching on to them. I think that the Dover portfolio takes some time to understand, just in terms of the diversity of the businesses in there. I would tell you that it's worth spending the time. It's not thematic other than the fact that we buy very good companies. I think that we have an operating model that we can improve the profitability over time. And we've got significant balance sheet firepower that allows us to continue to invest inorganically and transition the portfolio over time to create significant shareholder value.

Rich, thanks so much for being with us here today.

Thanks, Joe.