Dover Corporation (DOV) Earnings Call Transcript & Summary

All right. Good morning, everybody. Welcome back. We're going to keep things rolling along here with Dover, and I'm pleased to have on stage with me Richard Tobin, President and CEO. Rich, thanks for joining us. Always a pleasure. I know you have some slides to go through first. I'll let you run through those, and we'll dive into it.

Great. Thanks, Josh. Let's see if I can get these slides to move forward. I guess everybody wants to start with a little bit of an overall trading conditions update of where we are. Trading conditions remain robust against the majority of the portfolio. We continue to book well, especially in the businesses that are driven by current secular growth trends, heat exchangers, clean energy components, waste management, plastics processing, recycling, et cetera. Biopharma demand remains consistent with what we've seen in the trends through H1. So we look at this as something as a tailwind for '23 at this point because we're beginning to get some new orders there in preparation for '23. So we believe that the restocking in that industry will be complete by the end of the year. Price cost is reflecting positively driving margin expansion in Engineered Products. And Climate & Sustainability Technologies, this is pretty much what we expected. So if you look at the calendarization between where we had a lot of headwinds on the input costs in the back half of '21, we said that we'd have to cycle through the inventory to see some positive price realization in H2, and we're seeing that and with some robust margin expansion there. Supply chain, while improving, continues to pose challenges to our productivity. We're kind of -- I know everybody uses this phrase about whack-a-mole, but that's what it is. But it's also having a knock-on effect of our customers' ability to manage their own projects. And that is creating a little bit of a headwind, which is isolated into our aboveground Fueling Solutions business. Our customers -- our inability to keep up with their build schedules is going to depress revenue in that particular segment in the second year. We were pivoting that business because of the EMV roll-off anyway. So we are now introducing plans that will take $50 million worth of cost out of that business, which will be reflected in '23 -- 2023. On the macro, I guess, we can deal with that when we give Josh some questions to ask. FX has deteriorated since Q2. So we now estimate the full year headwind of approximately $0.35 from the original estimates that we had in January. I can give you my thoughts on where that's going from here in the Q&A. From a capital deployment perspective, we're continuing to invest organically behind growth and high-return productivity projects. I think that we've spoken openly in what we're doing on heat exchangers, what we're doing in terms of the capital goods space. I think a lot of that is being reflected in the top line trajectory of those businesses and the margin expansion that we're seeing currently, and we expect that to continue into the outer years. We are in the process of returning capital to our shareholders. So we announced an ASR in August. That will be complete over the coming weeks of $0.5 billion and remain proactive on the M&A front. Right now, there's a lot of noise around price discovery. So right now, the public and private markets are in a bit of a standoff where the private markets still want old public market valuations. And so we're just going to have to wait that out. We've got some amount of projects in the pipeline and could do some smaller deals between now and the end of the year, but the likely scenario is, is that '23, we're going to be a lot more aggressive in terms of M&A under the view that we believe that valuations of private assets will come down over time. Let's take a look at the slide here. Since 2000, we haven't done a tour de force portfolio presentation on Dover since 2018. I think we would have liked to have done it in the 2021 time frame, but there was a lot going on at the time between -- for everybody understands why. I can tell you that since 2018, we've achieved or exceeded the margin targets that we had set. Our organic growth continues to beat forward year expectations, and we expect that to continue into the future. But most importantly, if you recall in 2018, after the Apergy spin, we had said at the time that we were going to focus on expanding the profit margin of the business and then we'd look at broader portfolio moves when we had maximized the profitability of the portfolio. And quite frankly, we needed to deal with the negative effects of spinning out a lot of the revenue of Apergy, and that's why we intervened in the cost base. Since then, if you take a look at the revenue line, we've created scale, both organically and inorganically. And I think that gives us a lot more optionality in terms of broader portfolio moves going on from here because we're not going to have the negative leverage effect on our central costs. And by the way, we've expanded the margins on the portfolio itself. So whether it's a disposal or a spin, I think the valuation will be significantly higher than it would have been in 2018. So we're on the front foot in terms of broader portfolio moves as we transition the company from kind of a [ fix it ] strategy over the last couple of years into more a broader-based strategy going forward from here. In terms of scenarios, which I know, again, want to take Josh's questions, we are preparing for a different scenarios going into 2023. It's interesting out there. Industrial companies have high backlogs right now. So the signaling effect of what's going on is unclear. We're going to take a cautious stance moving into 2023. So we're going to be concentrating on liquidating our inventory balances both in industrial goods and finished products. If we get caught out a little bit in Q1 by not having the product available, then that's a risk that we're willing to take because we believe that we can catch up. That doesn't apply -- that comment applies to our shorter cycle businesses. Some of the longer cycle businesses, the Maags, the Belvacs of the world, well, because of the duration and the size of those contracts, we'll run them as we are. But overall, I think that we've got a recognition that we're going into an uncertain environment. And despite the demand environment remaining quite robust presently, I think that we have cause for caution, and we're going to set ourselves up appropriately for that. I mentioned the material cost actions that we're taking in Fueling Solutions this year. We have several larger footprint actions slated for 2023. And one of the things that we could not do during COVID, while we are working on kind of total efficiency of the group, was we had to pause a lot of what we wanted to do on footprint because we're just unable to execute it because of all the reasons that you can understand, and we've been chasing volume since then. Nonetheless, we've been doing a lot of background work in preparation for that. So I think that what you can expect going into 2023 is a meaningful intervention on the footprint to drive further productivity from here. And finally, as I mentioned earlier in my comments, it's been some time that we've done a Dover presentation on the company itself. We've reached the targets that we've set that seemed ambitious at the time in 2018, but I know everybody likes forward targets. So we will be announcing a new Dover company presentation that everybody will be invited, where we will reset targets likely out to the '25 to '26 time frame. And that's the opening comments.

Excellent. Thanks, Rich. You took all of my questions [indiscernible]. Maybe starting off with what you and I were talking about a little bit. I think conversations has been duplicated in the past couple of days as this kind of treasure hunt for bad news. On one hand, it sounds like you have kind of a clear-eyed view and are looking for that in the marketplace yourself. I guess where are you seeing kind of the -- what could be the canary in the coal mine was regionally or market-based that kind of gives you that early warning signal that you're using to apply to some of the other businesses?

I don't think that euro dollar is a pure reflection of disparity of interest rates. Part of the euro weakness is a reflection of growth projections, and I don't think that we could ignore that. And as such, I think that we're going to prepare accordingly despite the fact that the current signals are what they are. Having said that, you've got to be careful about looking at the pie charts that we give you about the dispersion of geographic revenue. We use Europe as an export hub far more than we do North America. So you think about businesses like SWEP, think about businesses like Maag, those are net exporters out of the European production base. So there is some -- it's not a question of, hey, Dover is 40% or 35% or [ 40% ] exposed to the Eurozone and let's put a negative view on that. I think you've got to be cautious about that. But having said it, on our short cycle business, as I mentioned in the comments, I think that we are going to err to inventory depletion early on. We operate in very concentrated niche markets. There's not a lot of optionality to go somewhere else. So -- and unfortunately, we've trained our customers to be late on a lot of deliveries in terms of supply chain. We're just pretty much going to have to continue that by willfully drawing down working capital.

And you mentioned this a little bit on the backlog front and maybe kind of the confounding view of that, right? It kind of obscures the view of the market. How would you sort of gauge the quality of the backlog today? So like you have these ERP signals, right, from your customers that say, "We have no inventory. Let's order more stuff." Maybe they don't need more stuff. Like how do you sanity check something like that? And how would you kind of view that in aggregate across the businesses?

Yes. I mean the businesses that we have that sell primarily through distribution, we have access. So we can see channel inventory. And for the most part, we're spending a lot of time pinging our distribution network to see where they are in inventory and try to get a gauge of what we believe demand is and what their depletion rates are. Overall, on the distribution side, it -- we're in a healthy position. So there's really no canary in the coal mine. But having said that, if there is a slowdown, everybody tries to slow down at the same time. So the distribution tries to liquidate their inventory before we can basically liquidate whatever finished goods that we've built up to service that. So while we're looking, you need to have a forward view that's outside of the data that you look at, almost intuition, and then you need to have an understanding about how can you flex your production to catch up if you get it the wrong way. And our bias is we'd rather catch up rather than slow down and preserve kind of stable production performance as much as we can because that's a big precursor to driving earnings. When it's an OEM sale, on the other hand, we don't have a lot of visibility at all. And in retrospect, I think that we got caught out a little bit on the biopharma side because we were a massive market share winner with a new product serving the demand. We're not going to apologize for it. We got all the revenue. We got all the operating earnings, and we converted that all into cash. There was excess inventory at the OEM level that's getting bled off presently. We're just going to take that pain this year. We're actually getting orders for '23, and that's a good indication that we're going to have an inflection point or a tailwind, hopefully, into '23 in terms of the demand there, and that's a very high-margin business.

So on that biopharma point, understanding they sort of ebbed and flowed or overcorrected on inventory, any sense on what kind of their point of sale has done? Abatement remained more stable throughout that?

Well, I think there's -- I'm not -- you'd have to talk to the Thermo Fishers in the world and the Sartoriuses. I mean they're the ones that can give you a far more lucid view in terms of that transition. We believe, based on their CapEx plans, that this transition to small batch supply, whereas where we sell our product into, is the winning technology going forward from here. So it's just a question of as everybody's transferring away from a lot of vaccine production to alternative therapies, we believe that's the winning technology. It's just a question of depleting what is a consumable product, quite frankly, in their supply chain.

Got it. And you touched a little bit about the productivity point. I want to spend a few minutes here because you said we're kind of entering the next phase of the journey from fix it to kind of running the business and highlighting the portfolio. I guess, first, just on the productivity side, understanding it's never really over, what are you really focused on today? Kind of where is the big opportunity?

While we were prevented from doing a lot of footprint work because of the reasons that I explained earlier, we have been working very, very, very hard in terms of SKU management. And many of our businesses in preparation to stand up these digital front ends to accelerate our goal for e-commerce, the precursor of doing that is to reduce your SKU offerings in a meaningful way. And in the Refrigeration business, in the vehicle services group, to name a couple, we have meaningfully intervened on our SKUs in preparation, a, to go to a digital format; and b, because of the productivity we get by not making a complex variety of product and basically picking the winners and losers. That also allows you, other than the benefit of the working capital benefits and the ability to price more efficiently, it also allows you to intervene on your footprint because if I don't have to make that complexity of the product, I can make it in a smaller footprint. And so that is what you can expect going into '23 as part and parcel to this intervention on the footprint.

You guys have talked more about automation than most, or maybe you put out more press releases about it, and other people are doing it, but it's good to see it, like it's good to be able to track it. Was there like a tipping point on paybacks where the technology got better or the way you were approaching the business, or to your point on SKU count, you can automate more when your run rates are higher? What sort of drove kind of that investment cycle for you?

Well, I mean if you go back to the beginning, I think that the amount of assembly labor as a percentage of COGS in 2018 was inefficient, right? So it was just purely a question of intervening on the business model and have a convincing argument to say, look, this is something -- there's always inflation in labor. There's been a lot of inflation in labor since we've kicked off these projects. So actually, the returns on these projects are getting meaningfully better as we advance forward from here. But it's part and parcel to -- like we hear a lot about, well, the Dover portfolio, I really don't get it because it's a variety of capital goods. And some parts I like and some don't. We look at it as what is the possibility in terms of earning generation across the portfolio. And if you go look at what is viewed as capital goods type of businesses, I mean, we're talking about getting those businesses at or very close to 20% EBITDA margins, which is quite healthy for capital goods. And that is through really a meaningful intervention on reducing the amount of assembly labor in those operations.

And you mentioned supply chain there. I mean it sounds like it's getting better, and I think some of your peers would agree as well. If I look at kind of the structural changes that precipitate out of this, how are you guys thinking about this maybe transition from, like, triage mode to something more permanent? Or on the other hand, like are your customers viewing it the same way? And does Dover benefit from that? I think you guys are kind of the near-shore option...

Yes. I think overall, we've been a beneficiary of reshoring. If I go back and say that this has been going on, we're kind of almost in year 3 to a certain extent. And so overall, we've been -- I think it's underappreciated in terms of what's possible from a revenue point of view. I think we've been -- because we're, by and large, a manufacturer and supply on a local basis. We are not really complex in terms of our own supply chain. Our supply chain difficulties, if we take raw materials out, which is really a function of '21, that's done now. Raw material costs are coming down and everything else, and the capacity is available. Our issues that we've had with supply chain is with our suppliers, many of which are presenting at this conference because of a variety of the same reasons together. So what we're doing to deal with that is SKU management, right? Because if you can reduce the complexity of the -- if I'm making a refrigeration unit, and I've got 5 different types rather than 500 types, and I can start to standardize, there's not just supply chain. There's a plethora of benefits that we can get at that, and that's what we've been concentrating on. The knock-on effect, as I mentioned in the opening comments, and what we're beginning to see, is where we see inflation manifesting it ourselves is on our customers' level, where this inability of labor and inflation is driving up CapEx, like longer-cycle CapEx projects, to the point where you're beginning to say a lot of, you know what, I need to stop. I need to complete what I'm doing now. Then I'm going to restart it again in '23. And I think that's what we're seeing right now in the aboveground Fueling Solutions.

Got it. On the kind of the inflation environment, you mentioned sort of that the material side getting some relief. I know you guys have a lot of source components as well. It's not all kind of primary conversion. If I marry those 2 together, is that kind of a net deflationary item here over the next little while? Or is that still kind of round 2 inflation, you guys need to be vigilant and aggressive on price?

Yes. Well, I mean I think the raw materials is well understood because all the information is out there, and you can look at forward curves. I find it interesting that in industrial world, everybody is just so adamant about prices are never going to come down. I find that difficult to believe, quite frankly. Those components that are very much tied to raw materials, our customers over time, if, in fact, that there is deflation on raw material side, are going to expect some relief because we've been raising prices aggressively. Having said that, on a rolling basis on raw materials, we're not -- we're -- as I mentioned before, we're inflecting positive, but all we're getting back is where we inflected negative last year. So on raw materials, you're basically pricing the top line to recover your input costs. You're net neutral. Your revenue is going up, and that's dilutive to margins. So I'm not overly worried about the cycle if we have to accommodate other than the optics of the top line. I'm not worried about raw material escalator, de-escalator because that's relatively easy to manage in terms of the timing of the inventory turns and everything else. What I'm interested in seeing is that everybody says that they're not going to give price back in '23. Putting raw...

But you've heard of value pricing, right...

Putting raw material aside, our expectation of our suppliers is not going to be that in '23, quite frankly. And that is going to be dependent on how competitive the market is, right? If there's a lot of competitors in the market into it and into an environment where there's going to be revenue headwinds, our expectation is that pricing is going to be reflective of that because then -- and the only reason I can say that is we spend an inordinate amount of time in viewing our own portfolio under scenarios of the competitive stack. And the reason where we invest is we like to invest into markets that have small TAMs with very few competitors. And by and large, then the pricing element remains relatively stable, and then we think that we can win just on stable pricing and overperforming on productivity. Some of the markets that we've seen over the past 2 years where the demand has been very high, everybody has been able to raise pricing. We'll see what happens if revenue starts to decline and how competitive pricing becomes from there. So we'll see.

Just given the niches, I would imagine it's a little easier to hold on versus like selling to Home Depot.

Yes. Nothing's ever easy, but I like where we're positioned if I take a look at each of our individual businesses and the competitive stack. We just don't participate in a lot of markets with massive TAMs, but also have a lot of global competitors. By and large, they are smaller TAMs and very niche competitors, by and large, are smaller than we are.

So I think we've kind of surrounded the hill here in terms of maybe what the end result is. How do you think this kind of plays out in orders? You guys have had kind of the unique position that's taken a while for people to understand. And I think you know what...

Yes, I know.

In terms of orders down, but book-to-bill, positive. Backlog, growing. Is that still sort of the environment you expect us to be here for a while?

Yes. Look, I think that we've been booking well and continue to book well. But the fact of the matter is that backlogs were aggressively high for all the reasons we understand. And so book-to-bill naturally is going to have to come down over time. But if you look at the aggregate value of the backlog and then project that into '23 in terms of our total revenue versus the backlog, I mean, we feel that we should get off to a good start just depleting that backlog. What's over the hill? I think -- I repeat myself. I think that we are going to take a cautious view in terms of the amount of working capital we carry in until we see what's going to happen with the backlog going forward.

Got it. And then just pivoting over to the growth side, you guys have done a really good job of outlining this with like the mini Analyst Day on biopharma and stuff like that. If I had to add up kind of these niche markets like that where they've just been not silently compounding, but like from an [ aggregate ] perspective, hard to tease out, add up all those markets across the business, what percentage of the portfolio do you think that is?

Look, every year, we give out guidance and we give out a revenue growth number, which gets modeled in, in that given year. And then the outer year, we are modeled in bottom quartile, despite the fact if you look at the slide, we have a track record of beating that number in the outer years as we roll forward. We've just gone through a strategic planning process. We feel good about the growth of the vast majority of the portfolio. I don't see any reason outside of the macro of what's going to happen with interest rates and the knock-on effects from that. But we feel very good about where we're positioned competitively, what markets we're exposed to. And then additionally, which is not a growth comment, we've got enough in the pipeline that even at flat growth or, hopefully, not negative growth in terms of pure cost takeout that we can meaningfully offset that going into '23. And that, by and large, is the way that we look at every year sequentially, outside of the COVID year. But even if you look at the slide in the COVID year, and you look at the revenue dilution that we had between '19 and '20 and look at the margin performance, I think it's -- it says that if you want to have a dire view of '23, and many do, I think that we've got the ability to intervene in our cost structure to prevent -- to protect profitability.

And then last question for me, and I want to open it up to the room. You talked about this transition from kind of the portfolio strategy perspective. What should we view as kind of the mark of that formal transition? What kickstarts that? I guess we'll probably get more detail at this Analyst Day, a date to be named later. But maybe just high level, sort of what marks that transitions early for you?

Yes. I mean like I said, I think that there were -- we've put some aggressive targets out there that we were in a fix it mode, that if we wanted to monetize portions of the portfolio, we're going to maximize the value of them. We've reached those targets. So at least our optionality in terms of the return that we'll make is better than it would have been just going through this notion of get everything out that's got a low margin in it because it's going to make our margins go up and in life, we're going to look like heroes. So I spend a lot of time doing that. More importantly, again, is if you go back and look at $7 billion to, let's call it, $8.5 billion in terms of revenue, we've reattained the scale that allows us to be -- to have more optionality, if we wanted to be creative about portfolio moves, both in and out. We don't have the problem with stranded costs that we would have had back in 2018.

Got it. Got time for a question in the room, if anyone has one.

Question I have is it relates to sort of the working capital, and this is not just germane to Dover, but your views may be applicable to other manufacturing firms as well. Being judicious in working capital makes sense to me. But when you think about that you're a core manufacturer, and when we think about overhead absorption and utilization, you can sort of draw some conclusions to what that might mean, at least for a temporal period in terms of factory productivity and gross margin production. How should we think about that? Because I think everybody at this [ conference ] probably struggling with that. What does the supply chain look like? What balance sheets look like? Is there a period where we kind of need to work some of that excess often? What does that mean, not just for the channel, but for the actual shop floor operations?

Yes. I mean I think moving faster and early allows you to plan and level load production. Moving late and hard swings you into under absorption of fixed costs and the like. Now I come from a much bigger capital goods background where the fixed costs are a lot higher. And the beauty of this model here is, by and large, we run very medium-sized businesses where fixed costs aren't -- there's just not massive factories out there. So we've got a little bit more flexibility there. But yes, I mean, at the end of the day, if you basically want to take it, you're going to lose production performance clearly in making that transition, but you're better off losing it slowly and early than waiting, waiting, waiting and getting this. And that's what we're trying to avoid, is that spike down because, oh my God, all of a sudden, here comes the first negative data point. And everybody -- I come to generation, I've been around too long now, but we've all been trained to do the same thing. At the first sign of negativity, everybody is going to pull the brakes at the same time, right? And then you're going to have a massive competition of liquidation in total, right? And you don't want to be the one standing there at the end. So I think the trade-off, and it's manageable, is yes, you're going to have to -- you're basically going to lose industrial absorption. You're going to have to cut costs to measure it with that as you're drawing down. The cash flow goes up, so that's good news. But you're trying to avoid this let's run up to this end game, and then you have to -- and then you get basically what we got in Q2 of 2020 during COVID when everybody basically put the brakes on and you saw the detrimental effect of what happens to margins at that time.

Perfect. I see we're out of time. Always a pleasure. Thanks for joining us.

Good to see you, Josh.