Dover Corporation (DOV) Earnings Call Transcript & Summary

Thanks very much everyone for being here for the third session this morning. It's my pleasure to have Richard Tobin, President, Chairman and CEO of Dover Corporation. Rich has a couple of slides to go through first. So please go ahead.

How much time do we have, Julian? 29 minutes?

Yes.

This presentation will take about 28.

Then one question for bookings at the end.

I'll hit these kind of quick because these are slides we used at the full year results. About in terms of the outlook, I think we're forecasting 1% to 3%, which is not dramatic. I think we want to get a little bit of handle on the macro going forward. But I think the good news is that our setup in terms of inventory, both our inventory and our customer inventory we think we're in a good shape to cut production proactively in Q3 and Q4, but nominally in Q4 to allow some of the channel to clear. We can talk about bookings. I'm sure it's part of your questions, Julian, as we go through the business. We've done a couple of acquisitions that we closed in January and the divestiture of the stakeholder that we announced will likely close at the end of Q1. So we expect the cash to come in from that. What else can I want to say. CapEx should be slightly down in 2024. We've done a lot of capacity expansion over the last 4, 5 years and some top grading of our facilities as those were onetime costs. So we think we're in pretty good shape. I'm not aware of anything significant that we've got in terms of capacity expansion coming forward. You can see what we've been doing on the M&A side in terms of the in and out and then we forecasted a pretty good year in terms of cash flow that you would expect to see anyway because all of that COVID inventory now has kind of washed its way through the system. So from a balance sheet point of view, we're in the best shape that we've been, at least in my tenure here at Dover. So in terms of M&A and capital return options are in pretty good shape. This is a slide that we used at our Investor Day last March in terms of our growth platforms. I think that Jack's probably updated the CAGRs on the bottom. So things are progressing nicely in terms of what we announced is kind of -- these are all organic. These are not inorganic, these are organic. Developments on our part. So we think that we're pretty excited about what we've got going on here and your typical slide of value creation over time, which we're going to endeavor to continue on in the next cycle going forward. I think that we've got the portfolio in pretty good shape. We think that we've got opportunity to continue to accrete margins going forward. Like most years, we're likely to have some restructuring cost out plans in terms of facility consolidation coming this year yet to be announced, and we expect to cycle adjusted EPS to continue to compound as it's done over the previous 5 years driven by top line growth and the margin expansion. So I think that is the last slide, Julian.

Perfect. Maybe first off, I suppose, the last kind of 4 years, there's been a very dynamic macro environment, your customers, your own business. It feels like you've got passed now that last phase of it, which was sort of inventory normalization. So how would you characterize sort of the demand environment today, supply/demand more in balance? Any sort of thoughts on that?

Yes, I mean, it has been quite dynamic. I mean you had basically the acceleration coming out of the COVID period where I think the top line growth was in the low teens coming out of that. And then since then, the growth rate in terms of unitary volume has actually not been great. So if you go and you parse out top line revenue growth across all the industrial space, generally speaking, a lot of it has been driven by that and not so much unitary growth. It will take a while because of supply chain and a variety of different reasons to kind of that inventory bubble that everybody accelerated out of the kind of unwind. I believe that we were very proactive last year of -- I think we announced more or less in the year that we were going to cut production, inventory to clear. We did that to earnings in the back half of '23. We said we were going to run for cash flow, and that's why we had a pretty decent cash flow target out there. We've delivered on that. What fundamental growth is going to be in '24. We've got 1 to 3. I think that's appropriately conservative. If you think about that side, we will probably get another, [ 1.5 ] point in price, it's not dramatic in terms of top line growth, but everybody is really trying to get an idea of, a, what the macro is going to be and b, this whole notion of higher interest rates and carrying cost of inventory and other. So I think these are numbers we can hit. I think that we got a low pass probably a tough comp in Q1 and then accelerate out of there. But overall, I think time will tell whether this is a soft landing or whether we go into to a GDP plus environment.

And then just sort of going back to the current period or current quarter. So you talked about the tough comp on sales. So there is a year-on-year acceleration filed in sort of. How much of that acceleration is simply the point on home versus restocking of customers with better final demand?

Well, again, I mean, we're talking about 1 to 3, right? So no one really knows what the headwinds of destocking was. I mean, you can try to calculate but at the end of the day, but I don't think anybody is going to predict that right. But the fact of the matter is, there was a significant amount of destocking. We can see it in our own [ liquid ] a lot of our sales go through distribution, so we can do channel checks on that. OEM sales is a little bit more difficult as we saw in heat exchanges in the back half of last year. But so we can see inventories dropping in relatively benign sales environment. So the question is, if you put that back into sales, that is what fundamental demand was. But that is I would say, it's probably in the 1% to 3% last year at the end of the [ May ]. For us, price was not overly meaningful last year, so it's almost a rounding error about worrying about price coming down. So I think that the setup is a relatively low growth environment right now. We can talk about pieces of the portfolio because we believe that some are going to grow quite nicely, and we've got some headwinds in other ones. But any consolidation 1 to 3 downs right until we see a stabilization of how this whole environment solidifies itself. But I think that we've done the hard work, at least in terms of the channel inventory, and I think that's critically important because we can run our factories at a baseline load and not have negative absorption and we believe one of the best ways to protect price is not get over your steps in terms of [ cap ] inventory, and we think that we're there.

And when we're looking at margin, as you said, Dover did not have an outsized price cost tailwind unlike some other companies last year. So when we're looking at kind of margin trends through this year, they sort of move year-on-year with the sales. So first quarter, it sounds like sales down a bit, margins down a bit year-on-year, and both of them accelerate year-on-year [ from that ].

Yes. I mean, look, it's very much a mix issue, okay? At the end of the day, we're not an automotive company where we've got this massive amount of fixed costs and there's a fine band of fixed cost absorption. So we're very much a mix issue, right? So it depends what the comps are during the time period. Look, you saw it over the previous 2 years with biopharma rolling down and we were able to preserve margins like the fact our highest margin business went into a pretty dramatic down draw coming out of COVID. So once we get beyond Q1 and we get into Q2, it's more of a general mix up. So if you think about that, let's take a look on the M&A side, DE-STA-CO is going to roll out and FW Murphy and a couple of smaller ones that we've close are coming in. We've basically replaced all of the lost profit at higher-margin business. So we don't replace all revenue, but what we brought back in from an M&A point of view is less revenue but higher margin. So it's part and parcel to this whole mix up the portfolio over time.

Got it. And bookings, you mentioned at the beginning, they have been under pressure for the best part of 2 years. It seems like those turned the corner last quarter. So do you sort of think we have the entitlement now of kind of bookings growth in each quarter.

Yes, I think that, that is going to be the one that we're watching closely, right? Because it comes back to what do we think that the demand environment is going to be. In total, the one thing [indiscernible] bookings. I mean the fact that bookings were down is only relative to the backlog that we had built up previously. So we knew naturally, that backlog was to come down and that would be reflected in bookings that is extense, that it's pivoted, somewhat I think anybody that's viewing this notion knows everybody is kind of giving out guidance. It's back-end loaded. One of the things you're going to have to look at is booking, right? So that is going to be a clear precursor of what we think the backlog is going to be like. It's going to be interesting because there's a big tug of war going on right now about everybody knows that supply chains have been kind of prepared. So lead times have come then come down significantly from where they were coming out of COVID. So there's a little bit of tug of war where everybody saying, well, can I wait before I bring the inventory in because cost of that inventory is significantly higher than it was in the past. I think there's -- so to the extent that you've got your total inventory in good position, you're in a much better position to kind of manage that situation largely through pricing actions.

And on that point on price, I think you were sort of early last year, the price tailwinds were narrow. That's happening. Are you concerned about sort of where that ends up narrowing? Or do you think we're getting close to the baseline.

I don't think I could ever say the answer to that question, I'm not concerned but I do not expect to come under any significant pricing pressure that we cannot weather. Now we have trade if the volume is up, sure. But under the current forecast for volume demand and all the work that we did in terms of lowering channel inventory, I think that we're in a very good position to defend our pricing position. And by the way, if you go back and look at what we've taken in price over the last 3 years, it's not been dramatic, meaning that our earnings were not [indiscernible] by massive price cost spread that you may have seen out there in a variety of different places. We took price, and I think overall, during the time period, we were price cost positive, but it has not been dramatic.

And then a lot of focus, I suppose, you talked about mix and some of the different businesses there. It seems like some of the biggest swing factors this year on mix, I suppose you'd say it's biopharma fell back in sweat, perhaps leaving aside the acquisitions divestments. So those 3 pieces, maybe a quick hit on kind of how you see those.

Sure. Belvac, yes. Look, we've known about Belvac, we've been signaling that for some period of time. Belvac is a 20% margin business. I think it's something that we can easily weather in terms of that cycling down because it's a CapEx levered business and CapEx and can make in this coming year and last year, by the way, is going down. So that one, I'm not worried about. SWEP is interesting. We are a subcomponent supplier in the heat pumps, and I know that you probably heard about heat pumps that everybody is chasing heat pumps we're in a quasi triopoly in terms of exchanges that we supply into that marketplace. It's only about 30% of the revenue is SWEP. We believe the pumps are going to grow at a time. Like everybody got very excited about volumes. So there was some inventory built up in the system again. Yes, it's a bit of a headwind in the first half, structurally, we think that, that's a growing business over time, and we're very well positioned. Biopharma in the 1 to 3 that we have, we didn't put a lot of biopharma in there this year. We got bunch over the last 2 years of listening to our customers' forecast. So we let them go first in terms of earnings this year. Orders are up, but let's be honest, off a very low base. But I think that we've taken appropriately a conservative view, and I would expect we do not have downside in our view with biopharma. And likely have some side to it.

Great. And so the overall sort of earnings algorithm of the year is we sort of start earnings are down maybe year-on-year in Q1. And then after that, growing each quarter above you through mix and [ immediate ] comp. Is that a fair summary?

Yes. And like I showed you the slide of the growth platforms that's kind of built into our forecast. I think again, there's upside there, I mean, based on what we see in terms of take rates. I told you in terms of where the balance sheet stands, we haven't been active in capital return. And I think that those were likely to be active there, either M&A or capital returns coming into the year? The liquidity that we'll have built up on the balance sheet once the stake or closes. So we'll see about the M&A environment. That's a little bit -- it's interesting. I mean, I think that we -- the vast majority of the assets that we buy are private [ health ] through individuals or PE, those valuations never really came down with the equity markets now that the equity markets are [ rallying ] again. It's going to be interesting to see what expectation is there as a result of higher interest rates. Again, it's a little bit of a low-growth environment for everybody in industrial world. So we'll see as assets become available and how aggressive people want to buy growth going into in '24. I think we've been arguably very good stewards of capital. I think [indiscernible] has been accretive, and we've never done over our [ fees ] in terms of valuation. I think that we've got the opportunity to do larger deals just because of the fact that our balance sheet is in such a good shape. So we'll see. Usually, at the beginning of the year, there's not a lot of activity, but you would expect as we get into Q2, especially monetization out of PE is probably likely where the assets are going to come from.

And on that point of sort of -- yes, that's where you get the source of your deals. In terms of target areas for you, I think DCF and then pumps and processing have been the bulk of the money the last 5 years. Should we expect that to continue that those 2 lines is highly likely. And then I think on the point of those businesses, I suppose, DCF investors still have some concerns around sort of second headwinds there. So maybe update us on how you view the medium-term growth in that segment. Maybe what are investors missing when we focus only on the dispensing equipment.

Sure. I would point to our investor presentation that we did in March in terms of -- I think that, that segment is still viewed as predominantly gas station equipment will go into ICE vehicles where Dooms Day was happening over the last 3 years because of EVs, not so quick here. It's a lot of where we've got cryogenic components in there now. We've diversified it through M&A. So it's not as levered towards ICE as it would have been back in, let's say, '18 and '19. Look, I think it's poised to have a good year this year. Again, that segment itself has got the largest exposure to distribution if I take a look segment by segment proportionality, though there was a significant amount of destocking headwinds that we're going over it, but I think that we facilitated. So we go into this year on a fundamental demand basis. I think that cryogenic components is actually going to have a very good year this year. I think the one that we're watching a little bit is equipment side of car wash only because that's generally an interest rate-sensitive business. I think it's private entrepreneurs. A decent amount of that volume and they're still trying to work their way into the new normal of interest rates right now. But the bulk of the segment, I think we feel pretty good about. And I think we've got aspirations to getting that segment at 25% margin and I think have kind of pathway to do.

Great. And on the portfolio overall, it seems like the announced moves the last few months, DE-STA-CO out FW Murphy in I guess one is when you look at Dover's overall valuation versus some of the parts peers. How do you sort of see that spread right now? And in terms of narrowing the gap, is it about incremental portfolio moves and executing on the base business? Or at some point, do you think maybe larger acquisition or exporter needed?

Yes, yes, yes. I mean, at the end of the day, the fundamental is driving margin performance of the core portfolio, augmenting that with M&A and being opportunistic on disposals an opportunity to create value that was larger, and we do have the optionality from the balance sheet to do that and then do a subsequent move in terms of funding that acquisition if you think about it that way, right? -- bulking up significantly and then spinning out a portion of the business. Those very nice light research reports about it and why don't you do it and everything else. It's a, it's not that easy. And b, I think that we've been very disciplined over the last 5 or 6 years and created a significant amount of value on what was perceived the underperforming portions of the portfolio. But as they reach kind of their nature, if you will, or we believe that there -- from a strategic point of view that we've done as much as we can, and then we'll be opportunistic in terms of in the portfolio. And that's kind of what we do with the stake at the end right? No one valued the stake at 14x EBITDA in our portfolio. But we were able to monetize it for EBITDA and structurally between its reliance on auto OEM and China, it was not checking the boxes. So like I said, we just took the opportunity to be opportunistic. So all the cards are on the table and available. I think a lot of speculation about how easy and go to worry your value at the end of the day, where we're driving performance, taking the cash flow out of driving that performance and then cycling up on the portfolio and when we can't return in the cash to shareholders. And I would expect both of that in 2020.

And the fact that it came out of the Engineered Products segment of Dover. At least on the outside, it looks to be one of the more sort of fragmented segment in terms of business that [ decided ] customer set and so forth. So is that the most logical segment perhaps [indiscernible] .

Well, I mean I would argue that it's not well understood, right? I mean I think it gets comped against capital good peers that have significantly lower margins than the businesses that help in our portfolio. So again, it goes back to this issue of, well, that's capital goods and maybe capital goods has looked, has perceived as lower value. So why don't you sell it? Well, I mean seller [indiscernible] capital goods multiples that's going to get 8 or 9x, the businesses are not 10% or 11% businesses. So again, I think to the extent that we can be opportunistic and get fair value, that's one [ process ] to do it because somehow the EBITDA multiple of the consolidated [indiscernible] magically go up once it comes out, I think it's a factor we would like to make that argument.

And then one advantage, I guess, of the threat is at any one time, maybe there's 20% of the portfolio that's under some cyclical pressure. How do you think about the -- in terms of end of time acquisitions in [indiscernible] or just 2 complex depends what sellers want to do at that time.

Yes. I think you [ end ] time. I mean, things are for sale and when perceived value is on the up and nothing's for sale when we perceive value kind of have a view of where we want to test. And now we've got a view of relative valuation. So if Dover trades at 13x EBITDA, it doesn't mean we're like sitting around and say, well, we can't pay over 13x EBITDA. We look at it as I would argue that you should look at it as from -- and the reason that the segments are constructed in the way we are is to facilitate us of some parts analysis and meaning that when we buy in the higher value portfolio, you would expect that that's the way that we look at multiples of M&A. And on a disposal point of view and look at the same way, and we try to keep that discipline as opposed just looking at it in consolidation, which is it is what it is at the end of the day.

I think maybe one last question before some of the audience response survey ones would be around kind of core operating margins. We've talked a lot about the portfolio and booking the top line you think people forget that there's sort of work on self-help on the margin front. So maybe talk about some of the areas of margin expansion you're most excited about the company's kind of push it through? And maybe on acquisitions, 1 or 2 examples of kind of cost synergies you have extracted.

Yes. I mean, look, at the end of the day, let's look to deal with the M&A [ portion ] I mean paying high multiples to buy, to bring in large businesses is not value creation. That's just mixing up with cash. So the only thing that we buy, we'd like it to have high margins because we believe the objective would be to mix up our margin, but you've got to have synergy value and you need to create value and cash out without naming names just continuing to buy high margin business, that's value creation at one end, and that's nice, and we do that through the corporate development group and everything else, but fundamentally, 95% of management time is spent on the core business and mixed it up in the core business and extracting productivity out of the core business. And that's why you can expect every year that we're going to take restructuring charges, and that's just us intervening and pruning fixed assets that are underutilized in a variety of things that we can do. You're going to see some more of that in the year coming. We've done a lot of work in terms of we got a little bit of stick over the last couple of years in terms of CapEx as a percent of revenue and that somehow were capital-intensive. I find that funny. It's like at the end of the day, we're not that capital intensive, but a big driver of the margin accretion that you can see in some of our businesses was because we reinvested in the physical assets through automation and a variety of other things, we will take a look, I think in 2019, we did about 8% margin in refrigeration. I think in Q4, we did 16% margin, right, and that is by intervening on the asset base and driving productivity. So that's where all the work is. The M&A is the sexy part, but it's easy to go buy things at the end of the day. The hard part is locking and tackling and driving the margin up. And I think that we believe that we can get a Dover portfolio to 25% EBITDA margin, and we're tracking that way.

I think we'll have to switch the audience response questions, so people can please answer the first one, there's 6 altogether, so it's pretty quick. Do you own Dover stock today.

[indiscernible], please.

So fairly unowned, so a lot of opportunity there. Second question is around general bias positive, negative or neutral. So fairly positive or neutral. Third question, through cycle earnings growth for Dover, versus the multi-industry average, above in line below.

I'll put my slide up again.

So generally in line with peers. Fourth question, what should Dover do with excess cash? There's clearly a broad list there? So generally, buybacks or smaller deals. Fifth question, what PE multiple should it trade on current year earnings? So generally high teens. And then last question, what's the biggest kind of share price headwind? Or why do people not own more of Dover. Clearly the biggest issue. Great. Well, thanks very much, everyone, and thank you Rich.

Thank you so much.