Dover Corporation (DOV) Earnings Call Transcript & Summary

Pleased to have Dover with us today. Rich Tobin, CEO, President, and a lot of other things, Chairman. He's going to join us today. I forget, are you diving right in with Q&A? Or did you have some opening remarks?

I mean I've got some opening slides, but they're no different than what we had in Q3. So why don't we just dive in? And then if I need to answer a question with a slide, I'll go to it. How's that?

Yes, why don't we keep it generic then. What's the state of the union from your perspective?

Nothing different than what you've heard from across industries. I mean, I think we knew coming into '24 that revenue growth had been flattered for the previous 2 years because of all the pricing that had gone into the system. And what you see now is more or less the organic unitary growth that we've seen over the past 2.5 years or so. I think that there's a hope of -- with the cost of capital coming down and that will drive some animal spirits going into '25. I think that we feel that '25 is going to be a better unitary growth environment than we've seen over the past 2 years. And so it goes back to -- if we go back to COVID and all the volatility and all the inflation, we go back to hopefully mid-single-digit top line growth rate, 1, 1.5 points of price realization and offsetting inflationary input costs with productivity over time. So kind of the old way that it looked. And then when it comes to Dover, we can talk about kind of -- that's the macro comment, I guess, is the best way to say it.

Yes, why don't we do the portfolio stuff and then for everyone here again [Operator Instructions] but we'll do portfolio, macro kind of current environment, how you think about it, then any kind of subset questions from there.

Okay. Portfolio, we're relatively active on the pruning side, so if I go back in my tenure, when we said back in 2018 that we were going to concentrate inwardly, I guess, and maximize what we thought was the individual businesses we're capable of doing from a margin perspective before we had discussions about portfolio pruning. I think now we're in year 5. We've expanded the margins of the total portfolio quite a bit. We've been increasingly an acquirer at the same time. So we're at more of an evenly balanced -- we've got a pristine balance sheet that allows us to acquire and if we want to -- and if we want to prune, we'll be pruning at valuations that are significantly higher than they would have been back in 2018 and '19.

So what's the goal then, right? I mean, at the end of the day, we're trying to get rid of cap goods. We're trying to focus on, call it, higher-value componentry or subsystems, however you want to put it. Journey is towards an end. I wouldn't say at the end, but you're towards an end. Right?

Well, I think that the sale of our Environmental Services Group is the start of kind of a new era, for lack of a better word. So our expectation would be to use our balance sheet -- well, I mean, to invest organically as priority #1 because we think we have plenty of avenues for doing that, but then from an inorganic point of view, to move the portfolio into businesses that we find attractive that have interesting growth vectors with them going forward.

So why don't we talk about what we're trying to accomplish with the gas platform because I don't know if people totally understand the uniqueness of the approach you've taken in that area and why you think it's such a good bet on growth and profitability.

Look, power demand is going up. I guess maybe we can just agree with that as a statement. And we're -- and electrical power demand is going up. So we've made -- and so you can chase electricity, right? And there's a variety and that's becoming an expensive crowded trade or you can invest into what we think is going to be the primary source of the precursor of that electrical power, which is natural gas. So -- which is an area that we understand because we had legacy positions in that space and because we had legacy positions, we could identify some critical components that we think that will grow over time, particularly in the area of cryogenic gas. So think about LNG, CNG, that type of thing. And so we've spent over the past 24 months, $1 billion plus in acquiring companies and rolling them up to kind of carve out a position in that space.

And to the point, just to emphasize, it's not a bet on 1 gas, right? I mean you're going to be relatively agnostic to this sphere.

Natural gas is the precursor of all alternative gas-based fuel. So that's basically the bet we're making on. So it's not -- hydrogen gets a lot of press, for lack of a better word. Sure, we'll participate in hydrogen, but the fact of the matter is LNG in terms of its size and scope and volume is far more attractive, we'll participate in hydrogen, but it's a little bit of an end game that's probably 5 to 10 years away.

And so maybe talk a little bit about what you're seeing from a pipeline perspective and why you're so confident the next couple of years are going to lead to some outsized opportunities for you in the market?

Well, I mean, I think there has been an enormous amount of quoting being done, and that's everything from new LNG trains through inter-regional pipelines to supply these LNG trains. I think that the permitting environment over the past 3 or 4 years has been not very good. So there has been spending, but it's been relatively held up because of permitting. I think that there was an educated bet that maybe permitting would become easier with the recent election. And so I guess we'll see. But based on what we hear, it looks to be the case.

Yes. I had one -- a different company earlier today or yesterday, [ it all blurs. ] But they basically said, look, I think one of the challenges from our seat -- my seat, investors, is that you don't see all the conversations behind the scenes, you just see the end product, but there's just a ton of conversations, pipeline work that eventually will have to come forward. Do you agree?

Totally. I mean if you're going to deal with the deficit, one of the ways you can deal with the deficit is economic growth. And there is an absolute massive lever to pull in terms of opening up that opportunity. So I'm reasonably assured that, that lever is going to get pulled.

So back to the M&A side of things. I know you've been outspoken about the amount of content in the marketplace that's going to come up for bid. Is it the type of businesses that you're interested in? I mean, talk about your actionability within the context of amount of private equity stock, some of these private companies saying, maybe I don't want to deal with another war or another round of...

The vast majority of our pipeline is in-sourced deals, meaning that our funnel is almost opposite, meaning we don't sit around having investment banking meetings and then find the opportunities and then go and try to bolt them in. All of our -- the vast majority of our opportunities come from our individual businesses. They're either competitors or adjacencies that we have and because of the size of our individual businesses, they tend to be private companies at the end of the day. Our natural competitor is privately-owned enterprises and to a certain increasingly amount of PE that's been kind of rolling up on the side. So we think that because of valuations in the public markets have moved up that a lot of assets within the PE world have stuck, can become unstuck, number one. And publicly traded assets basically are the fulcrum for determining the valuation of private assets. So if you're a private seller and you're looking at the stock market, you're saying, "Well, now is an opportunity for me." So there seems to be a little bit of a confluence here. One would have thought that it would have started in '23 because the handwriting was on the wall with interest rates cuts and everything else. But from what we can see bubbling out there, it looks like it's accelerating. We'll see how expensive some of these deals are. My -- I estimate that we're likely to do a lot more smaller private deals than we are taking big swings at auctioned assets, which just tend to attract valuations that are sometimes prohibitive.

It's more targeted too, right? As far as the divestiture side goes, how are you thinking then about the portfolio? I know there's going to be a restructuring of the segments coming up here, very well telegraphed, I appreciate it. But how are you thinking about what's left to do on the pruning side?

If you're not destroying value within the portfolio, even at currently or what our estimates are in the future, then we're willing to keep these assets in perpetuity. Having said that if we can monetize at an appropriate valuation and it allows us to kind of reduce exposures maybe to -- from a sum-of-parts valuation basis, it's never going to really trade at the consolidated multiple to the extent that, that math works, then we're happy to action it, but we're not a forced seller of any portion of the portfolio. We look at it in a couple of different ways. Look, we've got like more perfect information. We'll monetize from a portfolio assessment point of view, but we'll also monetize if we think that strategically that business is becoming impaired, because of a variety of different reasons. The customers are concentrating, the competitive environment is changing. So we'll action those also. So it's not just purely go by higher-margin business and sell the low-margin businesses. It's a little bit more complex than that.

Yes. No, makes sense. Last one on the kind of capital allocation side, external. What's the capacity sit at today? And then how do you factor in buyback into this equation?

Buyback less so than in the previous cycle, right? Because at the end of the day, the yield on cash deposits is not unattractive right now as opposed to 2 or 3 years ago where you've really got negative carrying cost of cash. So just from those economics alone. And additionally, I think that we're just a little bit more on the front foot from an M&A point of view because the amount of internal work that we need to do in the portfolio has been significantly reduced because of all the work that we've done and we've trained the management teams, they get it, they do it on their own. So it's allowed us to have a little bit more time to be on the front foot from an M&A point of view. But I'm not taking -- look, at the end of the day, if you look at the amount of liquidity that we have, in addition to the balance sheet capacity, are we going to go to 100% M&A capital deployment? I doubt it, right? So I think that we'll be like we've done in the past, we'll be opportunistic on buybacks, and it's an insurance policy, I have -- that we have, I guess, going into '25.

So let's use that as a segue to growth. If I look back to the Analyst Day, what? 4%, 6%-ish kind of top line growth in a, call it, normal environment. We'll talk about the fact that you think we're transitioning to a normal environment in a sec here. But the portfolio moves inherently seem like they're either at the low end making that growth profile that much more achievable or maybe even being additive to the growth. So maybe put the growth profile in the context of some of the recent moves you made on the portfolio swapping almost, right?

I'm going to take a guess that maybe I can blame Jack, if it's not in here -- there is -- I think I would look at it this way...

Now you can compliment Jack, right? So you can do both...

We're going to do top line growth -- relatively modest top line growth this year. We knew that coming into the year, quite frankly, because we had some of our either longer cycle business that had been working off backlogs that have been built in the previous year. So that was going to be a headwind coming into this year. And we've known that's been coming for a couple of years. Let's not get into heat pumps for a moment. I'll take any questions on that in a minute. But -- so we knew that was coming, so we had been investing. And in these particular cases, that's almost 100% organic with the exception of clean energy components, which I referenced before, to try to deal what we knew in terms of the accordion effect of the portfolio. And so that -- near that runoff of that backlog in '24 is 300 or 400 basis points of growth that we had to offset this year, right? And that's kind of why we have a modest growth rate this year. I'm not aware -- so -- and we believe all of the 3 on the right side of the slide have bottomed. So we don't have that headwind going into next year. So even in -- and I characterize this year to be a relatively low-growth environment in unitary demand. So if we get to a modest level of kind of the macro then it doesn't look herculean based on the track record of the portfolio this year.

And the moves you made have concentrated you on the left side of the panel.

What's that?

The moves you've made have concentrated you on the left side of this...

Yes, yes, yes. That's -- the CO2 systems, the thermal connectors, the biopharma and the precision components were all organic capacity expansion or product introductions, clean energy, as we discussed before, that is mostly M&A.

And this basically is the template for why you're confident next year is normal-ish, right, as a starting point, and then we'll see what we get when we get into...

Generally a prudent guide, but I'm reasonably confident in terms of my view on the macro.

So if I phrase it a different way and if you look at kind of the month-to-month cadencing or week-to-week, are you at the point where you're getting more stability in the underlying patterns on orders? Is it sequentially normal yet? Or is it still pretty choppy?

We're -- we went through this phase of backlog explosion because of supply chain and everything else. Then the pendulum swung hard back the other way because of all the inventory that was built up into the system. We're kind of trying to find where we are right now. I think that there's an understanding in the marketplace that lead times have shrunk dramatically. And right now, you can pretty much get most of the products that you want in a reasonable time frame. And coupled with the fact that it's kind of a low-growth environment, your book-to-bills are almost like a make-and-ship situation quarter-by-quarter. If the macro improves and demand goes up, my estimation is that lead times will begin to extend a little bit, and that will be reflected in book-to-bills and backlogs and a variety of other things as we move into '25. So we're not overly concerned right now that book-to-bills are at 1 or slightly below 1 because it's just a reflection of whatever demand is there, there's capacity to fulfill it.

And the inventory side is pretty flattened out.

Yes. Inventory has all been blown out of the system. Arguably, the distributor inventory because they know that lead times are low right now, is lower than kind of normal.

So if I think about your equation for next year, is it as simple as the $300 million goes away, you still have these good growth vectors. And the pieces not addressed on this slide are stable from current levels, and we'll see if they get a little better, right?

There's thousands and thousands of other issues. But if we want to look at it that way, that's a fair assessment.

So speaking of thousands and thousands of other issues, what's your early take on the election, tariffs, impact for you, any of the high-level thoughts?

We would characterize ourselves as winners the last time we went through the Trump tariffs because, by and large, we are a proximity manufacturer, meaning we make the product and source the components within the region that we sell the product. Now, that doesn't apply to electronic boards and things which -- the fact of the matter is all of the global capacity is in Asia. But for the most part, I think that last time we went through this, we would argue that we gained market share during that period. So I don't think it's going to be a negative. Whether it's a positive for us or not, I'm not entirely sure, but I think that we're not agonizing, at least yet, about what's going to happen with the tariffs. I don't believe that Mexico or NAFTA tariffs are at risk. That's my personal view.

What worries you at this point then? I mean it feels like if I think back over the last 2, 2.5 years, we've had a few more stress points, this probably feels the least amount of stress, least amount of concern points in the portfolio. I mean, agree, disagree, what's the pressure point at this point?

I mean there's always something to be worried about all the time. That's -- we're in the business of worrying. Look, I think that the systems that we've been putting in and our ability to extract synergy value across the portfolio that we own, we're not done. And I think most importantly, as I mentioned before, I think the management team gets it. We know how to run it. So it allows us to be kind of on the front foot of being less inwardly focused to allow us to be a little bit more outwardly focused.

So a couple -- just a quick one on the margins before we transition to some of the unique end markets. Where do we stand in the margin journey here? Some of the puts and takes in the portfolio are going to be additive to that profile over time, the internal things you're working on are additive, return to volume growth should be helpful. How should we think about that trajectory?

Yes. I mean, we're in a -- we just came through a 2-year period of mix down, meaning our fastest-growing business were dilutive to our consolidated margin. We are now, we believe, inflecting to mix up, and that is because of portfolio moves and certain high-value portions of the portfolio that are exhibiting the highest growth. So we're endeavoring to get the consolidated segment margin to 25%, and I think that we're going to start -- we'll continue to track that way as we go into '25.

All right. So a couple of end markets here then. Biopharma, how do you think about the growth trajectory there? And then maybe if China doesn't really come back, can that market grow similarly to what it did historically?

Well, we are by no means a proxy to the biopharma market in total. I'd leave that to our clients to kind of articulate that. But we have a particular technology that is sold into the biopharma processing that we believe provides significant value. Are we going to immediately return to the solid days of COVID demand? Probably not. It's probably going to take us years to track there. But we're growing in the 20s right now after a period of shrinking. So how long is a piece of string? I think for now, we're confident that our biopharma business is going to grow quite well into '25.

And is that core end market growth, just inventory levels, meaning that you're finally doing sell in, sell out? Is there an exploration component to it because I know those things do tap...

There was. And I think that, that's all in the rearview mirror. So the channel inventory, whatever the definition of channel inventory is, it's all flushed and there was a -- you can't give keep that product inventory forever. You have to -- it basically becomes invalid after a while. But that's kind of behind us. The demand that we see right now is that bioprocessing equipment systems that have been sold, that are operating out there. So we're not levered to new systems as much as we are, it's the systems that are running every time you change a batch, you have to pull off all these components. They're single use. So it's just as long as the biopharma industry in total, processes, then that is what's driving consumption.

Makes sense. Imaging side, some leading indicators there are turning a little more positive. Do you think that has systemic legs? Or is this just a little bit of a catch-up from some underinvestment?

Yes. I mean if you look over a period of time, it's mid 3% to 5% growth. It's got some pricing power, so you probably get 1.5 points or so of pricing out of it. We think we still have some margin opportunity. If you go back and take a look at the margin performance of that business for us, it's actually been quite good in a relatively low growth environment. And we think that, that has still got some headroom. In terms of M&A, there's adjacencies around there, but because of the concentration of the market. But it's a high-value business that we think will just continue to be a steady Eddie and perform. And every dollar of additional revenue contributes to the mix up of the total portfolio.

Absolutely. Heat exchangers you mentioned earlier, I mean you look at the data coming out of Germany as an example, it's bottomed, right? It can't get much worse...

True.

Is there a true recovery behind this? Or is this -- at least we found the bottom and then when the recovery hits then we're in a better spot.

The diversity of opinion between the market participants, meaning the people that build these actual heat pumps is quite wide, I think is fair to say right now. So we shall see, right? We are a subcomponent -- a critical subcomponent that gets delivered into heat pumps at the end of the day, and we've got the capacity and we've got the market share and everything else. But I think that we'd like to wait until all the market participants opine about what they think about '25. We got fooled before. This is the best way to say it. So we'll allow the end user to say what they think about growth. It can't go lower.

Yes. At least at the minimum, it's floating along the bottom. So the thermal connector piece, got a question here. I know with the gas platform, you talked about how you are at the front end of that curve from an electrification perspective. Does the thermal connector piece tie into the data center side? And what kind of application might that look like if so?

It is basically the connector that is attached to the cold plate that delivers the cooled water to the chip. So it's interesting, we -- our biopharma business is actually a connector business by its nature. It just happened to be really successful in biopharma. So it ended up almost being called a biopharma business, but it actually is a connector business at the end of -- from an engineering and product development point of view, it's a connector business. We've been a supplier into supercomputing for years, who is the ones that actually developed liquid cooling that is basically moved over to the NVIDIA chip stack. So we were almost like the incumbent in the industry of liquid cooling. So to the extent that it's now moved over into these big data centers, we're prepared. We have a -- we built a bespoke facility to accommodate this product line. So we're ready to go in terms of the demand. The demand, as you can imagine, albeit small numbers from a starting point of view, is quite robust.

Any thoughts generically on short-cycle dynamics versus more project and CapEx dynamics. And I'm kind of asking the question from what are your customers saying on the content projects and getting those to move forward more aggressively versus -- and compare and contrast to kind of the short cycle commentary they might have or the buying patterns they might have?

Yes. The constraint for project-related businesses up until the beginning of this year was labor availability and labor cost. That is largely unwound now. And that's where you're seeing like markets like in refrigeration, store remodelings, right? That inflected a year ago, and you can see the volume growth that we got there because you can actually run projects and do them on time and at cost, where in the previous 2 periods, every CapEx project that anybody ever did came in late and over budget. So because of a variety of different things. That's largely unwound. And that's why our CapEx kind of levered businesses are actually doing quite well. The bigger, longer trail ones, like we talked about on the clean energy side, just because of the -- or the data center side because of the complexity, you just got to see through all of the early hype of announcement, announcement, announcement and just understand that those projects go through what we call concrete and rebar phase for about a year before anybody starts ordering the subcomponents that go into those projects. So we're kind of making our way through that phase right now.

Well, please join me in thanking Dover and Rich for their time today.