Dover Corporation (DOV) Earnings Call Transcript & Summary

Thank you, everyone, for being here this morning. Dover Corporation. Rich Tobin, Chairman, President and CEO. Thanks very much, Rich, for being here.

Maybe just start off perhaps with kind of how you see the current demand environment. I think your orders growth has been very good the last couple of quarters. Maybe explain some of kind of the drivers there. Do you think it's sustainable?

Yes, sure. I think that our orders inflected positively in the back half of '24 for 2 primary reasons. I think that the short-cycle business by itself has started up in preparation to what everybody thought would be a decent growth environment once the elections [Technical Difficulty] that was going to go. And then specifically to our portfolio, we had a couple of businesses that had been through a counter cycle or a down cycle, and that has come back the other way. This whole burn off of post-COVID inventory, everything that we've discussed multiple times. So overall, we're pretty pleased. I mean, we gave out guidance early this year because of the fact that we had a pretty sizable disposal in the beginning of the fourth quarter of last year. So just to level set everybody where we are with Disc Ops and everything else, we thought it would be prudent to do our '25 guidance. We didn't change it between October and the end of January when we posted results. I mean, arguably, we could have changed a bit because FX is running against us in terms of translation, about $100 million in revenue and $20 million worth of profit on FX, the calculation on FX between October and January, but I think we had enough headroom in our guidance to just absorb that for the time being. And as you mentioned, our portfolio, generally, the significant amounts of our profits we book in Q2 and Q3. So what we really look for in Q1 is order rates because that's generally a precursor about the activity that we'll get for the balance of the year. And as an update, I mean, January is closed and the order flow or the order rates that we saw in Q4 have rolled over into Q1 so far. So, so far, so good.

Good. And on that point on the businesses that had that headwind around post-COVID inventory normalization. I guess you had SWEP around heat exchangers, Belvac in can-shaping, MAAG around polymer processing. And I suppose we'd have a sort of the half or 3.5 business would be the vehicle wash, which has had a tough time, more around interest rates than anything else. How quickly do you see each of those getting better kind of from here?

They've all got specific drivers to them. Belvac is basically 100% levered towards can making CapEx. We don't expect that to come back materially in 2025, but we don't expect it to get worse either. So from a comp point of view, I think we've lapped it at this point. MAAG should grow some in 2025. SWEP, I'll leave it to all the forecast of everybody that's at this conference from heat pumps. I mean I think you've heard the answer 100 times here. I think that what we can say is where we cut production relatively heavily in Q4, so our inventories are down, and that also allowed any inventories into the system to be depleted. When that restarts in demand, I think it's an open question. I'll say what everybody else is saying, we expect to inflect positively in the back half of '25, but I think it's a wait and see right now.

Yes. I see. And then vehicle wash, it's sort of...

Vehicle wash never really went down. It just was something that had been growing quite nicely. I think the good news there is, we held some pretty healthy margins despite kind of a boring top line there. The better news there is what had the underground equipment for Fueling Solutions, which is in the same segment, has been down for a couple of years because of inflation and labor-related issues coming out of the COVID that's a very lucrative business to us, and I think we saw some pretty positive stuff there with [Technical Difficulty] cycles through, that's a mix up for the segment.

Great. And if you think kind of across the businesses, is there any delta in terms of, say, aftermarket activity versus greenfield project or it's really vertical by vertical you have to go through?

You almost have to go on vertical by vertical at the end of the day. And like in the Fueling Solutions group, the number of gas stations in the country is actually shrinking, but the size of the individual gas station, I'm sure you've seen them is significantly larger now. So you can't say that, that's adding capacity. It's actually making that capacity more efficient over time. And when those stations are built, it's -- because it's highly regulated, it's got to be all new kit that goes in there. So you've got to start from the tanks all the way up.

Yes, and I think company-wide, Dover has this sort of 4% to 6% organic growth target through cycle. Kind of just given what you've seen since that last Investor Day, seen how the business has performed. There have been some portfolio changes. How do you feel about that 4% to 6% target?

I think our guidance right now is 3% to 5% for the year. So I mean, I think we're putting our money where our mouth is to a certain extent on the organic side. We like the mix of what's driving that growth. It's probably 50% organic investment. So that's kind of the flow-through of R&D and some capacity expansions that we've done over the last 36 months and then coupled with inorganic investment coming through into some -- what we believe are some high-growth vectors that we've been investing in. So this is the first year that I can think of in probably 2 or 3 years where we go in and take a look at the portfolio, generally speaking, 1/3 of the portfolio is accelerating into higher growth, 1/3 is kind of steady Eddie and 1/3 maybe cycling down. We don't have a cycle down this year. So that's good news, and that's why we're really at the top end of the range of what we think that the growth capability is going to be.

And I think one area that you've highlighted as a growth area is around kind of CO2 systems. Maybe help us understand kind of rough scale or market share of that business. How rapid is the sort of customer [Technical Difficulty].

It's been great. We have been in Europe for many years. And I got to get the years right now, the beginning of '23. We brought the technology to the United States. We repurposed a facility in Conyers, Georgia. We platformed the product. It used to be an ETO. It is still an ETO product in Europe. And because it was a, let's call it, new market in terms of the United States, we decided that we were going to just platform the product and change the dynamic away from ETO to platform. We've now successfully launched all 3 platforms. So the margin opportunity is significant, and from a market share point of view, we've got very, very healthy market share in this particular product line.

And when you look at the sort of customers, is it a handful of very large ones driving it today across the...

It's the same customers that we have in food retail. So you know the names. The adoption rates are all over the place. You've got people that their business model is kind of like green. So they're kind of the leaders, and they tend to be the European chains like the Aldis of the world just adopt CO2. Then you've got the legacy retailers that are slowly doing the adoption, largely driven by whether the states are requiring it or not.

And I said CO2 systems is one of those you've highlighted as high growth, above fleet average. There's a handful of other ones, clean energy, precision, biopharma, liquid cooling. When we think of those each in turn, how much are you adding kind of capacity-wise across them? And...

We've been early on all the ones that you've mentioned in terms of capacity. So for CO2, we've got a brand-new plant. So we've got multiple shift potential there at the end of the day. Thermal connectors has inexplicably turned into a little bit of a short-cycle business. You would think that everybody planning these big data centers would be buying the subcomponents well in advance. They don't. But we are basically capacitized what is likely to be maybe the '26 to '27 demand presently. So it's just a question of starting up the manufacturing cells. So -- and we did the same thing in heat exchangers for heat pumps and the like. So from a footprint point of view and available capacity point of view, we think that we're in a very good position in terms of being competitive from a lead time point of view.

And when we think about these handful of above fleet average growth assets, what about the margin profile there? As you get this above-average revenue growth, what sort of incrementals or leverage?

That's [Technical Difficulty] right? We want to be launching accretive to the businesses that are launching them. So CO2 systems is a better margin product than the traditional refrigeration business. The thermal connector business is not quite at the margin of biopharma, but as it scales, it will clearly be accretive to consolidated margins for sure. We'll see if it can get to the lofty margins that we see in the biopharma side. The cryogenic components, which is the inorganic investment side, will get -- will be accretive to the segment. We probably got all of to work out kind of the footprint restructuring because we've made [Technical Difficulty] let's call it, restructuring and efficiency. We'll execute all those projects and what we see on the other side on a per piece gross margin basis, it's going to be accretive to the segment.

And when we think about firm-wide incrementals or operating leverage, again, there's been these portfolio changes. You've got high leverage this year. Do the changes you put in place make that sort of 30-ish percent through-cycle number look conservative or it's a good starting place?

Talking of the margins, Julian. Look, we always had 25% to 35%, but that's a legacy position. We are targeting 40% plus this year. And that is a combination of mix up on -- from a portfolio point of view and the fact that we've got carryforward of restructuring that we did last year. So in any given year, if we do this correctly, we will have earnings potential of actions that we've taken in the prior year. So if we do this correctly, every year, we'll have somewhere between $30 million and $50 million of roll-forward restructuring benefit, which is pure profit at the end of the day, right? So that gooses the incremental margins up. And then because I think that we've disclosed quite a bit of information about the segments, you can see the gross margin per the segment, it's hard to convert at gross margin because you do attract some amount of cost. But clearly, by doing 40% this year, we would expect that we would convert, that 25% is probably not a relevant figure anymore.

And a couple of the businesses that are -- or segments, let's say, that are below the fleet average, maybe start with Engineered Products, a lot of divestments there the last 18 months. How kind of satisfied are you with the shape of Engineered Products today? You've got that low 20s margin aspiration from before with the sort of old portfolio, how do you think about it now on margins?

Well, I mean, at the end of the day, we can mix away. So as we grow the higher-margin portions of the portfolio, it will just dilute the weighting within the portfolio. But -- so we're not a forced seller, and we won't destroy value by just selling things to make the margin look better. And the disposals that we did in 2004, arguably, we were paid at a higher multiple on those sales that was embedded in the sum of parts of our business. So that's kind of the way that we look at it. If it's not -- if we can get a premium to where we believe it's trading within our portfolio and we believe that it's going to struggle to be accretive to kind of what our aspiration consolidated margin is, then if we have the opportunity, then we'll act upon it.

Got it. And if we look at climate and sustainability, I think the CO2 growth is a margin tailwind. Longer term, is that a division or a segment that can do 20-plus percent margins? Is that what you're aiming for?

Yes, I can. So it's the traditional refrigeration business, which was single digits not too long ago, is in healthy high teens now. And then as CO2 scales and gets larger within the portfolio, will just drag it up on a mix basis. So I don't think you could get the traditional business to 25%, but you can get it to 20%, which is more than double than it was not too long ago.

Got it. And on the CO2 side, good growth, seems like a high profit margin entitlement. Do you see much in the way of new competitors coming in or incumbents who are behind suddenly trying to catch up?

We're not going to be alone for sure. We are alone with having a platform offering now. And arguably, that's kind of a 1- to 2-year head start. But clearly, if the TAM of this market is what we think it is, I don't think that we're going to be left to ourselves for sure.

But your point would be you'll have built out by then a good amount of installed base with large...

All we need to do is to have a product that, from a performance point of view, works. We've got one of the largest installed bases in Europe. So from a confidence of execution point of view, I mean, does the product work because it's a new technology in the United States. I think we've got a good story to tell there. And like I said, we -- for 36 months, we worked on launching a platform product that we think meets everything from the smallest retail store up to the largest refrigeration warehouse.

And then DII, it's not a business that gets much attention for some reason from investors, I think it's been performing at a very high level margin-wise. Maybe help us understand kind of some of the strategic points you're focused on in DII.

Well, look, I mean, I think that it was helpful that Veralto spun out because it gave kind of a shining light into that business and Veralto is our largest competitor. It is a 2% to 5% grower year-over-year-over-year. It's the most global business that we have. So you shouldn't look at really quarterly results of that business because there's a lot of FX running through it from time to time and mix, but it always ends up in the same place at the end of the year. Our management team has done a terrific job in terms of expanding the margin of that business. I don't think that we're nearly done there because I think we've just gotten way more efficient in managing the structure of a global business that was almost run intra-regionally for many years country by country. Now we've basically shrunk that business model where we're running it at almost as one global factory, and that's been the biggest contributor to the margin expansion.

And then within pumps and process, the way people on the outside talk about it, it seems to be -- it's sort of biopharma and then everything else. Clearly, inside, it is, I'm guessing, not run like that. But how do you think about these are some of the verticals aside from biopharma where you're trying to sort of lean into?

Look, when we benchmark the individual -- look, we've got the knowledge to look at the individual pieces within the segment, clearly. And when we benchmark those individual pieces, all have listed peer comps at the end of the day, and we benchmark extremely well in terms of top line performance and margin performance at the end of the day. Over time, would we consider splitting that business into a couple of pieces? Sure. But I think externally reporting more than 5 segments gets to be a little bit messy after a while. So I think we would ask for some time to scale them up to the extent both organically and inorganically. And as we did that, then we would consider basically at least resegmenting to give a little bit more light between kind of the precision components side of the business and the biopharma side of the business.

And then acquisition-wise, I think as you've seen the last 2 years, people went into this year saying this will be a year of great M&A activity. So far, it seemed quite quiet, just overall M&A, particularly January was a very weak month, I think. How are you kind of seeing M&A yourself, the sort of appeal and size and number of targets that are coming?

There is a lot in the system that's coming. My personal view is everybody is waiting for price discovery. So nobody wants to go first. Eventually, something is going to have to break and go. And then when it goes, everybody is going to find out whether we're back to no free money 2020 multiples or if there's some rationality in terms of the multiples. But the asset has got to come at the end of the day. So there's some larger ones in there. I mean it's been in the press a couple of ones in the last couple of days. That's probably not for us. We'll likely stay in the -- up to $800 million, $850 million. We look at everything at the end of the day, and we found something that was super compelling, then sure, we would consider it. But the likelihood is there'll be a -- we would look at a series of bolt-ons on our kind of higher-value vectors that we have. So we'll see. I'm just as interested as everybody in this room, is interested to see what trading multiples are going to be in 2025.

And what's the appetite to kind of move outside of where Dover is right now? I mean you've got -- again, the sort of half dozen high organic growth verticals where you've added organic CapEx. Would you put more M&A money into those or perhaps think about adding a seventh or eighth high organic growth leg?

Yes. Look, at the end of the day, Dover Corporation doesn't buy companies, right? Our companies are the single source of identifying targets that we're interested in, and they tend to be either competitors or adjacencies to establish positions that we have. A lot of companies that go to auction. We will dabble in them, but we don't participate in quite a bit. Number two, we know the companies because they're either competitors or adjacencies. And from an execution risk, the company within the Dover portfolio needs to be able to absorb the target, right? I just can't -- it's not like I'm buying things and saying, well, this is a great idea, you go run it, right? I mean we're very cognizant of execution risk in M&A. So we want -- and the way that we believe that it works is if we have conviction at the lower level and that company is large enough to absorb the target, generally speaking, it tends to go reasonably well, knock wood.

And in terms of business model, let's say, aside from brands close to ones you own already. Should we expect anything more in the way of a push towards recurring revenue or dare I say it software or sort of precision components is the preferred.

Yes. I think the highly regulated precision components with established positions where performance outweighs price sensitivity is kind of we'll do software deals, but they tend to be add-ons that add value to existing positions as opposed to let's go buy software because it makes our gross margin go up. We're not a software company, so I can't sit up here and say we know how to operate a large-scale software company. We just don't have that expertise.

And the point around sort of deal size, that's partly, I guess, what it's a function of the market niches that you're in that they tend to be fairly small handful of players. So there's kind of an automatic limit on the size. Is that the way to look at it?

The vast majority of the companies that we compete with are private companies. I mean there's a lot of public companies we treat with, but if we really tear it apart, and we like to compete with private companies because we think we have a distinct advantage in terms of cost and productivity versus private companies. We also like small TAMs because we think a small TAM with a concentrated supply base is ripe for getting high margins if you do it right. So that business model works for us because we're not competing with a lot of assets that are coming because everybody wants a large TAM and to make the argument of I can gain market share because the TAM is so large. I think we look at it in a different way that we like it when the TAM is small, and we can dominate that TAM if we do it correctly.

Got it. And when you look around, say, the broader industrial landscape, every quarter, it feels like someone is announcing some separation, whether under internal or external motives. I guess sort of Dover has had a decent re-rating recently, but any thoughts from you around the merits of larger divestment or spins?

Look, it's part and parcel to be in the multi-industrial world, right? It's a constant chatter in the background. I don't -- I think we will stick to the playbook that we have. I mean, to the extent that we scale up and we get larger, but at $8 billion in revenue to do a spin and shrink to unlock value, I think it's a tough argument at our particular size. I mean there's a significant amount of stranded cost associated with that. So it's never say never, but I think right now, that's really not. I mean we run the numbers to beat the band. So I mean, we're well aware of a variety of scenarios of spins and sales and everything else. I think at the current scale, it's going to be the playbook that we showed over the past year. We're not afraid to divest and get smaller as long as we can create value doing it. But I don't think that we feel that we have some urge to simplify the portfolio presently.

Perfect. Well, with that, we'll switch to the audience response survey. So first question, do you currently own shares in Dover? [Voting]

I think an opportunity.

Right. 60% no. Secondly, what's the sort of general attitude to Dover at present? [Voting]

So 60% positively inclined. Thirdly, it's around through-cycle earnings growth for Dover against the multi-industry average. [Voting]

So in general, sort of 60% in line. Fourth question, it's around usage of excess cash. [Voting]

So 2/3 is bolt-on acquisitions. Penultimate question is around what PE multiple should Dover trade at? [Voting]

So in general, around the sort of S&P market multiple. And the last question is kind of why should it trade there? Why not have a premium, let's say, to the index? [Voting]

So three quarters say core growth. So with that, thanks so much, Rich.

Thanks.

Thank you. It is a pleasure. Thanks a lot.