This blog is devoted to helping investors make informed decisions. It will be regularly updated and provide opinions on earnings results. It is not intended to give investment advice and should not be taken as such. Consult your investment advisor.
Dover Corporation(NYSE: DOV)
is one of those industrial companies that the market never seems to
knowingly overvalue, and everyone is cautious with it as a consequence.
It strikes me that industrial cyclicals are always going to be
relatively undervalued because investors can’t be sure how a company
will be positioned coming out of a slowdown. In Dover’s case, I think
its long term history of performance deserves a bit more respect and,
provided investors can tolerate some volatility, it is worth a closer
look.
Dover over the Cycle
Dover is certainly a company that knows how to execute across the
cycle, having generated a 10% compound annual growth rate (CAGR) in
revenues over the last 10 years alongside 14% earnings growth. Moreover,
free cash flow tends to consistently be around 10% of revenues, and it
has increased its dividend for the last 57 years. As such, it belongs in this group of select companies;
throw in the share buybacks and this is a pretty shareholder friendly
company. All of which is fine, but how does Dover make its money?
I’ve broken out rolling segmental earnings.
The case for Dover revolves around diversified end markets and how
they allow the company to generate growth across the cycle. Thinking
longer term, its strategic focus is benefiting from favorable long term
trends in Energy, product ID, refrigeration and Energy markets.
Essentially it is a typical ‘GDP Plus’ type of growth story.
Growth Slowing
However, because its prospects are correlated to GDP growth it will
fluctuate with sentiment over the macro conditions. As such, Dover’s
last results stated the familiar refrain of Europe being stable but
weak, China slowing and modestly stronger conditions within the US.
We can see some of these factors represented in bookings.
Dover confirmed that growth is slowing in China and in particular
within its export led industries. For example, Dover’s electronics end
markets saw bookings decrease by 10% to $343 million and did not
forecast any ‘near term recovery.’ The best way to see where future
growth in consumer electronics is headed is to keep an eye on Intel (NASDAQ: INTC)
because its sales reflects inventory decisions by the large electronics
firms. As such, Intel keeps reducing guidance and gross margin
forecasts. It will get worse before it gets better. While that is
already in the price, there are other warning signs.
Nokia(NYSE: NOK)
is Dover’s biggest customer within handsets, and its travails should be
well known to investors. Much depends on its product activity, and
prospects there must be seen as uncertain at best. Even if the company
is eventually taken over, this implies structural changes which may or
may not help Dover. Other risks include the falling US rig count, which
has affected the likes of Baker Hughes (NYSE: BHI)
this year. Energy is the largest profit center, and a lower rig count
is an issue for Dover because its drilling related revenues tend to be
high margin.
The other main threat is the failure to execute at Sound Solutions.
Granted it has been a difficult environment for handsets and it is an
ever changing market, but there is some tardiness in making
manufacturing changes in its Beijing operations. The intent to shift to
semi-automated production is music to the ears of Cognex(NASDAQ: CGNX)
stockholders since it is a huge beneficiary of Chinese production
moving towards automated production lines -- an interesting piece of
‘color.’
Where Next for Dover?
Frankly, no one likes buying companies that have just reduced
guidance or changed their outlook over the last quarter, but Dover
deserves at least a monitoring look. There are plenty of near term risks
(macro, Nokia, rig count, Sound Solutions) that would keep me out of a
position right now, but if it dips then it would become interesting.
Dover has generated around 10% of its revenues in free cash flow over
time and if you figure that a 5% FCF yield is acceptable then valuing
the stock at 2x revenues makes sense.
As this graph demonstrates, it never really trades up to 2x earnings,
but when the economic going is good a ratio of 1.75x seems to be the
peak. Of course interest rates are far lower now, so arguably the stock
has room to run. The slowing rate of growth in bookings indicates that
revenue growth will be no more than low single digits for the next
couple of years.
In conclusion, I think Dover is an attractive stock, but it might be
worthwhile monitoring now while keeping an eye out for the risks that I
mention above. Apologies if this article doesn’t produce the kind of
hard resolution that many readers want, but the greatest weapons a
private investor has are patience and preparation, and I don’t plan on
giving either up just yet.
No comments:
Post a Comment