Oil and gas-focused industrial stocks like Dover Corp (DOV +2.29%) have seen an uptick in prospects in 2017 with the recovery in energy capital spending, and Dover has raised organic revenue guidance in its three other operating segments. The company is having a strong 2017, and its three-year outlook to 2019 -- provided at a recent investor meeting -- suggests that the stock could have further upside potential. Let's take a look at what investors can expect.
Dover Corp growth prospects
Dover's prospects are improving in 2017. However, what really caught my eye at the recent investor meeting was the aggressive projections for organic growth and margin expansion across all of its segments in the 2016-2019 period. I've summarized the guidance below.
|
Segment |
Organic Growth Rate |
3-Year Margin Improvement (bp) |
|---|---|---|
|
Engineered systems |
3% to 5% |
150 to 200 |
|
Fluids |
3% to 5% |
300 to 400 |
|
Energy |
double digits |
>1,200 |
|
Refrigeration and food equipment |
3% to 4% |
300 to 400 |
|
Total |
4% to 6% |
350 to 450 |
Data source: Dover Corp presentations. bp = basis points, where 100 bp = 1%.
Valuation matters
Based on my calculations, the midpoint of these projections would produce revenue of around $7.9 billion in 2019, representing a 15.7% increase on the $6.8 billion produced in 2016. However, it's the margin expansion that really counts. Dover's segment operating margin was around 13.7% in 2016, and a 400 bp (midpoint assumption) expansion would lead to segment operating margin of 17.7% in 2019. Ultimately, this translates into segment operating profit of around $1.4 billion in 2019 -- a near 50% increase.
Image source: Getty Images
Of course, I'm not the only one who is crunching numbers on Dover: Vertical Research Partners' Jeff Sprague has released a note forecasting earnings per share of $5.25 in 2019 -- representing a 61% increase on diluted EPS from continuing operations of $3.25 in 2016. Furthermore, given Dover's excellent history of free cash flow (FCF) conversion, it's not hard to accept Sprague's forecast of FCF of $5.42 in 2019.
To put these figures into context, based on the current price of $82.85, Dover currently trades at a forward 2019 P/E ratio of 15.8 times earnings, and an enterprise value (market cap plus net debt)-to-FCF multiple of 19 times. As you can see below, these forward valuation multiples make the stock look attractive compared to the kind of multiples it's traded at in recent years.
DOV PE Ratio (Annual) data by YCharts.
Will Dover Corp make the numbers?
That said, the question is whether management will achieve its targets in the coming years. The following chart breaks out segment operating profit from 2016 and then uses projections based on management's guidance for segment operating profit in 2019.
Data source: Dover Corp presentations, analysis and chart by author. In thousands of U.S. dollars.
Simply put, Dover needs oil and gas capital spending to stay in growth mode, and that obviously depends on energy prices. As you can see in the chart above, the big jump in earnings is expected to come from the energy segment. In addition, around 29% of fluids segment revenue is expected to come from pumps in 2017 -- a large part of which comes from the petrochemicals industry.
Moreover, Dover's energy segment exposure by end market in 2017 is heavily weighted (67% of the total) toward drilling and production (which is largely dependent on a growing rig count), with the product mix split between 65% coming from core products and only 35% coming from recurring and replacement products. In other words, buying Dover based on its future earnings projections means buying a stock on the expectation that oil prices will at least stabilize. Dover's oil-and-gas-based earnings are highly cyclical.
What rivals are saying
While Dover's management feels confident in its projection, it's worth considering what its competitors like General Electric Company (GE +1.96%) are saying. (For reference, Dover competes with GE/Baker Hughes and others for around 78% of its forecast 2017 energy revenue.)
In one of his last presentations as CEO, Jeff Immelt sounded a note of caution concerning GE's oil and gas outlook. "We see orders improving, but it's off a low base. So I still think we have to underwrite caution in that space." His comments served as a reminder that GE's oil-and-gas-based revenue continually failed to meet expectations in 2016.
The bottom line
All told, Dover's investor presentation contained a lot of promise for investors, but based on GE's commentary and Dover's heavy exposure to the cyclicality of oil and gas capital spending, it's far from a given that Dover will meet its numbers by 2019.
In short, the stock is attractive if you like the outlook for oil prices and want some exposure to energy, but worth avoiding if you aren't confident in the future of energy prices.
