A superficial look at the near-28% decline in the year-to-date stock price of multi-industrial company Dover Corporation (DOV 0.73%) could easily lead to a conclusion that something is very wrong with the business. However, I think the plunge is creating a very interesting entry point into an attractive company on a compelling valuation Here's why.
The company was always well known as an industrial stock with heavy oil and gas exposure, and the stock probably wasn't worth holding unless you were positive on oil prices and specifically capital spending on upstream energy.
Image source: Dover Corporation
However, management successfully spun off its upstream oil and gas business -- now called Apergy Corporation (APY) -- and focused the remaining Dover on engineered systems (printing and ID and a motley collection of industrial businesses), fluids (pumps and fluid handling solutions), and refrigeration and food equipment (mainly to the food and beverage industry).
It's not the most exciting collection of businesses, but Dover is a high cash-generating company trading on a good valuation and management has aggressive margin expansion plans in progress.
Dover Corporation's attractive valuation
Excluding Apergy, Dover expects to report full-year earnings per share of $4.70-$4.85, representing a 15% increase from last year and adjusted free cash flow (FCF) equivalent to around 10% of full-year revenue. By my calculations, that puts the stock on a forward P/E ratio of 15.2 times 2018 earnings and a price-to-FCF ratio of just 16.7 times.
Compared to its multi-industry industrial peers and its historical valuation, Dover is an attractive stock.
DOV Price to Free Cash Flow (TTM) data by YCharts.
In addition, now that Apergy has been spun off, the valuation gap between Dover and its industrial peers should close.
Why the stock price declined
The price drop in 2018 is probably down to four elements.
First, Dover investors were rewarded with one share in Apergy for every two they held in Dover as part of the spinoff -- this accounts for a large part of the stock-price dip.
That said, on an adjusted basis, Dover Corporation stock is still down around 11% year to date. This is somewhat in line with the mid-teens declines in 2018 for fellow industrials like Caterpillar (CAT -0.55%), 3M Company (MMM 0.86%) and Illinois Tool Works (ITW 0.66%). It's probably partly due to the market concerns on the industrial sector regarding its exposure to potential trade wars. If there is going to be an escalation in retaliatory tariffs and other protectionist measures, then major exporters like the industrial companies listed above will surely be negatively impacted.
Third, strong increases in some raw material costs have led to margin pressure -- Caterpillar management's commentary on margin during the first-quarter earnings call alarmed the market in May -- while 3M and Illinois Tool Works have also seen rising costs threatening their margins.
The final reason relates to what management called "softer than expected retail refrigeration markets in the first quarter" in the refrigeration and food equipment segment. As you can see below, it was a weak quarter for the segment, driven by an 8% slip in organic revenue within refrigeration -- essentially, grocers are holding back on buying retail refrigeration units.
| Dover Corporation Segment |
Adjusted Earnings Q1 2018 |
Growth |
Bookings Q1 2018 |
Organic Growth |
|---|---|---|---|---|
|
Engineered systems |
$99 million |
15% |
$720 million |
8% |
|
Fluids |
$56 million |
7% |
$625 million |
6% |
|
Refrigeration and food equipment |
$29 million |
-13% |
$373 million |
-14% |
Data source: Dover Corporation presentations. Table by author.
Will Dover Corporation hit its guidance?
I think it's fair to say the stock is a good value based on its estimates for 2018, but the real question is whether you believe in the numbers following some weakness in the retail refrigeration market in the first quarter.
On the first-quarter earnings call, outgoing CEO Bob Livingston warned investors that "[r]etail refrigeration in the second quarter will continue" to be negatively impacted "by "softer overall markets," but he predicted a much stronger third quarter based on the "new awards that have been booked recently" and a growing sense of confidence due to "conversations we're having with customers" on their capital spending plans.
Livingston also said he was being a "bit conservative" with his guidance for the, far larger, engineered systems segment. As for fluids, he declared "pretty strong confidence that we are going to see sequential both revenue and margin improvements in this platform and in this segment as we move through the year." n-q1-2018-results-earnings-call-transcript?part=single
Discussing the rising cost environment, he argued that Dover was pushing through the price increase, which means the company would be "slightly positive" on pricing/cost in 2018.
Is the stock a buy?
On balance, I think Dover is worth picking up. There are some doubts around its 2018 earnings estimates, but they relate to one of its smallest businesses (retail refrigeration) and management is sounding a confident note on the likelihood of a second-half recovery.
Meanwhile, the valuation offers some margin of safety for error, and management continues to expect ongoing margin expansion. All told, Dover is well worth looking at for value-oriented investors.
