Shares of Dover (DOV 0.16%) rose 23.8% in January, according to data provided by S&P Global Market Intelligence. The increase marks a recovery in the share price following a 16% decline in November. The stock outperformed the S&P 500 even before the company's earnings report at the end of the month sent it surging by double digits at the end of the month.
Dover is an interesting stock for value investors. Based on management's guidance at last year's investor day, the company is set to generate significant amounts of free cash flow (FCF) in the coming years. It is now calling for $2.5 billion to $3.5 billion in operating cash flow from 2019-2021, with capital expenditures equivalent to 2%-4% of revenue. All told, this should lead to FCF conversion of 8%-12% of revenue over the next three years, making the stock look like a good value.
There is a snag, however. The company's growth plans involve generating margin expansion by restructuring two underperforming businesses, namely retail refrigeration and Dover Fueling Solutions, or DFS (fluids segment). Naturally, the market had doubts about Dover's plans, but the fourth-quarter results and guidance definitely helped settle nerves.
Management stuck to its forecast for FCF conversion and reported an impressive 8% growth in bookings with all three segments (engineered systems, fluids, and refrigeration and food equipment) bookings getting a boost by at least 7.8%.
Based on its guidance for 2019, Dover should generate $570 million-$860 million in FCF putting it on a forward price-to-FCF multiple of between 15-22 times FCF. The midpoint represents a good value for a company expecting to generate nearly 19% growth in adjusted earnings per share in 2019.
Regarding retail refrigeration, CEO Richard Tobin declared himself "cautiously optimistic" for improved revenue performance based on the backlog, and has committed to spending on automation in order to cut costs in the future. Meanwhile, with DFS "margin conversion while improving sequentially is the largest opportunity performance improvement going into 2019 and we are targeting to progressively track to the margin objectives that we laid out in September through the year," according to Tobin.
There's nothing sexy about the investment proposition at Dover. However, if the company can quietly go about cutting costs via restructuring and investing in automation while generating low single-digit growth, then its margin expansion prospects look good. When you throw in an undemanding valuation, it might appeal to value-oriented investors.
The key to 2019 will be to monitor the progress of margins and what management says about the success of its investments in automation and downsizing initiatives while hoping that revenue growth expectations are realized.