Dover Corporation (NYSE:DOV) recently released its first set of quarterly results since the spin-off of its former communication technologies segment, Knowles Corporation (NYSE:KN). The report was impressive for three key reasons, and Fools should start to think about upgrading their expectations for the company. Here's why.
Bye, bye, Knowles Corporation
The first two factors relate to the spin-off of Knowles Corporation, how it changes the investment proposition with Dover Corporation and, ultimately, the ability of Dover's management to initiate expansion opportunities.
First, the spin-off will remove the vagaries of the handset market from potential Dover Corporation investors. Usually, when thinking about an industrial conglomerate, one needs to compare a host of investing options, all with their individual specific end markets. However, they all tend to be tied to general trends in industrial spending.
On the other hand, with Dover Corporation's communication technologies segment (Knowles), Foolish investors were almost forced into taking a view on which handset manufacturer would be hot this year. For example, Nokia and Blackberry used to be major customers of Knowles, but now, Apple and Samsung respectively account for 25% and 15% of its revenue. Investors trying to predict trends in the handset market add a layer of uncertainty and risk to a stock's proposition. Following the spin-off, Fools can now focus on Dover's four industrial and energy segments.
The second reason is that the Knowles spin-off will allow Dover's management to focus resources on its four main segments. Below is a table of how Dover's management is trying to expand market opportunities for each segment based on information interpolated from the outline given on the company's recent conference call.
|Segment||Share of 2013 Segmental Revenue||Expansion Opportunity|
|Engineered Systems||29.6%||printing and ID sales to new industry verticals|
|Refrigeration & Food||19.8%||new products that enhance customers productivity|
The international expansion plans are particularly important because growth prospects look better for oil exploration outside of North America for 2014. For example, oil services company Baker Hughes (NYSE:BHI) recently forecast that the overall U.S. rig count would rise only 4% in 2014, versus a 9% increase internationally. Interestingly, Baker Hughes is predicting that this figure will average 1830, while Dover's management discussed a figure of "almost 1800."
The following chart graphs the U.S rig data from Baker Hughes:
The recent pick-up in U.S. rig activity is welcome, but Dover needs to follow the greater growth in international markets.
Dover Corporations's free cash flow, and improving trends
The third reason is that Dover's free cash flow conversion is improving. In the past, the company has consistently converted around 10% of its revenue into free cash flow, but on the conference call, President and CEO Bob Livingston said that he "felt confident" about 11% conversion for 2014, and "in the long run," too.
This point is significant if you consider that the company is currently trading at a relatively high enterprise value (market cap plus debt) to revenue ratio. If free cash flow conversion is now 10% higher, a rough rule of thumb could see the ceiling to the graphed ratio increased by 10% to say, 1.9 times sales.
Granted, this doesn't make the stock look cheap right now, but it does suggest that the stock is worth looking at given any weakness from the current price.
The bottom line
Dover Corporation doesn't look like a compelling value, but the company has aspirations for growth now that the spin-off of Knowles Corporation has taken place. In addition, its forecast of 6%-7% revenue growth (with 3%-4% coming organically), may prove a bit conservative if Baker Hughes' forecast for the U.S. rig count is more accurate than Dover Corporation's estimate. Moreover, an improving industrial economy will help Dover. All told, it's not a raging buy, but investors should increase their expectations for the company.