Download Dover Corporation (NYSE:DOV) Memo

Dover Corporation (NYSE:DOV) Memo
Name: Adam Rathgaber Phone #: 608-­‐385-­‐6051 College/School: University of Virginia Year: 2nd Company Description DOV is a diversified industrial manufacturing company headquartered in Downers Grove, IL. It operates in four main markets: Energy, Engineered Systems, Fluids, and Refrigeration & Food Equipment. DOV’s Energy segment works with oil drillers and refiners by providing artificial lifts, pumps, and high accuracy sensors. Their fluids segment develops fluid transport products for fueling and washing systems. The Refrigeration & Food Equipment segment provides parts for industrial sized refrigerators as well as capital goods for food production. The company operates in several other categories, which are grouped under their Engineered Systems segment and include printing and aerospace components, among others. A Fortune 500 company, Dover Corporation employs over 28,000 people and was founded in 1947. Thesis / Key Points Ø
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DOV is a good, stable company trading at a significant discount to its intrinsic value – Although DOV is not a company that often makes the headlines with innovative products or impressive growth figures, I hope to show in this memo that it is a remarkably stable company that will continue to offer steady cash flows to investors into the foreseeable future. These cash flows are made even more attractive by the fact that the company has paid a steadily increasing dividend for a very long time. For reasons shown in the Misperceptions section, the market has valued DOV at a price well below its intrinsic value. Through a DCF model that assumes a modest 3% annual growth rate, steady margins, and a 2% terminal growth rate, we arrive at a target price of nearly $107 for an upside of more than 30%. In the comparable company valuation model, I used the EV/EBITDA multiple and used a target multiple of 10x, slightly below peer average. I felt that this number was justified because DOV generally grows slower and is much smaller than many of its competitors. This model yields a target price of about $95, or a 24% upside. By combining these two models I arrived at a final target price of $101 for an upside of 26%. The takeaway from this memo should be that DOV is a very stable and slow growing company that the market has actually priced well below the value implied by its financial record. I believe that DOV will continue its past performance into the future, and that the market is slowly beginning to realize its error in valuation. DOV has very stable cash flows and margins that will likely continue in the future-­‐ Over the past decade, DOV has enjoyed very stable performance, beginning with their top line. Since 2004, the company’s revenues have grown at an annualized rate of 7.06%, while only declining in one year (2009). After the worst of the financial crisis in 2009, the company quickly rebounded and continued along its pre-­‐recession trajectory. Gross and operating margins have not only remained stable over this time period, but have actually slightly increased. This is especially impressive when considering that DOV consistently makes acquisitions to either add new products to its portfolio or expand existing operations. I am very confident that DOV will continue to effectively manage costs and remain efficient in the coming years. The revenue growth and expanding margins have led to annualized net income growth of 13.1% per year, with net income declining only in 2009 and 2012. However, operating income actually increased in 2012, with the net income decrease attributed to only non-­‐operating expenses. Again, DOV has steadily increased its performance in every year except during the unprecedented financial crisis. Finally, free cash flows have steadily increased as well, with the values decreasing in a couple years due to changes in CAPEX. Overall, the financial show a history of very stable performance, which I hope to show will continue in the coming years. DOV’s diversified product portfolio serves as an effective hedge against risk from competition and technological change-­‐ As shown in the company description, Dover Corp has many different products serving customers in many different industries. As a result, I believe that the company is largely resistant to either price competition or technological change in any one market. Of course, there is still risk if many markets are coincidentally under competitive pressure or the economy as a whole collapses (such as in 2009), but Dover Corporation is better insulated most of the market. Revenue is split fairly evenly between all segments, with the miscellaneous Engineering Systems segment accounting for 43% of revenue. This has two effects. First, the corporation’s bottom line will be less affected by poor performance in any of its sectors. Second, due to this effect, DOV will be able to temporarily compete on price and maintain market share without a large effect on its bottom line. This is something that contributes to the stability mentioned in the first thesis point, as small threats to DOV’s business aren’t vastly affecting company performance. Of course, the opposite of this is also true. This diversification ensures that DOV will never have a huge year as far as top line or net income growth goes. The validity of this strategy is determined by the valuation of the security. DOV has been able to grow due to smart acquisitions made with a reasonably aggressive capitalization structure-­‐ Dover Corp’s management has stated that it wants to have 3-­‐5% organic revenue growth per year and 3-­‐5% growth from acquisitions. These acquisitions are sometimes to expand the company’s product portfolio by breaking into new industries and sometimes to bolster existing production. For example, since 2011, the company has acquired 26 companies for a total of $2.7 billion. The largest of these acquisitions was Sound Solutions, Inc, which was purchased in 2011 for $779 million and enabled DOV to enter into communication technology manufacturing. These acquisitions are sometimes unprofitable at the beginning of the venture, but DOV has been consistently able to efficiently absorb them into their existing operations. These acquisitions allow DOV to find growth in other areas, and help them reach the low growth targets their valuation requires. Furthermore, DOV has maintained a capitalization structure that is both conservative enough to create only minimal default risk and aggressive enough to allow these acquisitions to be profitable. I believe that management’s extensive track record of making good acquisitions will supplement the organic growth in DOV’s existing businesses and allow the company to grow in the coming years. Dover Corporation (NYSE:DOV) Memo
Misperception Ø
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DOV is a fairly small firm in its industry, and does not enjoy some of the benefits enjoyed by its larger competitors – While DOV is a fairly large firm with close to $9 billion in revenue, it has competitors that are much larger. Other diversified industrial companies such as GE and Siemens AG have well more than $100 billion, and as a result enjoy things like economies of scale and superior pricing power. However, I believe that the market is wrong in this instance and there is no justification for these companies’ higher multiples. Even though DOV may not be able to benefit as much from economies of scale as its larger rivals, the financial data shows that Dover Corp has done an excellent job of controlling costs. DOV has above average margins and ROE when compared to comparable companies, and this has less to do with the size of the company and more to do with DOV’s balanced growth strategy. DOV attempts to achieve 3-­‐5% growth from both existing operations and acquisitions, and this slow growth strategy helps ensure that costs don’t spiral out of control. In addition to this, DOV has shown that it is willing to spin off inefficient operations, as it did with electronics manufacturer Knowles Inc in early 2014. On the pricing power side, Dover Corps wide range of products and divisions ensures that DOV can weather temporary price competition in a few of its product segments. DOV will be negatively affected by declining oil prices – As the price of oil has declined in recent months, investors became worried that this would hurt revenue in DOV’s energy segment, its largest. The reasoning from the market was that as oil prices fell, oil drillers and refiners (DOV’s main energy customers) would see declining profits and would have less money for investment in Dover Corp’s products. This anxiety was a big reason for the security’s price decline in the late summer and early th
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fall, culminating in a low of $72 on October 15 . However, the quarterly earnings report released on October 16 disproved this belief, with YoY revenue in the energy segment increasing 8.5%. Since the earnings report was released, DOV is up nearly 7%. I think that the market is beginning to recognize this misperception and the security is currently moving towards efficiency. VAR Ø
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Statement from Ms. Gabrielle Grotte, Investor Relations at diversified industrial manufacturer Alfa Laval. She spoke about the stability of the industry as well as its future. “Alfa Laval is exposed to a large amount of different end markets and applications. For us this is a positive thing since it, in a way, means we have a built-­‐in hedge in our business. Our end markets normally are in different stages of the economic cycle. Some are early, some are late and some (like food) you can argue are non-­‐cyclical. It is rare that they all grow at the same time or drop at the same time. Because of the large number of end markets -­‐ it also means that it is rare that our exposure to one single market is particularly large -­‐ the exception perhaps being marine. I know of no changes in technology, market structure or regulation today, that would have an impact on the group as a whole. But naturally, considering our broad exposure, there may be things going on in individual markets, which I may not be aware of. But even if that was the case -­‐ it is important to remember that our exposure to the individual market (ex Marine) is limited -­‐ so a potential change in one of them is unlikely to change the picture for the company as a whole. Of course it is impossible for me to predict what the future may hold and what the impact will be. I can only speak of our experiences so far; that our broad business exposure normally tends to smooth things out.” Statement from Mr. Doug Beaver Jr, Regional Sales Manager at diversified industrial manufacturer SPS Tech. He spoke about risks to businesses in the sector. “There are no significant risks to our current operations. All Aerospace fastener manufacturing is ultimately dependent on the Commercial aviation companies (primarily Boeing and Airbus), and Military (Defense spending, and/or wartime missions). Our business rises and falls with the success of those industries. We have been fortunate to have recent growth in the commercial build schedule. The last cycle downturn was in 2009, but the recent private sector progress really looks to continue to increase over the next several years with no foreseeable end prospected at this time.” Both of these statements support the thesis point for DOV that the diversified nature of the business helps reduce risk, both from competition and the overall economy. How It Plays Out Ø
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In the coming years, I expect DOV to continue to reach its organic growth targets of 3-­‐5% per year. I expect this growth to be fueled mostly by growth of the segments DOV operates in, especially energy and communications technology, as well as overall growth of the economy. As the company itself said in last year’s annual report, predicting growth from acquisitions is more difficult and inconsistent. However, over the long run I believe that the company’s historical growth from acquisitions in the low single digits is very attainable. Putting these together, we can expect growth rates in the mid to high single digits, which is well over the growth rate implied by DOV’s valuation. In the more short term, I believe DOV will ride the generally recovering economy and margin expansion from integration of acquired companies to solid financial performance and positive earnings releases. Barring any unforeseen difficulties, I think the general state of DOV should remain largely the same, and our capital appreciation will largely be driven by the security price returning to its fair value. I expect DOV’s price to continue along the trajectory that we have seen since DOV’s last earnings call. I don’t anticipate holding this position much longer than 6 months, as this is not a security whose value is driven by its long term potential. Risks / What Signs Would Indicate We Are Wrong? Ø
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DOV’s wide diversification does indeed minimize risk, but this makes it very difficult to grow quickly. In a rallying bull market it is possible that investors may ignore Dover Corp in favor of more glamorous growth stocks. DOV is not the type of stock that will be able to ride a wave of investor hype and optimism. The market may stay irrational for longer than we can afford. While the short term decline in oil prices hasn’t hurt Dover Corp’s bottom line, an extended period of low oil prices may cause Dover Corporation (NYSE:DOV) Memo
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drilling and refining firms to cut back on capital expenditures, hurting DOV’s biggest operating segment. The company could make a series of bad acquisitions. This would have not only the effects of hurting growth and margins but also increases financial risk. DOV’s history of dividend increases could catch up with them, forcing the company to either stop the increases or to continue them and leave less earnings to reinvest in the firm for growth Signposts / Follow-­‐Up Ø
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Important Company Financial Data Earnings Release in Mid-­‐January Dividend Announcements Monitor Oil Prices Monitor technological developments in any of DOV’s major segments Look for intense price competition from larger rivals in any segment Current Ratio: 2.2x Quick Ratio: 1.6x Leverage: 2.02x Interest Coverage: 11.3x ROE: 20.4% P/E: 13.9x EV/EBITDA: 8.0x Exhibit 1 Financial Ratios Exhibit 2 Comparables Valuation Dover Corporation (NYSE:DOV) Memo
Exhibit 3 DCF (Cash Flows) Dover Corporation (NYSE:DOV) Memo
Exhibit 4 DCF (WACC) Exhibit 5 DCF (Valuation) Dover Corporation (NYSE:DOV) Memo
Exhibit 6 Target Price Dover Corporation (NYSE:DOV) Memo
Ideas for the Club 1. A paper money portfolio competition within the club, possibly with prizes. Because it isn’t possible for every member to give valuable input on our actual portfolio every week, I think it would be cool to have a competition where everyone makes their own paper money portfolio. We could track the results and potentially offer prizes to the winners at the end of the semester. I think that this would be a great way to get everyone involved and encourage everyone to practice investing. This would not only help non-­‐managers stay involved and potentially generate new ideas, but I think it would also serve as a good way to learn. 2. Management gives a presentation about famous investors and investing strategies. MII has done a great job this past year with their education sessions, both for the new members and the returning, and I think that this would be a great next step to take. Showing quotes about investing, stock screening criteria, and famous investing success stories from people like Ben Graham, Warren Buffett, or Philip Fisher would help people start to apply the things they’ve learned so far. This presentation could also talk about broader investing strategies like value, growth, or macro and ways to apply these strategies in MII. 3. Assign associates and their teams to different industry groups. I think that allowing associates to indicate their preferences with regards to which industry the stocks they are covering should be from (and allowing analysts to do the same) would help keep members interested in their respective positions. Also, it could help people start to get a feel for which benchmarks and metrics are important in different industries and help them build expertise in a sector. I know that many funds are organized this way and it seems like a smart way to do it.