Any significant worries about a failure of the second half industrial recovery thesis seem to have been set aside for Dover (NYSE:DOV). With the company deciding to spinoff its Knowles electronic components business and outlining significant opportunities in markets like energy and refrigeration, analysts and investors are on board with the solid potential of this industrial conglomerate. Although Dover is by no means overvalued and should offer better growth than most of its peers, newcomers to the story may just want to wait in the hopes of a better entry price.
SEE: Cashing In On Corporate Restructuring
Spinning Knowles Makes Solid Long-Term Sense
It wasn't altogether surprising that Dover announced its intention to spin off its microphone, transducer, speaker, and receiver business (collectively known as Knowles). Although I was a little surprised to hear that management didn't actively shop the business, a tax-free spinoff should be a good option for a business that never really fit within the company and always seemed to be a talking point in the wrong sort of way.
While Knowles showed some solid growth for a while as the company's MEMS microphones made a significant splash in the market, the market is getting more competitive. Investors who've followed the mobile device component market won't be too surprised to hear that although microphone and speaker content per device is growing, a host of cheaper vendors have entered the market and pressured Dover's share.
What's more, this is a business with short product/technology cycles and high ongoing R&D and retooling needs. That's fine for a company like Analog Devices (Nasdaq:ADI) that is used to that, but it's not really a Dover-type business in that regard. Consequently, I see spinning this division as a net positive to long term cash flow and capital returns.
SEE: Operating Cash Flow: Better Than Net Income?
Playing Solid Trends In Core Markets
Sell-side analysts came out of Dover's recent analyst day pretty excited about the opportunities in areas like energy and refrigeration, even if this really shouldn't have been “new news” to committed Dover-watchers.
Dover has a very good opportunity to leverage its acquisition of Anthony, a company that makes specialty glass doors for commercial refrigeration. Energy is a major expense for retailers like Wal-Mart (NYSE:WMT), and Anthony's products boast not only 30% better energy efficiency than the second-best offering, but about two-thirds overall savings. With rival Hussman being reorganized by its private equity buyer (it was previously part of Ingersoll Rand (NYSE:IR)), this is a significant near-term opportunity for retrofit/upgrade sales.
Energy is likewise a meaningful opportunity, particularly as the company is less tied to rig counts than in past years/cycles. General Electric's (NYSE:GE) acquisition of Lufkin (Nasdaq:LUFK) is a threat to Dover's artificial lift business, but Dover management said they see at least 40 potential deal targets to expand their energy business. I'd expect to see GE and National Oilwell Varco (NYSE:NOV) competing for some of those deals, but it looks like Dover is very much committed to this business.
I would also expect to see Dover's Fluid Solutions segment emerge as a bigger part of the whole. Companies like IDEX (NYSE:IEX), Flowserve (NYSE:FLS), and Colfax (NYSE:CFX) have been pretty bullish on long-term demand from not only the energy markets, but “process industries” like chemicals and food/beverage, as well as water infrastructure projects around the world.
SEE: Fueling Futures In The Energy Market
The Bottom Line
To a certain extent I feel like Dover's recent announcement with Knowles and the analyst day simply woke up sell-side analysts to what had already been going on at Dover. I don't think Dover investors will mind, though, as higher estimates and price targets haven't done the stock any harm.
I still like this business, but I'm a little cooler on the stock since the recent move. The 6% long-term free cash flow (FCF) growth I expect is pretty good relative to Dover's peers, but the valuation today looks more or less fair. I'd be in no hurry to sell this stock if I already owned it, but I'm not sure I'd rush to build a big position at today's prices.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.