Dover Does A Little Better

By Stephen D. Simpson, CFA | July 18, 2013 AAA

Dover (NYSE:DOV) is doing nothing to contradict the notion that this company may be one of the better organic growth stories in the industrial sector today. Better still, businesses like energy, refrigeration, and “industrial” should be tilting more towards upside risk today than downside, suggesting a pretty good runway for growth in the coming years. So long as Dover continues to post better-than-expected results valuation won't matter much, but new investors should be aware that these aren't exactly cheap shares today.

Very Good Results For Q2
Dover's report for the June quarter was quite encouraging. Revenue rose 9% for the quarter, or about 5% on an organic basis – well ahead of the 3% or so organic growth forecast of most analysts. Growth was led by the Engineered Systems segment (up 13%), and particularly the refrigeration business (up about 26%). Energy was up 6% on balanced growth, and Comm Tech was up 11% despite the various and sundry worries about shipment numbers at Samsung. Printing and ID was the lone weak spot in the quarter, with revenue down less than 1% and weaker than the mid-single-digit growth reported by Danaher (NYSE:DHR).

SEE: Danaher Hits All-Time High

Dover gave up some of the positive momentum from sales in its margins. Gross margin was up a bit from last year (and basically flat sequentially). Operating expenses were quite a bit higher than forecast, though, as SG&A as a percentage of revenue increased from about 19% last year to nearly 23%. With that, operating income still rose 13% and the operating margin still expanded more than a half-point.

Balance Boosts Energy
Within that 6% overall growth rate for Energy revenue, Dover reported that revenue from drilling operations rose 3%, while production and downstream were up 6% and 10%, respectively. Bad weather has impacted the ability of companies to drill in Canada, and that seems to be the primary cause of the decline in margins and backlog for this segment for the quarter.

Those results could suggest some headwinds for National Oilwell Varco (NYSE:NOV) and Baker Hughes (NYSE:BHI), but the reality is that the relevant products (drill bits and pressure transducers) are only small parts of the overall picture for those two energy companies. Likewise, the positive results in production and downstream should offset the impact for National Oilwell, as well as other players like General Electric (NYSE:GE).

The Second Half May Be Even Better
Earlier in the year, Dover management was expecting recoveries in North American drilling and better comps in refrigeration to help accelerate growth. Given the strong performance of refrigeration, that's an encouraging development. As a reminder, one of the bigger near-to-intermediate growth drivers for Dover should be a movement to “close the case” by offering food retailers new enclosed refrigerated display cases. With that, I wouldn't assume that Dover's strong performance is necessarily a tip-off for the upcoming results of Illinois Tool Works (NYSE:ITW) or Middleby (Nasdaq:MIDD) in their food equipment businesses.

The Bottom Line
I still see a lot of ways in which Dover could do well in the coming years. Artificial lift isn't going anywhere but up in the North American energy market, and the cost savings that Dover can offer to retailers in refrigeration seem too good to ignore. Elsewhere, I believe there's still the opportunity to add scale to the fluid solutions business and see a macro-driven turnaround in industrial and printing/ID.

The only downside is that the Street is already pricing in a lot of this progress. I might be too stingy in the cash flow margin expansion I'm forecasting for Dover over the next decade, but for now I'm looking for top-line growth of about 5% and free cash flow growth of about 6%. With that, I think $81 is a fair price for these shares. Given that the odds seem to favor further growth and outperformance for Dover, I suppose this is a stock where overpaying today may work out, but I'd nevertheless caution readers that these shares don't look like a significant fundamental bargain today.

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