Is Dover Worth The Trouble?

By Stephen D. Simpson, CFA | April 26, 2011 AAA

Multi-line industrial conglomerates like Dover (NYSE:DOV) often trade at a discount to their underlying cash-flow generating capabilities. To some extent this is a byproduct of straddling many different industry groups - they are harder to track and forecast, and many analysts and institutions decide they do not need the hassle. This is old hat for investors in names like Illinois Tool Works (NYSE:ITW), Danaher (NYSE:DHR) and so on, though sometimes these conglomerates do come into favor as a sector play.

TUTORIAL: How To Read Financial Tables

In the case of Dover in particular, the company does not exactly make it easy for investors - the company's press release does not even often include an income statement or balance sheet. True, the company does offer a good amount of information, but it requires some effort. The real question for investors, then, is whether the stock is worth the work and the hassle.

A Solid Quarter Across the Board
Business is going well at Dover. Overall revenue growth of 24% was underlined by 19% organic growth (made up completely of volume growth). Growth was also relatively balanced - the company's Engineered Systems segment was the laggard with 16% revenue growth (if that can be called lagging), while Industrial Products, Fluid Management and Electronic Technologies grew 21%, 34% and 28% respectively. (For more, see Conglomerates: Cash Cows Or Corporate Chaos?)

Like many companies, Dover is seeing some gross margin impact from costs and currency, and gross margin slipped about half a point this quarter. The company more than made up for it through operating efficiencies as segment operating profit jumped 28% and overall operating income grew 32%. Among the segments, only fluid management saw a decline in unit operating margin.

Dover also exited the quarter with a strong book of business, as bookings jumped 27% from last year and increased from the fourth quarter by a double-digit percentage.

Not Just An "X" Company
Some have tried to categorize Dover by its relatively larger exposures to markets like semiconductor capital equipment and energy production, but that is increasingly misleading and unhelpful. After all, the company's MEMS microphone business is significant for markets like smartphones, and the company has been moving into other relatively new markets like solar. All in all, that is part of the bull thesis on this name - it's more dynamic than people often seem to think.

Of course, that does not mean that this is a free-money opportunity. Companies like Eaton (NYSE:ETN) and General Electric (NYSE:GE) are fierce competitors in markets like material handling and energy-related products, while others like Agilent (NYSE:A) are looking to build their own market shares in electronics. Still, Dover is a somewhat niche-oriented company with a more or less hands-off approach from executive management, and that often helps companies remain more nimble in the face of more bureaucratic competitors.

Better Execution Should Mean Less of a Discount
Apart from being in attractive markets, Dover also seems to be executing better. The company already offers a pretty respectable return on capital and double-digit order growth should offer up the opportunity for even more operating leverage. True, this is a company with broad economic vulnerability (profits dropped almost by half in 2009), but that could change if the company is successful in diversifying more of its business around the globe. However, it seems safer to assume that order growth is going to start to weaken as the recovery matures.

The Bottom Line
Conglomerates are doing relatively better in the market than in past years, as investors no longer seem to be applying quite the same discounts. Coupled with Dover's better execution and financial results, the stock is in a tricky place. It definitely seems priced to be a good holding for those who already own it, but the undervaluation may not be quite enough to give an appropriate margin of safety for new investors. Given that the "rebounding industrials" story is already a bit long in the tooth, Dover is a good candidate for a watch list, but perhaps not the most appealing buy today strictly on its valuation merits. (For more, see Conglomerates: Risky Proposition?)

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