Dover Corporation (NYSE:DOV) Q3 2023 Earnings Call Transcript

Dover Corporation (NYSE:DOV) Q3 2023 Earnings Call Transcript October 24, 2023

Dover Corporation reports earnings inline with expectations. Reported EPS is $2.35 EPS, expectations were $2.35.

Operator: Good morning, and welcome to Dover’s Third Quarter 2023 Earnings Conference Call. Speaking today are Richard J. Tobin, President and Chief Executive Officer; Brad Cerepak, Senior Vice President and Chief Financial Officer; and Andrey Galiuk, Vice President, Corporate Development and Investor Relations. After the speakers’ remarks, there will be a question-and-answer period. [Operator Instructions] As a reminder, ladies and gentlemen, this conference call is being recorded, and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. Thank you. I would now like to turn the call over to Mr. Andrey Galiuk. Please go ahead, sir.

Andrey Galiuk: Thank you, Angela. Good morning, everyone, and thank you for joining our call today. An audio version of this call will be available on our website through November 14, and a replay link of the webcast will be archived for 90 days. Our comments today will include forward-looking statements based on current expectations. Actual results and events could differ from those statements due to a number of risks and uncertainties, which are discussed in our SEC filings. We assume no obligation to update our forward-looking statements. With that, I will turn this call over to Rich.

Richard Tobin: Okay. Thanks, Andrey. We posted very encouraging results [and let us] become a dynamic operating environment across our different end markets and geographies. Revenue and order rates improved sequentially in the quarter on normalizing lead times and inventories, improving demands across several end markets and a return to normal seasonality. Our backlog continued to normalize in the quarter, in tandem with lead times as we shipped longer-dated orders from our books. Broadly speaking, margins performance in the quarter was exceptional, reaching an all-time high driven by productivity, cost controls and disciplined pricing, which more than offset the negative product mix in Pumps & Process Solutions. The proactive structural cost actions we have undertaken over the last 12 months are paying dividends and should support strong margin conversion going forward.

Our recent portfolio moves, the acquisition of FW Murphy and the sale of De-Sta-Co followed the portfolio intent and priorities that we reiterated at our Investor Day earlier in the year and continued our portfolio evolution towards higher-growth and higher-return businesses at attractive valuations. Our balance sheet position and cash flow are strong and provide attractive optionality as we continue to pursue bolt-on acquisitions in a more favorable M&A environment and evaluate opportunistic capital return strategies. We have reduced our EPS guidance for the full-year and are now targeting the low-end of the previous guidance range. This is driven by continued lag in biopharma recovery that we expected to happen in the second half of the year.

Temporary cost and supply chain issues that I’ll expand upon later and a general trend towards inventory liquidation across supply chains as a result of macro uncertainty and prohibitive carrying costs, I’ll cover the specifics in the segment commentary. Overall, demand remains good across the portfolio, considering the plentiful negative macro headlines. Our new product launches and capacity additions and identified areas of growth are all on track, and we expect that our fourth quarter production posture will help balance our channel inventories with prevailing demand, lead times and inventory carrying costs by the end of 2023. We are increasingly convinced that inventory position will be critical to the pricing dynamic and financial results moving into 2024.

Going into 2024, we expect to see growth in our bookings driven by secular growth exposed in recovering end markets, and we expect to carry an elevated backlog into next year in select businesses. Between our demand outlook, flexible business model and in-flight structural cost actions, we see good foundation for value creation in 2024. Let’s move on to the performance highlights on Page 4. Consolidated revenue was down 2% in the quarter despite sequential growth in four out of five segments. Bookings were up sequentially, but down 4% organically year-over-year, resulting in a book-to-bill of 0.93, reflecting better lead times and strong shipments against our longer-dated orders. As a result, our backlog continued to normalize, but remains elevated relative to pre-pandemic levels.

Segment margins were up 50 basis points to 21.7%, a record since the Apergy spin as broadly based productivity and portfolio improvements were more than able to offset biopharma mix. Adjusted EPS was up 4% to $2.35 in the quarter. And positive price/cost dynamics, together with cost containment actions, strong execution, more than offset lower volumes. Let’s go to Slide 5. Engineered Products was down 3% organically in the quarter. General weakness in Europe and Asia, together with lower shipments in vehicle service, more than offset the record quarter in aerospace and defense and strong shipments in waste hauling. Order rates in the segment were up 12% organically in the quarter, primarily driven by waste handling business, which continues to take capacity reservations well into 2024.

Margins at 20% were up 260 basis points year-over-year driven by a better mix of recurring and aftermarket revenue, price/cost and productivity investments made in previous periods. I’d like to mention the announcement of our agreement to divest De-Sta-Co, one of the operating units within the Engineered Products segments and an attractive valuation. This is not related to [indiscernible] performance, but we leave the valuation we achieved underscores the quality and strong performance of the businesses that we have proven to have best-in-class operating margin and less cyclicality than typical capital goods businesses. Clean Energy & Fueling revenue was flat organically in the quarter. We saw double-digit growth in components for LNG and hydrogen markets.

And the aboveground retail fueling business returned to growth as post-EMV recovery is in progress. High interest rates led to project push-outs in vehicle wash and an unforecasted channel destocking has resulted in slower activity in LPG components and belowground fueling, which are highly margin accretive to the segment. Margins in the quarter were at 20%, were up 40 basis points on structural cost actions in our retail fueling business and solid execution more than offset negative mix. Imaging & ID was down 4% organically as slowing demand in China and a difficult comparable period in marking and coding printer shipments more than offset the growth in serialization software and marking and coding consumables and professional services. Margins in Imaging & ID was strong at 26%, though down year-over-year against an all-time record high for the segment in the comparable quarter.

Pumps & Process Solutions was down 7% organically in the quarter. Precision components and hygienic dosing systems posted another quarter of excellent growth, but were more than offset by the continued softness in biopharma. Industrial pumps and polymer processing [were stable] in the quarter. Segment margin of 27% was down to the lower mix of biopharma revenue. Topline in Climate & Sustainability Technologies was up 2% organically. CO2 systems continued its double-digit growth trajectory. Heat exchanger shipments remained strong in North America and Europe, though we experienced the beginning of demand headwinds in Asia. The segment posted strong margin performance of 18% in the quarter with our food retail business or refrigeration business operating at a robust 15% margin.

The steady margin improvement trajectory in refrigeration has been noteworthy as positive mix and productivity investments have driven excellent margin conversion. We expect the margin improvement trend to continue for the whole segment. I’ll pass it on to Brad here.

Brad Cerepak: Thanks, Rich. Good morning, everyone. I’m on Slide 7. The top bridge shows our organic revenue decline of 2%. Both acquisitions and FX translation contributed positive 1% to the topline in the quarter. FX, which has been a headwind for the past year and a half resulted in $0.02 of positive EPS impact in the quarter. Based on recent movement in the euro/dollar exchange rate, we now expect FX to be a $0.01 to $0.02 headwind in the fourth quarter. From a geographic perspective, the U.S., our largest market was down 7% in the quarter due to lower shipments in vehicle service, biopharma, LPG components and belowground retail fueling. Europe was down 5% and Asia was down 3%. China, which represents about half of our revenue base in Asia, was down 5% organically in the quarter.

On the bottom chart, bookings were down year-over-year due to normalization of lead times and strong shipments against elevated backlogs. Now on our cash flow statement, Slide 8. Year-to-date, free cash flow came in at $688 million or 11% of revenue, represented an increase of nearly $400 million year-over-year. As discussed previously, with supply chains improving, we have begun actively working to liquidate our working capital balances in 2023. We accelerated our inventory reduction in the third quarter and expect the trend to continue as we plan to balance our inventory levels by the end of the year. Free cash flow generation has historically peaked in the fourth quarter. And again, we expect strong fourth quarter cash flow to finish the year.

Our forecast for 2023 free cash flow is 13% to 15% of revenue. Let me turn it back to Rich.

Richard Tobin: All right. I’m on Slide 9. We expect Engineered Products to generate moderate growth in the fourth quarter. Aerospace and defense should remain strong. Meanwhile, the auto strike will weigh on several businesses in the near-term. Growth in our waste handling business, which is expected to be robust in the fourth quarter into 2024 will be reduced in the near-term by recent strike at a major truck OEM impacting deliveries. Shipments in vehicle aftermarket expected to be lower versus a record previous year on higher interest rates weigh on service shop’s ability to finance CapEx. We expect margins to improve in the quarter on positive price/cost tailwinds and benefits from our recent productivity capital investments.

Clean Energy & Fueling is expected to remain steady. Clean energy, LNG and hydrogen components should continue their robust trajectory and order trends in aboveground retail fueling point to continued post-EMV recovery. We expect channel destocking and interest rate-driven headwinds in the belowground fueling segment, LPG components and vehicle wash to maintain through year-end. We expect stable margin performance as the $60 million in aggregate structural cost containment actions in retail fueling should offset negative mix from lower belowground and lower car wash volumes. Imaging & ID is expected to be down organically against a difficult comparable period driven by slowing demand in Asia and a subdued outlook for textiles. Serialization software should continue its growth trajectory.

Our new customer conversion margin performance should remain at attractive levels at this segment. Pumps & Process is expected to remain roughly flat organically in the fourth quarter. Precision components should continue growth tailwinds from energy transition projects. Polymer processing is booked for the year. The recovery in biopharma components has been very subdued. And although channel inventory levels are now below pre-pandemic levels, end customer demand has not recovered enough to drive 2023 growth despite earlier forecast indicating recovery. We have reduced our production and inventory levels appropriately and will remain in this posture for the balance of the year. This is generally a short-cycle business, and we can ramp as order rates recover in 2024.

We expect year-over-year margin headwinds on negative mix in biopharma. And after several years of impressive topline growth, Climate & Sustainability Technologies is expect to moderate in the fourth quarter as demand for heat exchangers abruptly slowed in Q3 due to near-term uncertainty in European heat pumps. As a result, we are reducing production levels to allow for inventory to be cleared in the fourth quarter. Traditional refrigeration demand will retain its seasonality with reduced activity during the holiday season. But we continue to see robust demand for our CO2 refrigeration systems and are ramping up production and go-to-market efforts appropriately. We expect continued year-over-year margin improvement through year-end on productivity gains and improved mix.

Going to Slide 10. Our updated EPS guide reflects the near-term changes in demand and our production posture, temporary and isolated issues in the supply chain and costs related to acquisitions, integration and divestment activities. We expect these headwinds to be partially offset by a lower effective tax rate in Q4 as a result of tax reorganization activities driven by upcoming regulatory changes. As I’ve highlighted, we believe our changed operating and production posture focused on reducing inventories and prioritizing cash flow over volume in reaction to the dynamic operating environment is critical to setting up 2024 outlook where we can maintain and expand operating margins. Let’s go to Slide 11 and take a quick look at the inorganic moves that we made during the quarter.

Here, we summarized the two recently announced transaction that align well with our portfolio priorities and enhance the overall quality of Dover’s portfolio through margin growth and reoccurring revenue uplift, all while reducing our exposure to automotive and China. Importantly, we are able to acquire FW Murphy, a lower valuation multiple than our sale of De-Sta-Co and the after-tax proceeds from the De-Sta-Co sale more than pay for FW Murphy, preserving significant balance sheet capacity for additional capital deployment options. Slide 12 provides more color on the rationale for the acquisition of FW Murphy by our precision components operating unit, which is part of Pumps & Process Solutions segment. FW Murphy brings a highly complementary product offering to our existing position in reciprocating compression industry.

FW Murphy Solutions capitalized on the growing adoption of advanced remote monitoring, control real-time optimization solutions as customers seek to reduce costs, improve uptime and lower emissions. In combination with our best-in-class clean technology and our leading position in sealing and valve technology for alternative energy applications, including in hydrogen, the FW Murphy acquisition offers a compelling value proposition into a global industry where we see robust demand from energy transition investments. The FW Murphy acquisition provides a good segue into our next topic, which is to highlight, the recent developments in investment in sustainability-driven markets, starting on Slide 13. There has been plenty of interest around hydrogen as a result of the recent announcement of $7 billion in federal funding for multiple regional hydrogen hubs that are expected to also attract $40 billion in private funding and a roster of blue chip industry participants.

Dover has established a position in hydrogen with the 2021 acquisition of Acme, which supplies flow control components for liquid hydrogen and [indiscernible], which offers turnkey hydrogen refueling sites. Additionally, we are organically invested in extending DPCs gas compression components to participate in gaseous hydrogen applications. In short, there is no hydrogen economy without compression. We have great relationships with the industrial gas and hydrogen players and aim to participate throughout the whole value chain through transport and storage through end-use in collaboration with equipment OEMs. We are well positioned to capitalize on growth in hydrogen and industry with a high focus on safety and regulatory compliance with high technological requirements for participation.

Moving to Slide 14. The EPA recently finalized its rule under the AIM Act with a deadline for new installation of refrigeration systems to be compliant with lower GWP requirements by January of 2027. We believe this rule is a clear tailwind to our CO2 systems business. And we have had a leading position in the European CO2 market for over a decade where we enjoyed steady double-digit growth trajectory. We were the early mover in transplanting this technology to the U.S. where we currently enjoy technological lead and have the largest installed based and broadest differentiated offering. We have proactively expanded our capacity in addition and in participation of market growth and have been investing behind a platform-based product strategy to drive standardization, thereby reducing costs for ourselves and our customers, improving product quality and simplifying the sales process.

Our global CO2 business is approximately $200 million in revenue. The U.S. market is in the early innings, and our business is on track for 30% growth in 2023 with a strong outlook. We are also excited about our new CO2-based heat pump offerings for industrial and district heating applications. It’s early days, but we have an active pipeline of orders. And finally, on Slide 15 shows our latest views on heat exchangers since it has become a battleground topic. Our heat exchanger business supplies brazed plate technology, which is currently the most sustainable commercialized heat transfer technology for fluids. We have been the clear beneficiary of the sustainability and climate tailwinds across various applications with a lot of attention drawn recently from our participation as a key supplier to hydronic heat pumps.

Heat pumps have emerged in recent years as a technology of choice to decarbonize residential heating, which is responsible for a significant portion of global emissions with hydronic heat pumps as a primary technology to retrofit houses that rely on water-based heating. Legislative initiatives in European Union and individual countries are driving the conversion of fossil fuel boiler with heat pumps. Recent uncertainties about subsidies in select European countries have weighed on near-term volumes, as I indicated earlier. Our exposure across multiple OEMs and geographies, and as such, we are not over-indexed to any product or customer concentration risk. We remain confident about the long-term growth prospects for heat pumps and our technology.

It is important to note that European residential heat pumps represent only a quarter of our heat exchanger business. You see several solid growth vectors driven by sustainability tailwinds and continue to share gains from other legacy heat exchanger technologies. We have proactively expanded our capacity as we expect continued robust growth trajectory in heat exchangers, albeit with slightly lower rates in the near-term as various dynamics in Europe slow down. I close my prepared remarks by thanking our global teams for driving our strong financial performance during the quarter. And it’s time for Q&A.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Steve Tusa with JPMorgan. Please go ahead.

Steve Tusa: Hey, guys. Good morning.

Richard Tobin: Hi, Steve.

Steve Tusa: So I think you were a little more positive in early September than this fourth quarter guidance, understand maybe the world’s changed a little bit since then. Maybe you could just discuss that. But then just looking ahead, thinking about perhaps a more cautious view of the world for next year. What’s kind of a low-end assumption for next year when it comes to organic and margins? Just to kind of level set us on a case where perhaps the orders don’t recouple as strongly to the trend lines or the trend lines are a little bit weaker. Like in your macro view, what is a more cautious outlook for next year bring for Dover? Because you’ve been talking about growth there as things recouple the trend. It seems like that would have changed over the last month or so.

Richard Tobin: Okay. That’s a lot to take on this. Steve, let’s give it a try. Look, I think if we look at our forecast for the year, we were just wrong about biopharma. I mean, we were getting indications from our customers that there was going to be some nascent recovery. We actually did see some order upticks, but quite frankly, it just never turned into much. So that’s a little bit different than we were back in September. I think we just have to throw in the towel on biopharma demand and it gets pushed to 2024. We didn’t expect in terms of market dynamics was this UAW on trucks, right? We thought it would stay limited into the car sector. And unfortunately, what we were betting on is being able to ship quite heavily out of ESG in Q4.

We’ll actually have a good quarter in Q4, but it’s not going to be as robust in our plans. I think I mentioned on the heat exchangers. That was a little bit of an abrupt reversal and really didn’t happen until almost the end of Q3. So up until about 30 days ago. Everything looked good there. And I think that we’ve got a little bit of a pivot as what we understand is there’s a lot of finished goods in the supply chain that need to be reduced from there. So at the end of the day, I think it slowed some and – which leads into the next question. And the next question, our positioning now is to drive for cash because I think that the way we’re going to be able to protect margins into 2024 is not to be long inventory. We had a lot of discussions around here about incentivizing revenue in 2024 driving revenue, but then you start touching on things like price and you start touching on things like payment terms, and we’re not going there.

I mean I think that the strategy that we have is to adapt quickly and efficiently to the market demand, bring down our inventory with the hope of – with the strategy of protecting margin into next year. And I think if you look at how we’ve handled demand this year, it’s exactly what we’ve done at the end of the day. I mean, we talked about it before. What we had seen over the previous two years was not a lot of unitary demand. You saw a lot of pricing going into the system. So we came into this year saying, there’s probably going to be less price and some unitary demand, but the important – and I think that we’ve done that in terms of managing, which is reflected in our margins year-to-date, is managing not getting oversupply and over our SKUs a little bit in terms of inventory and that we’re going to take that on for next year.

Do you want me to make a call on the market next year? I think we’re going to have to wait on that. Clearly, there’s a lot of headwinds in the system. I don’t want to get on a personal soapbox, but the amount of liquidity that’s being withdrawn is going to show up somewhere. And this notion that we’re all going to wait on the government to bail us out because of this wave of government spending coming, I find that a problematic strategy. So I think it all is going to be triggered by monetary policy between now and the end of the year, which is going to allow for us to predict growth into next year. What I can tell you is, is if we do what we’re planning on doing in Q4, we will not be long inventory, and we’re not going to get into a situation where if there are kind of topline headwinds that we’re going to have to start playing price to drive growth.

Steve Tusa: So like should we just think about flat as a starting point for next year?

Richard Tobin: No, I don’t think so. I think that we’re ahead of the curve. Remember, we’re a component supplier into end market industries, right? So we’re first at the end of the day. So I think that if we get this right, we’ve got topline growth next year, even in a pretty benign kind of macro environment, I think that we can drive growth. And I think that’s part of the reason that we covered some of those growth vectors in terms of our investment at the end of the presentation.

Steve Tusa: Great. All right. Thanks a lot.

Richard Tobin: Thanks.

Operator: The next question comes from Jeff Sprague with Vertical Research Partners. Please go ahead.

Jeffrey Sprague: Thank you. Good morning. Hey, Rich, maybe a question on restructuring and thinking fueling in particular. I think you had a lot of restructuring planned there for Q4, but it looks like you’re guiding margins kind of flat, I guess, on a year-over-year basis. Could you speak to that? Maybe it’s some of the absorption issues you’re talking about on inventory, but love some more color on the margin trajectory there?

Richard Tobin: Sure. I think if you go back and look at the script, basically, what it says is the restructuring that we took is going to protect margins into Q4 because we actually have a poor mix forecasted for Q4 because where we’ve been seeing the headwinds in Fueling Solutions is in the below-ground portion of the segment, and that is highly accretive to margins. We’re basically – you heard me answer Steve’s question there, we’re taking the position of let’s allow inventory to be draw down even we would argue at this point, below even normal levels between now and the end of the year and protect production performance into next year. So the restructuring benefit – the restructuring that we’ve done is actually protecting margins into Q4.

Jeffrey Sprague: And on these questions of just kind of what’s at the customer level, right, whether it was biopharma earlier this year, heat pumps, maybe now, some other pockets, how would you kind of square up your visibility and kind of comfort level on understanding what the right level of inventory is or when the customer demand equation might turn a little bit?

Richard Tobin: Yes. I think we’re getting a lot better at it. At the end of the day, where we sell through distribution, we have visibility, right, because we’ve just got a material position within distribution, so we can see pretty much stocking levels. At the OEM level, it becomes a lot more difficult. At the end of the day, we’re relying on the OEMs to basically tell us their own position. So let’s take heat exchangers. Up until 45 days ago, it was still a demand capacity deficit of give us everything you’ve got and then all of a sudden, for reasons that I tried to cover, the markets come to a halt because there’s a recognition of the seemingly is a lot of finished goods in the chain now that need to be bled off. So like I said, from – if it’s distribution, I think that we’ve got a pretty good handle on it. When it’s OEM, we just got to take the signals from them.