In part 33 of the 54 part Dividend Aristocrats In Focus series I take a closer look at the operations and competitive advantage of diversified machinery manufacturer Dover Corporation (DOV, Financial). Dover is a mid-cap company with a market capitalization of $13 billion. The company has increased its dividend payments for 59 consecutive years, one of the longest active streaks. Dover’s business segments are analyzed below to give a better idea of the operations of the company.
Business overview
Dover operates in four separate segments. The company’s segments are shown below along with percentage of total earnings generated for the company over full fiscal 2013.
- Energy: 36% of total earnings
- Engineered Systems: 38% of total earnings
- Fluids: 10% of total earnings
- Refrigeration & Food Equipment: 16% of total earnings
The company’s energy segment manufactures equipment for the oil and gas industry. Dover specializes in artificial lift technologies for the oil and gas industry. In addition, the segment manufactures bearings and compressions. The energy segment accounts for over one third of the company’s earnings. Key brands in the segment include Cook Compression, TWG Power, and Quartzdyne.
The engineered systems segment was the company’s largest in fiscal 2013, accounting for 38% of total earnings. The engineered systems segment is highly diversified; it serves the printing, vehicle, aerospace and waste management industries. Key brands in the segment include Environmental Solutions Group, Texas Hydraulics, and Sargent Aerospace & Defense.
The company’s fluids segment manufactures pumps and fluid transfer devices for the oil and gas, retail fueling, chemical, hygienic and industrial markets. The segment is Dover’s smallest based on 2013 earnings. Key brands include CPC, Hydro Systems, and PSG.
Finally, the refrigeration and food equipment segment provides solutions in refrigeration, electrical, heating and cooling systems and in food and beverage packaging. The segment is the company’s second smallest, contributing 16% of total income in full fiscal 2013. Key brands in the segment include Anthony, Hill Phoenix and Tipper Tie.
Competitive advantage
Dover’s competitive advantage comes from the core technological advantages it has developed through decades of operating experience and strategic acquisitions. The company is able to protect its technological edge through patents, increasing the longevity of its edge over competitors in the various markets it serves.
In addition, Dover has done an excellent job of branding its solutions. The company’s large portfolio of industrial product brands gives each of its solutions to various industries recognition within the specific industry. The company further supports many of its individual brands by adding the brand is a “Dover company” so customers know what to expect from the experience. Dover’s combination of technology, patents, and industrial brands has allowed the company to sell its manufactured products at a premium price. The company currently generates an operating margin of around 20%, and double digit net profit margins. Dover’s margins have been steadily increasing over the last decade. In 2004, the company had an operating margin of 14% and net profit margin of 7.5%.
Dover’s increasing margins show the company’s competitive advantages are strengthening as it acquires more bolt-on businesses and further enhances its technology and brand portfolio. The company has been attempting to streamline efficiency in recent years. Examples of this include combining four manufacturing facilities for the company’s Hill Phoenix brand into one new facility, and combining 5 separate manufacturing facilities in the company’s energy segment into one facility in Houston, Texas.
Growth prospects
Dover is targeting 3% to 5% organic growth, with additional growth being spurred by potential future acquisitions. The company has a solid balance sheet; it has the capacity to continue adding smaller businesses to its operations. The company is also targeting continued margin expansion from better efficiency going forward.
Over the last decade, Dover has managed to grow revenue per share at about 6% per year. The company has decreased its share count by over 2% a year over the last decade, boosting per share earnings and revenue numbers.
Based on the company’s projected 3% to 5% organic growth coupled with share repurchases of 2% per year and Dover’s current dividend yield of 2%, I expect a CAGR of at least 7% to 9% for shareholders going forward. The company can do significantly better if margins continue to expand and future acquisition opportunities present themselves. Both of these two occurrences seem likely; in light of this, I believe shareholders of Dover will see a double-digit CAGR over the next several years.
Dividend analysis
Dover currently has a dividend yield of about 2% and payout ratio of about 30%. The company has grown its dividend payments in line with earnings growth in recent years. Shareholders of Dover are in no danger of missing a dividend payment. The company’s conservative payout ratio and long streak of consecutive dividend increases make it very likely Dover will continue to reward shareholders with increasing dividends for the foreseeable future.
Valuation
Dover has historically traded at a premium of about 1.1x to the S&P500’s PE ratio. The S&P500 is currently trading at a PE multiple of about 19.2. At the market’s current level, this implies a fair PE multiple for Dover of around 21. The company is currently trading at a PE multiple of just 15. I believe the company to be significantly undervalued at current market prices. The company’s recent stock price reflects the general pessimism causing the company’s low PE ratio. Over the last six months, Dover’s stock has declined 7% while the S&P500 has risen about 6% in the same time period.
Recession performance
Dover remained profitable throughout the Great Recession of 2007 to 2009. The company did see EPS declines at the height of the Great Depression in 2009, but future earnings power was not impaired as Dover managed to hit new EPS highs two years later in 2011. The company’s EPS throughout the Great Recession and into recovery are shown below to give an idea of the impact of recessions on the company:
- 2007 EPS of $3.22
- 2008 EPS of $3.67
- 2009 EPS of $2.00 (recession low)
- 2010 EPS of $3.48
- 2011 EPS of $4.49 (new EPS high)
Dover’s operations are affected by recessions as it sells components to businesses affected by recessions. The oil and gas industry will hold off on capital expenditures during recessions when money is (relatively) tight. In addition, many of the company’s other industrial suppliers experience cash flow reductions during recessions and hold off new purchases as well. This explains the company’s EPS drop in 2009. While Dover is not immune to recessions, it has proven it can last through protracted economic downturns and remain profitable.
Final thoughts
Dover Corporation is a high quality business trading at a fair price. The company’s stock price has a high standard deviation of about 30%, however. Higher than average price volatility is likely due to the company’s susceptibility to recessions. Dover has a 2% dividend yield, which is somewhat below average for businesses with a long history of dividend increases. On the plus side, the company has a low payout ratio of 30% and fairly solid long-term growth prospects.
The company is ranked in the Top 50 based on The 8 Rules of Dividend Investing due to the aforementioned financial metrics. Dover is rated as a hold at this time. The company is solid, but I believe there are better investment options available in the diversified manufacturing sector for dividend growth investors at this time.
