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Morningstar | Dover Posts Strong 3Q Performance With Some Puts and Takes; Raising Fair Value Estimate to $87

Narrow-moat rated Dover had a solid 2018 third quarter, and we raise our fair value estimate to $87 from $86 previously. The increase in our fair value estimate, however, primarily relates to the time value of money, with some other puts and takes. Our new estimate implies an 18 times multiple to our updated, full-year 2018 adjusted EPS estimate of $4.82, which represents the midpoint of management’s narrower guidance (and at the high end of prior guidance). The changes in our EPS estimates, however, mostly relate to higher share buybacks than we previously modeled, which we like given prior undervaluation in the stock.

We’ve been impressed with how the Engineered Systems segment has expanded its margin, but on balance, that’s been somewhat offset by our disappointment in the Refrigeration & Food Equipment segment’s top-line weakness. Overall, we think recent results underpin our conviction that Engineered Systems’ installed base benefits from a switching cost moat source, leading to a strong base of highly recurring revenue in consumables. Markem-Imaje also makes proprietary inks, indicative of some intangible assets in the business, as well. Management indicated it had previously expected a top-line sequential slowdown in Engineered Systems given: 1) some seasonal factors; and 2) scheduled production shutdowns at its European operations. Even so, the Engineered Systems segment held strong given some margin benefits from increased operating leverage. Tobin specifically called out the Printing & Identification platform in his remarks and indicated broad-based geographic strength in Markem-Imaje.

We’ve long been monitoring the recent weakness at Refrigeration & Food Equipment, but admittedly, the extent of the short-term weakness has surprised us. The Street has recently raised its price targets on management’s restructuring efforts (somewhere between 5% to 10% on average), and while we like what we’re hearing, we don’t expect that the Refrigeration segment’s fortunes will reverse overnight. To be fair, however, this business is inherently lumpy, and we’ve not altered our long-term forecast. We believe it can be difficult to rationalize cost with demand. Compounding this problem, is refrigeration’s negative pricing environment. Thus, “calling the bottom” is an inherently complex (and fruitless) exercise. Even so, we’re encouraged by a couple of factors that renew confidence in some of our assumptions. First, declining backlog rates are smaller than we’ve seen previously. Second, management also indicated that pricing headwinds “have moderated” there some, which we think is a key insight.

Other important updates we’ve been following closely include any color on restructurings and any future Dover plans for Europay, Mastercard, Visa (EMV). EMV is a global standard for authenticating credit card transactions that ultimately impacts the firm’s Fluids segment and its downstream offerings. Dover appears to be somewhat in limbo here, and we’re hoping the firm carries adequate inventory for what we believe should be a strong secular tailwind. Finally, management indicates it’s on track with its restructuring plans and expects $16 million of incremental benefits in the fourth quarter of 2018.