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Morningstar | New CEO Kicks Off Initial Review of Dover With Rightsizing Initiatives; Maintaining FVE

Narrow-moat-rated Dover's new CEO, Rich Tobin, presented a rightsizing plan to the market Sept. 11. The plan calls for broad-based selling, general, and administrative expense reductions of $100 million, net of $30 million reinvested in high-return growth initiatives. The SG&A reductions will occur without affecting research and development expense, which the company reports within its SG&A expense line on the income statement. Based on Tobin’s comments, we anticipate that a clear majority of the rightsizing initiatives will come in the form of reduced head count. The company also anticipates implementing a longer-term facility consolidation plan beginning in the fourth quarter, which should take it into 2020.

Tobin demurred from providing analysts updated 2018 or 2019 guidance but expects to deliver an update on Dover’s footprint moves to the market at the start of 2019. Even so, we don’t expect to materially change our $86 fair value estimate. Tobin was clear that this was not a five-year plan, and the latest news doesn’t alter our long-term fundamental view of Dover. As such, we are taking a wait-and-see approach to these announced actions, particularly as we’ve previously modeled in cost savings to the firm’s SG&A line with corresponding offsets in the form of increased corporate costs.

That said, we are pleased with Tobin’s candor during the call. He was not afraid to point out Dover’s recent shortcomings, particularly as it concerns execution. For example, Dover Fueling Solutions has had several missteps with footprint consolidation in Europe, which has not gone according to plan. As a result, the company has incurred additional frictional costs, which have spilled over into operations in the form of logistics and overtime pay.

We also appreciate Tobin’s frank assessment regarding the refrigeration segment, which confirms our suspicion that prior management was overly optimistic vis-a-vis the demand cycle. As a result, we particularly welcome the rightsizing initiatives in the refrigeration segment. On the bright side, Tobin indicated that the refrigeration business probably still operates below replacement rate, a view we’ve also shared in the past. Moreover, we’re not surprised by Tobin’s assessment that Dover lacks the operating leverage he would have expected, which we suspect is at least part of the reason the stock had been recently trading at a relative discount to peers’ earnings.

We think Tobin is right to try to focus on organic growth opportunities as opposed to M&A, given current valuations, particularly as Dover has had less success integrating larger companies versus smaller bolt-ons from the private market. We’re most interested as to which businesses in Dover’s portfolio Tobin will choose to retain versus dispose. We don’t expect to hear any material news on the front, however, until maybe a year from now. One keen insight we gleaned is that while refrigeration posts comparably lower margins than Dover’s other businesses, from a return standpoint it outperformed some higher-margin businesses. We suspect Dover will choose to hold on to this high-return business with less attractive internal growth prospects as its cash flows likely go to support the growing dividend, which has increased for over 60 consecutive years.