Dover Corp (DOV) — Q3 2024 Earnings Call Transcript

Thank you, Connie. Good morning, everyone, and thank you for joining our call. An audio version of the call will be available on our website through November 14th, and a replay link of the webcast will be archived for 90 days. Our presentation today is on a continuing operations basis to exclude the impact of our divested waste tolling equipment business from historical results. Please reference the 8-K filed on October 10th for further information. 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. And with that, I will turn the call over to Rich.

Thanks, Jack. Good morning, everyone. Let's start with the performance highlights on Page 3. Overall, the quarter was modestly better than our internal forecast, which I'll cover in the upcoming segment results slides. Top line performance was broad-based across the portfolio. We are especially pleased that the rotation from our longer cycle businesses to our growth platforms has continued to drive positive margin mix for the total portfolio. We expect that to be an underlying theme as we head into 2025. Segment margin performance for the quarter was solid at 22.6% and represents an all-time high for Dover's consolidated portfolio. Bookings were up 5% organically in the quarter with particular strength in clean energy, thermal connectors, CO2 systems, and biopharma components, further bolstering our positive mix outlook. Adjusted EPS from continuing operations was up 6% to $2.27. During the quarter, we completed the divestiture of our Environmental Solutions Group business, reducing our exposure to the capital goods sector. As you can see from the bottom right of the slide, the reconciliation of this impact to our full year adjusted EPS guidance from continuing operations. As a result of this transaction, we will exit 2024 with record capital deployment firepower, providing us with a variety of value-creation opportunities going forward. Our outlook remains constructive for the balance of the year. Our third quarter performance has given us room to manage demand seasonality to drive cash flow optimization through year-end by thoughtfully managing capacity utilization. Our setup for 2025 is compelling with positive portfolio rotation into higher margin businesses as we lap easy and long cycle comps through the year. This is further augmented by our exceptional balance sheet and optionality to pursue value-creating capital deployment strategies. Let's skip to Slide 5 on segment performance. Engineered Products posted strong top line performance on volume growth in vehicle services and industrial winches. Aerospace and defense was lower in the period due to shipment timing and a difficult comparable quarter. Margin was down modestly because of margin mix on reduced aerospace and defense volumes. Clean Energy & Fueling was down 1% organic as positive performance in clean energy components and North American retail fueling was offset by lower volumes in vehicle wash and retail fueling equipment in Europe and Asia. Bookings were positive in the quarter, as below-ground retail fueling volumes are inflecting positively along with cryogenic components. Margin was flat as favorable product mix was offset by near-term integration costs of our most recent acquisitions. We expect this dynamic to have a material positive margin swing as we complete our integration activities through 2025. Imaging & Identification posted an excellent quarter on solid marketing and coating performance in the U.S. and Europe. New printer shipments inflected positively during the quarter, which is a good signal for customer capital spending. Margin performance was robust as management actions on cost to serve and footprint optimization continued to drive incremental margins. Pumps & Process Solutions was up 2% organically on robust shipments in thermal connectors, precision components, biopharma connectors, and pumps; biopharma revenue is up mid-teens, year-to-date and over 30% versus the comparable quarter of the prior year. As forecasted, polymer processing equipment was down in the period. All in, Pumps & Process Solutions segment bookings were up 15% organically in the quarter as biopharma and growth platform cycles inflected positively. Segment revenue mix drove 200 basis points of margin improvement on excellent performance in production growth in Biopharma and thermal margin mix from the FW Murphy acquisition and tight cost controls in the polymers business. Revenue was down in the quarter in Climate & Sustainability Technologies as solid demand in food retail systems was offset by tough comps in beverage can making equipment and weak demand in the broader HVAC complex, particularly in European residential heat pumps, and our brazed plate heat exchanger business. We had hoped to see positive bookings inflection in heat exchangers in the quarter, but that was not the case. So we have taken down our forecast in the back half of the year in that business to preserve production performance for 2025. The frustrating results are that we were able to hold segment margins flat despite the lower volumes due to excellent performance in our retail refrigeration business that was augmented by exceptionally good shipment rates in CO2 systems. Despite the short-term challenges, we like the setup going into 2025 based on increasing CO2 demand, where we expect bookings to inflect materially higher together with market recovery and heat exchangers, both of which are margin accretive. I'll pass it to Brad here.

Thanks, Rich. Good morning, everyone. Let's go to Slide 6, just a reminder that our presentation today is on a continuing operations basis excluding our divested Environmental Solutions Group business from the historical results. Let's go to the charts. The top bridge shows our revenue growth. The impact of acquired businesses this year more than offset the disposition of DESTACO which closed on March 31 by $21 million, while FX was basically flat. From a geographic perspective, the U.S., our largest market, was up 8% in the quarter on healthy broad-based demand. Europe and Asia were down 5% and 10%, respectively. China, which represents about half our revenue base in Asia, was down 17% organically in the quarter, primarily due to shipment timing within polymer processing. On the bottom chart, bookings were up $90 million organically year-over-year on solid broad-based demand across most end markets. Below-the-line items were slightly unfavorable on a year-over-year basis in the quarter on higher corporate costs, mostly related to acquisition deal costs. Our cash flow statement is on Slide 7. Adjusting for taxes paid on the gain of DESTACO, which are non-operational in nature, our free cash flow was 17% of revenue in the quarter, up $48 million year-over-year. Year-to-date cash flow on this chart is 11% of revenue. The fourth quarter is historically our highest cash flow quarter as we expect more favorable working capital balances over the rest of the year. We are on track to deliver our full year adjusted free cash flow guidance of 13% to 15% of revenue, unchanged from prior guidance. With that, let me turn it back to Rich.

Thanks, Brad. I'm on Slide 8. It was a busy quarter with the portfolio moves, discontinued operations, and some counter cyclicality within the portfolio. As a result of that, we thought it prudent to lay the groundwork for 2025 earlier to provide some hopefully helpful views. Let's start with the portfolio. We articulated throughout the year that underlying demand across many of our end markets is solid and that remains the case as we look forward into 2025. With a diverse portfolio such as ours, we enter each planning cycle constructing a view of the overall macro, the individual business cycles, and our competitive position. In 2024, we had a familiar challenge similar to what we faced in the post-COVID period, navigating the biopharma demand cycle. In 2024, we managed a down cycle on the portion of our high long-cycle portfolio, as well as the regulatory and stocking idiosyncrasies in cheeses and heat exchangers as shown on the right side of the page. As you can see on the slide, we managed to offset significant cycle headwinds by mixing up our consolidated margin on broader short-cycle improvements augmented by our growth platforms, which we invested in both organically and inorganically. As we complete 2024 and begin forming our view for 2025, we do not foresee the same counter cyclicality in the portfolio. Bookings and customer forecasts indicate that our growth platforms are in a multi-period demand cycle. We are particularly pleased with the growth rate and biopharma components, thermal connectors, precision components, and CO2 systems, all with margin accretive attributes to the portfolio. We expect heat exchangers to return to growth in 2025 on the recovery of heat pumps and large-format demand in district heating and data center applications for which we are expanding production capacity today. Let's move to Slide 9. Organic investment, inorganic growth, and shareholder-friendly capital return remain front and center to our strategy, and we have done all three so far in 2024. We have been more active on portfolio pruning this year at attractive valuations as we methodically reshaped the portfolio to higher secular growth and less cyclical end market exposures. As mentioned earlier, we will exit 2024 with significant optionality for capital deployment and/or capital return, which is reflected in the balance sheet capacity bar on the right. Let's finish up with Slide 10. I've already covered the adjusted EPS guidance to accommodate the discontinued operations earlier in the deck, which is summarized on the left. At the time of the ESG announcement, we were often asked about the assumptions needed to offset the lost earnings from divestitures in 2025. We prepared the bridge on the slide to provide some direction on the moving pieces on a pro forma basis. Let's not get too excited. We will, as always, provide formal 2025 guidance after the close of the year, but I thought it would be a reasonable pro forma view that provides clarity on the moving parts. Left to right, we start with predisposal EPS from our previous guide. We treat retrospectively the disposals on a full year basis. We treat the cash balance prospectively as it would be held for the full year in the short-term in highly liquid positions, where it is presently, which includes the retirement of commercial paper costs in 2024, and we roll forward the 2024 acquisitions' earnings benefit. We get to a rebased 2025 EPS of $8.60 to $8.75 on a base model that assumes zero organic growth in 2025. If we model a 3% to 5% organic growth at a 40% conversion rate next year, which includes $25 million in restructuring roll forward that is already completed or underway this year, we get an additional $0.55 to $0.90 of EPS. As I mentioned earlier, we are accelerating our synergy capture from recent acquisitions, including footprint consolidation, so what I would expect is that the restructuring contribution will be higher in 2025. Considering what was covered in the growth platforms' growth trajectory, margin mix, and long cycle comparable performance discussed on Slide 8, the top line and incremental margin assumptions seem reasonable. Now, I certainly doubt that we'll sit on that amount of liquidity unless there is a drastic negative change in the macro. In that case, it is nice to have an insurance policy. Clearly, this model can be flexed for share repurchases and M&A, but the model timing is problematic. So this is a simple value view. Our preference is to be active on the M&A front. At present, that environment is getting better, and we have an interesting opportunity pipeline, but rest assured, we will proceed with the capital discipline that we have demonstrated in the past. With that, let's go to Q&A.

Thanks. Good morning. Yes. It's early, but it feels late. Just on the comment on climate sustainability, Rich, that you made as you were going through kind of the opening comments. The comment about materially higher in 2025, was that a total segment comment, a heat pump comment? Can you just maybe elaborate on the moving pieces within that segment in particular?

Yes. I mean, I think there was a bookings comment more than anything else. If you recall back last quarter, we had said that we would hope to have seen bookings increase in brazed plate heat exchangers for European heat pumps. That was not the case. So we have taken down our full year estimates in that particular product line. So that's negative to bookings now. We're going to take down production just to let whatever the remaining clearing event needs to take place between now and the end of the year. So we'll cut production in Q4 also in terms of the estimates. At that point, I think it's fair to say that bookings based on what we see in our forecast for 2025 demand and heat pumps should inflect positively going forward there, and in CO2 systems based on feedback that we're getting from the market in terms of spend, we would expect a material amount of bookings inflection there, whether we get it all in Q4 or whether it splits between Q4 and Q1, we'll see. But based on our market read, we think that we’re going to be materially up on CO2 systems in 2025.

And then I appreciate the bridge here, it's definitely helpful. Just thinking about that $0.50, right, that's tied to cash on hand. Obviously, the deal impact can vary depending on what you pay for stuff and the right multiples. Do you foresee a scenario where it's less than $0.50 because you're more active on the M&A front? How should we think about that?

I tried to address that in my comments, Jeff. Ultimately, someone mentioned that it would be prudent to hold onto liquidity, and even with potential rate cuts, deposit rates would influence the outcome. I indicated that I don't expect that to occur. When it comes to mergers and acquisitions or share buybacks, the calculations can get complicated. We've modeled the scenarios, exploring the impact of 15 times margin accretion and what closing in the first quarter would mean, as well as the implications of a $1 billion share repurchase. However, I wanted to emphasize that we're not in 2021 anymore. Holding onto liquidity is no longer a zero-sum game as our cost of carry is no longer neutral or negative; it has become significant. If you review our interest expenses on commercial paper for 2024 and factor that in, you'll see that the gap in lost earnings that we're trying to illustrate is considerably smaller due to that carry. Therefore, I anticipate that the interest income line may appear overstated because I expect us to utilize our M&A capital. It's important to note that our cash balance reflects the proceeds and after-tax returns from disposals without considering our cash flow for the fourth quarter, so that figure is a bit understated.

Very clear. Right. And also, you've got additional leverage to deploy if you want to. Great. Appreciate it. Thanks. I'll leave it there.

Hi. Good morning. Maybe a lot of good color on the slides. Maybe one thing I wanted to touch on was just the overall organic growth backdrop. Your tone sounds pretty confident. I think bookings up mid-single-digit organic is sort of broadly what you expected. Just wondered sort of what your impression was of the broader environment in terms of customer activity, anything notable moving around? And tied to that, when we look at your segments, say in Q3, very, very wide spread of organic growth outcomes. One division up low double digits, one down high single-digits, when we're thinking about the 3% to 5% framework you have on Slide 10 for 2025, is the core assumption that the sort of variability across the five segments is much narrower and kind of all are contributing to growth.

Yes, Julian, I think that's what we were trying to do with Slide 8. I mean, I think the $300 million headwind was like a 4% or 5% growth headwind that we carried into this year that we were able to offset by the kind of the investments in our growth exposures. So what we're saying here is, we don't see any indication on the growth platforms for that growth rate... the law small numbers, of course, is that will continue at the same pace, I guess, in terms of growth going forward. Then we'll begin to lap the headwind that we have, basically, which is a long cycle part, is beverage can making, which has completely bottomed at this point and polymer processing, which we believe has bottomed at Q4 what we're going to see in heat exchanges next year. I'd like another quarter to figure it out and see what everybody is going to say about heat exchanges. But what we can from our channel checks, we would expect that by cutting production in Q4, we'll probably undercut into the market and just push demand into next year. So, if I look at the core portfolio, I don't see anything else that is in cycle down in 2025. We're just getting that behind us. And that was a 3% to 4% or 4% to 5% headwind this year. So that's why I think it's reasonable to expect, I think when we modeled the year was 3% to 5% and the incremental margin, if you take out the restructuring benefit is basically where we've always been at 25% to 35%.

That's very helpful. Thank you. I have a quick follow-up on one of the segments. DII doesn't often get much attention, but it demonstrated excellent margin performance again in Q3, which we also saw in the first half. Can you clarify? I understand there is a mix commentary contributing positively for DII. Is this a structural change in the mix due to how you've repositioned that business, or is it simply the dynamic between consumables and equipment that might fluctuate next year?

The consumables equipment will vary from quarter to quarter, but if you examine it over longer periods, it becomes less significant. You will hear comments about it each quarter, but over a 12-month cycle, it tends to stabilize. The margin performance reflects the management team's excellent job on cost efficiency. This is a global business that benefits from synergy in cost efficiency on a global scale. Most of the changes seen over the last three to four years have not been due to volume but rather a shift in the business model. Therefore, I believe that the margins reported now are a reasonable reflection of what this business can achieve, taking into account the pipeline for 2025 and 2026.

Hey, good morning, guys.

Hey, Scott.

I wanted to follow up on the M&A question. It appears that the deals we've observed over the past couple of years are within certain multiple ranges. The only successful deals seem to involve a significant amount of synergies. When you assess your existing portfolio, is there enough scope to acquire assets that can enhance your position as the best owner of those assets? Or do you believe that multiples will decrease to a level where this will no longer be feasible?

If you review the multiples from the past four to five years, they seem reasonable. When we announced more significant deals, a significant portion of the return was linked to synergy extraction. The smaller deals don't offer much opportunity for this, but for the larger ones, we've developed a system to extract synergies from our core portfolio, which has led to significant margin expansion. The advantage of this system is that when we engage in M&A, we can apply the same strategies because we have practiced on ourselves for five years. The deals need to be of decent size, and the recent larger deals in Clean Energy have shown promising synergy extraction. This year, we achieved a 20% margin in clean energy. We anticipate that we will take about three quarters of 2025 to complete the footprint and related tasks, but we expect to grow those businesses based solely on synergy extraction through 2025.

That's helpful information. I have a question. When you're selling these thermal connectors, who is specifying the product? Is it the cloud companies or the cooling experts? I would also like to revisit your thoughts on that design.

Yes, I'll respond this way. We've been in this business for a long time, so this product isn't something we're just starting to push because of the AI buildup. It was originally designed for supercomputing applications, which previously had low volume usage of water cooling. While there are recommended specifications, selling to the user or builder is still necessary. It's complex, but we are in a position to claim that we have the most product actively used in the ecosystem today.

Right. But the point is once it's spec-ed in, if it needs to be replaced for preventive maintenance or whatever, it's like-for-like, right?

I think that would be the assumption, yes.

Hi, good morning. Thanks for taking my question.

Good morning.

Just wanted to touch on fueling and the comments around below-ground fueling inflecting positively. And any sort of context or perspective in terms of the cycle trends there and what you're seeing now in terms of how early on we are in seeing some growth?

Yes, we have faced challenges for three years due to inflationary pressures and labor shortages. Retail operators have consistently failed to meet their capital expenditure projections because of the inflation affecting the system. However, with improvements in labor costs and availability, we are starting to see positive changes that will enhance margins for that specific business. We anticipate continued progress from this point forward. On the demand side, the activity has been fairly subdued, so it's not immediately visible. Our focus remains on managing for margin, and we've made some tough decisions about the business, especially in Europe and Asia, which has dampened top-line growth. In particular, when combined with cryogenic components, if we execute this effectively, we aim to achieve a 25% EBITDA margin for the entire segment at the exit rate, which is our goal.

I appreciate that. And then I just wanted to circle back on the restructuring. I think you talked about as we head into next year, $25 million of carryover, but also made some comments that there could be more. And so I just wanted to make sure I heard that correctly in terms of are there additional sort of planning efforts underway and where we could see more of that happening across the business?

Yes, I think that the $25 million is either completed or to be completed in fiscal year 2024. So that's the roll forward of what we get done this year. But we've got a lot to go. Like I mentioned previously, I think that the synergy target that we had put in the cryogenic acquisitions was about $20-ish, some of that requires footprint consolidation over time, which takes longer. So, back to my comment about driving that segment to 25%, we will be incurring costs clearly through the first two to three quarters of next year, which will require some more restructuring costs, which will pick up in kind of the further roll forward. So that number that you see in the chart, again, is incurred or to be completed in fiscal year 2024.

Hi. Good morning.

Hi, Steve.

I'm going to ask an even dumber question than Scott. What is the actual revenue kind of guidance for this year, like the absolute kind of rough number you're guiding to for this year?

I don't know. I think we gave you a range in the top line, right, of one to three.

Right. But is that number around $7.6 billion?

I don't know off the top of my head. Got me.

I suppose it's not a foolish question.

I'm sure we can get it, and you can follow up with Jack to give it to you, but I don't know what the exact baseline number that it comes off.

The headwind businesses, as we'll call them, how big are those this year? Are those about like $3 billion in total?

No, no, no.

$1 billion. Something like that?

I'd have to do the math in my head. I mean, what are we talking on a 2024 full year basis?

Yes. I mean, what was the $300 million based on?

Yes, it's around $1 billion.

Yes. Okay, got it. And as far as your outlook next year for pricing, is it a little more normal? Is it anywhere that you're seeing any kind of price pressure? Or is it kind of modestly positive or maybe even like a point or something like that for next year?

The pricing outlook appears to be modestly positive, primarily due to the mix of factors. We're strategically extending our commitments into 2025, as the input costs for commodity metals are quite favorable, and we’ve made adjustments to accommodate this.

Okay. And then just one last question for you. For the other businesses, aside from DII, are there any that you think might see declines next year? Are there any in particular that concern you outside of the secular growth areas, DII, and the businesses facing headwinds?

Try to cover in the commentary. We knew about Belvac. We knew about MAAG. We kind of knew but got it wrong on heat exchangers. There's not another business in the portfolio with that kind of quantum headwind as we look into 2025. So the only kind of worry that we would have would be about the macro, and then we'll see.

Hi, good morning, guys.

Hi, Joe.

It's a tough act to follow. I'm going to frame Steve's question in a more positive light. If we are approaching some certainty with the elections in the next month, project financing might improve due to interest rates. One of your competitors mentioned that this has significantly affected their car wash business. Considering the broader impact of both the elections and interest rates, where do you see potential advantages for your business? How do you anticipate this will unfold in 2025? I understand you don't have a crystal ball, so we’re looking for your best estimate at this time.

I think we would have hoped that interest rates would have a greater impact on volume in the second half of 2024. However, due to election uncertainty and various other factors, there's a noticeable sense of caution. It's not negative, but it falls short of expectations. When we analyze the quoting process for project-based business compared to how long it takes for those quotes to convert into actual orders, the situation isn't a failure. If the cost of capital remains low and we achieve some level of certainty going into 2025, I would anticipate positive changes, particularly in our project-related businesses.

Okay, fair enough. And then we talked a little bit about the recovery in biopharma, which is awesome to see. The next kind of logical question is like when can we get the margins back up to that 30-plus range? And I know that you're feeling good about the recovery of that business into 2025, and so just kind of any thoughts around getting back to 30% next year?

It was 29% for the quarter, considering that MAAG is likely reaching its lowest point now. To MAAG's credit, despite facing challenges in revenue, they managed to maintain excellent margins during this time. The key factor for me is the growth rate in biopharma and thermal single-use pumps, as everything in that segment, if it continues on its current path, will contribute positively to the 29% margin we just reported.

Good morning, everyone.

Good morning.

Hi, Andy.

Rich, with the understanding that you aren't giving out 2025 guidance, as you just said, you did say that we should expect 40% incrementals with some restructuring tailwind and mix benefits. And as you know, you've talked about 25% to 35% long-term incremental. So, should we get more excited at this point that with accelerated portfolio transformation, Dover is really making that transition to a higher incremental margin capable company? Or is that a bit premature?

I don't think it's premature at all. We appreciate ESG, but the reality is it was a high-growth business with lower margins compared to our overall portfolio, which is one reason for our recent actions. I don't want to reiterate too much, but if you refer to Slide 8, it reflects what we discussed at the last Investor Day; this is where we are investing both organically and inorganically. We aim to focus on businesses that exhibit higher growth rates and better margin profiles. You noticed this firsthand when you visited DFR and Conyers; the CO2 systems business is indeed a high-growth segment with significant incremental margins. We are pursuing various strategies, including portfolio construction and both organic and inorganic investments, all aimed at enhancing our consolidated segment margin by 2025. We're committed to achieving this goal through any means necessary.

Love it. Okay. And then just another question you love around bookings. Just one clarification, like was DCST really the heat exchanger stuff, the big difference in what you thought versus that book-to-bill of one? I know you mentioned macro is maybe still holding some projects back. As you look at Q4, do you see book-to-bill getting closer to one if CST does begin to show some life on the heat exchanger side?

It depends on the order intake for CO2 systems, as we are reducing our booking assumptions for heat pumps. Our initial forecast for heat pumps has deteriorated as we approach Q4, and this has been factored into our projections. We anticipate a significant increase in bookings for CO2 systems, but it remains uncertain whether we can convert forecasts into actual orders in Q4.

Got it. But it's coming in the next couple of quarters, just a question of when.

Yes.

Good morning, everyone.

Good morning.

So, a couple quick ones. Just on the comment of managing capacity utilization, I don't think this is of the scale that you would have talked about fourth quarter last year. Is this just tied to the heat exchanger piece? Or is there anything broader? Any comments on inventory levels in the channel?

Yes. Overall, we'd like to maximize cash flow in Q4. Then depending on how we are in terms of backlog and the delivery assumptions that backlog, if we believe we can push production performance in January out of Q4, it's prudent to do so at the end of the day, right? Because it flexes up cash flow and it preserves fixed cost absorption into next year. So, we'll do that in select businesses in Q4, and that's why we're kind of happy about the results in Q3 because it buys us the room to do that because we don't want to be like trying to protect margin in Q4 by building inventory, right? So it's not nearly what it was back in the beginning of the destocking days where we consciously made a decision to do that across the wider portfolio. This is a more selective comment.

Makes sense. And not beating a dead horse here. I just want to make sure I understand. The 25% margin comments for DCF, that was applicable to the whole segment, not just the gas piece or something more insular exiting 2025?

The whole segment.