Thank you for joining us today. My name is Mike Allen, an industrial analyst here at Baird, and we're pleased to welcome Dover Corporation with us. Rich Tobin, CEO, is gonna be joining me for the fireside chat today, and we're really gonna dive right in. So if the internet's working, you can use the card in front of you. Send it to sessionthree@rwbaird.com. It'll hit my handy iPad here, and I'll make sure I incorporate any questions you might have. If that's not working, or if you feel bold, just raise your hand. I promise I'll call on you, and I promise I'll make sure you guys are included in the conversation. So with that, Rich, really, thanks for joining us today. Let's just level set everybody.
Maybe just give a state of the union on how you're seeing the world as we sit here today. I know you have a lot of strong opinions.
Thanks, Mike. I don't think it should be a surprise. I think we've been pretty vocal about the knock-on effect of liquidity withdrawal and the rise in interest rates, that it's going to drive necessarily a reduction in working capital throughout the system. And I think we didn't see it very much in the first half of the year, but you can see it accelerating in the second half of the year. Because, you know, and I'll point it back at Dover, if you take a look at what our cash flow forecast for this year was, it was a pretty heady number as a percent of sales.
And what we said at the time was, lead times have come down, you know, supply chain has improved, and there was just not this necessity to carry excess working capital. So as backlogs come down, because of that nature, corporates and our customers would bring down working capital. So that was always going to be negative to demand this year. The hard part is forecasting by business, by region, and then whether it's a slowly deflating balloon versus a more significant deflation. And I think up until mid-year, and so the previous eighteen months, let's say, had just been a naturally, slowly deflating balloon, and it was good because pricing was still positive and everybody was kinda managing it.
I think what we're seeing now is another six months of liquidity withdrawal and a recognition of there's macro uncertainty into 2024, so the safe bet now is let's all- let's draw down inventory. Because you know what? If I need it in the 2024, and 2024 is a better year than I'm expecting, I pretty much can get it back out of the supply chain, because if you look at logistics and freight costs and everything else, it's been largely repaired. So in terms of our own posture, kind of we're reacting to that business by business, region by region. We think that the biggest challenge for 2024, let's just say it's a low growth environment in 2024.
I think that the challenge is going to be pricing in 2024. We've had a period of some pretty heady numbers in terms of inflationarily driven pricing. Everybody says that they're not gonna drop pricing to go and gain market share and volume. We'll see. But one of the best ways that you can manage that is not having excess inventory, because generally speaking, that's where panic sets in. You know, when I've got too much working capital in a low growth environment, I make it through Q1, and then I panic. So, and what we said at the end of Q3 was, based on what we see, which I've just described, that it's better for us to drop production rates between now and the end of the year, manage our inventory down, and then to the extent that we've...
Basically kick the production performance and industrial absorption benefit into 2024 at this point.
Well, basically, you're trying to match sell in and sell out as you get into next year.
Exactly.
So a lot to unpack there. Why don't we start on the pricing side of things? Because I think one of the biggest questions, not just for Dover, but for the industrial complex in general, is everyone thinks they can make price. History says that is a pretty bold statement. The way we tend to think about it is, those models that have always had that one to two price churn pulse onto the bottom line, highest likelihood of maintaining that price. These models that have maybe a little bit more peaky, peaky type pricing-
Mm-hmm.
- bigger risk.
Mm-hmm.
One, how do you think about it? Two, where do you see the risk and opportunity in selling to your portfolio?
We have not taken a lot of price in 20. By the time we finish the year, I think our price benefit is gonna be a point or two, right?
Mm-hmm.
So we took a lot of price when... Remember, if you go back, our backlog accelerated first, right? We're kind of like a middleman to end users, both distribution and to our OEM partners. So if you go back and take a look at our backlog build coming out of COVID, it was enormous, right? And then at that time, because of all the frictional costs of building it up, we were raising prices pretty aggressively back then. We have not. Basically, what we have in 2024 is mostly the rollover effect of pricing that we took in the second half of 2023. We've essentially not raised prices hardly at all. I mean, just physical raised prices.
Second half of 2022.
2022, sorry, 2022. Thank you. Second half of 2022. We haven't really raised pricing. Isolated incidents we have, but most of our full year price is going to be what we did in the second half of 2022. Just trying to plan for what's gonna happen. Could you have forced price this year? Sure, you can, right? But look, we've got a lot of very sophisticated customers. They can see logistics costs coming down. They can see raw materials coming down. When we were raising prices, what we were saying, logistics costs, raw materials, and everything else. So you've gotta, you gotta manage the dynamic as best you can, and I would argue that a significant portion of our portfolio, because it's either engineered into the product or it's regulatory driven, it provides a buffer as opposed to just the volume price dynamic.
But that also speaks to, historically, your ability to pass through price was relatively consistent, net across the portfolio.
Yeah, never a lot, but never not highly volatile.
I mean, it feels like that's what we're gonna be reverting back to as we get to 2024, plus or minus.
I think so. Like I said-
Yeah
... I think the challenge is going to be, if you enter into 2024 with excess inventory, you're going to be very challenged on the pricing dynamic.
Now, you're taking your inventory down. Are you seeing that same dynamic happen across channels? Do you think people are ahead of you, following you? I mean, it feels like you're early, frankly.
Well, you know, we're—like I said, because in a lot of cases, we're a subcomponent supplier, we tend to be early in the cycle up and down, right? So we've been... We can talk about biopharma and some other particular end markets that we have. Yeah, the channel's been slowly taking inventory down, as I mentioned before. Like, think about a balloon slowly letting air out. We would argue right now, based from our channel checks, that our inventory and distribution, this is a general statement because we have a lot of operating companies, is below what it should be. And we're having quite the interesting conversation with our distribution partners of this arbitrage between who holds the inventory and who gets to mark up the goods as they pass through distribution.
Our argument with our distribution partners is that we're gonna have to arbitrage some of that profit away if you're not gonna hold adequate inventory.
Yeah.
But make no mistake, I mean, think about it. If you're, you know, a decent-sized industrial distributor, and you've got $100 million of inventory that you are financing through working capital loans at 2%, what are they now? 8%? 9%? It's not immaterial to basically a business that runs at single-digit profit margins.
And yet, when you listen to your tone, doesn't necessarily sound like next year has a chance to be at least directionally towards normalized, right? I mean, you're positioning yourself for growth through a lot of these actions, but you also have a lot of insular things specific to Dover that can help.
Yeah, I, I look... Macro aside, we like where we're positioned. We've got some growth vectors that we believe that are insulated, let me use a careful word here, from kind of the macro and the working capital argument to a certain extent. We are very much regulatory-driven in certain of our product lines. I think we highlighted that at the end of Q3. I think that in terms of new product development, I feel better about what's in the pipeline at Dover than I ever have in my tenure here, so it's not always... I mean, I think a lot of people think that Dover was this margin accretion story, and then there's this argument, okay, when it's gonna run out because it's been, you know, we've moved it up close to 400 basis points over this last cycle.
While we were doing that, we were actually spending a lot of money in R&D and product development. So I think, we've got some vectors of growth. So to me, the worry that I have is the macro. I mean, how good or bad does it get? We're just gonna have to adapt to it, but otherwise, I think that we feel really good. On top of that, I think, you know, if we, if you go back to 2018 when I started here, there was a lot of questions, you know, just like every multi-industrial portfolio, "Why don't you sell this? Why don't you get rid of that?" And we said at the time that we thought that the portfolio in total was undervalued, right?
And that we were gonna work really hard to improve the value of the individual pieces, and as we did that, then we can make more astute choices about monetization of pieces of the portfolio, and you saw us do that in the last quarter, right? So I would argue, I would argue two points. Number one, by weighting, the value of that business that we sold was significantly higher than we would have received in 2018, despite the fact the cost of capital is up. And the multiple we sold it at, I don't think anybody has got that multiple in the sum of the parts of our businesses.
Mm.
So our optionality going forward is, if Dover's multiple, just because of the complexity of portfolio, is not gonna command a multiple that we're happy with, we can begin to be smart about monetizing those pieces over the next couple of years.
So as we think about monetization, and we think about bringing assets back on, you know, you've done a ton of work over the years to centralize business functions and really start leveraging that thought process. I'm guessing that limits how aggressively you can be on the exit, probably not as much of a limiter on what you can bring in, other than what your normal balance sheet looks like.
That's true, right? So because we've built these central pillars, the amount of our ability to extract synergies quickly and efficiently is a lot better than it was, right? Back in the old days, the Dover, we buy good companies, and we don't screw around with the management team. We've got a completely different philosophy here, right? The reason for Dover Corp to exist is to put the tools in place, if we're an acquirer, to be super efficient in terms of our ability to extract synergies. Yes, there is a negative of gathering a lot of that to the center, because when you carve something out... We've sold a couple businesses, and quite frankly, the first one, the buyer is still using our back office because it's so efficient. So we'll see.
Yeah. You know, you, you referenced it briefly there, but most recent activity, pretty positive arbitrage in terms of growth margin profile, price paid on a relative basis. I mean, that feels relatively unique relative to the landscape out there. So maybe talk about what the buyer-seller mentality is, ease of pushing some of these portfolio moves forward at this point, or if there's opportunity for a pause here, just given interest rates, given uncertainty in the backdrop, et cetera.
Well, I mean, the good news is that the cost of capital has increased significantly, and one of the drivers of multiple expansion, at least in the hunting ground where we generally are, has been private equity, right? Because there was just a free money business model that allowed that to go on for a period of time, and we got stopped out by, I can't tell you how many, 30, 40 different opportunities over the last couple of years just because of valuation. So one could argue now that having a good balance sheet has put us in a position where, A, we're more, the competition is less, and B, multiples have come down. So, and I think that you see that.
Conversely, I mean, if we go back to when we sold DESTACO, DESTACO was primarily a Tier Two automotive business. I mean, that's, it was the vast majority of the revenue stream. That's not a particular area of interest for us, quite frankly. But at the same time, its margin profile, as compared to other Tier Two auto suppliers, was highly accretive.
Mm-hmm.
So that allowed that natural arbitrage to take place, and I think if you were to go through the pieces of our portfolio, and instead of comparing the consolidated margin of Dover, which is a lot better than it used to be, at least that there are pieces of our portfolio, particularly in the capital goods portion of the segments, that would be margin accretive day one if acquired by kind of a peer cap goods competitor, which allows some amount of multiple arbitrage in the selling price.
How much of an advantage do you think you're in today strategically with the capital situation versus sponsors relative to the last few years? It gets a lot of press. You know, I think the magnitude of how much of an advantage it is, it might be slightly overblown, but would love your perspective.
Well, I mean, I think on the bigger deals, there's still plenty of liquidity out there.
Yeah.
But then again, we don't participate in kind of the bigger deals. You know, our competition with private equity is kind of more middle market, so the nature of those balance sheets are relatively small, and because of that, it's actually puts more pressure on the cost of capital, as opposed to something that's large, which just gives you different opportunity in terms of structuring the transaction. So for us, we think that we're in a good spot right now just because of the scale of the assets that we look at.
So you know, earlier, you referenced the margin side of things, 400 basis points over the last cycle. Certainly have a healthy margin target, potentially with some room-
Mm-hmm
... based on the guide you put out. I think obviously, the demand environment's gonna play a piece into the timing and how that progresses. But talk about what the levers are today and how that differs from the previous cycle.
Sure. I almost got to do it piece by piece here. We have spent probably over average to our peer group in CapEx over the last three to four years, and that has been reinvesting in our capital base, of which 90% has been efficiency based. So if you look, you know, what we did in refrigeration, for example, you know, counterintuitively, we made a pretty big capital investment in that business, but despite the fact it was our lowest margin business, and we've moved up, we've basically almost doubled the margin. We've done that in a variety of different businesses, and we haven't earned all of the possibility because there are a variety of different timing in terms of when we did that. We've done some acquisitions.
Most of them are mixed up in terms of margin. So as we grow those businesses, the mix effect will bring them up. Yeah, I think that's probably the two biggest drivers. I think that we've got room in terms of just natural productivity. I mean, if you look at this, you know, this has been a difficult year. The fact that our margin is up despite the fact that Biopharma is significantly down, if you go take a look at what we were making in Pumps and Process Solutions 24 months ago in terms of margin, the negative mix effect on that and our ability to still have accretive margins is tantamount to the fact that we're not just chasing the businesses that we think that are winners.
I mean, we're basically investing across the portfolio to push everybody's margin up. And to the extent that we, while biopharma was coming down, we pushed up the capital goods and refrigeration up so much that we've held margins. You know, biopharma is gonna turn around one of these days, and when it does, it should be a significant tailwind to us going forward.
Yeah, a couple points in there. First, you know, part of the reference point for this conversation seems to be you've been a little earlier in a lot of things. My guess is the CapEx side is an area you've been early on because you're seeing CapEx budgets start moving up, creeping, and if all of these secular drivers play out the way people think, higher CapEx levels this cycle seems inevitable relative to last cycle. I'd be curious to how you think about this.
I think that putting aside pure expansion CapEx, on productivity-related CapEx, our PAC CapEx should come down from here, right? We've basically gone on the lower margin businesses in the portfolio, and spent a bunch of money to improve the productivity. Those are every 15-year kind of investments. We're pretty much done there. We spent a lot of money on IT over the last cycle because that allowed us to put all of our central processing together in Manila. You can't do that with a manifestly disparate IT base, right? So we basically collected that all together. That, knock wood, at least in my tenure, we don't have to do it again.
I think what remains to be seen, and let's think more positive, if in fact the Fed could get its ass to its act together, and we can get rid of all this ridiculous regulatory issues that are going on, and we can go back into the growth cycle, we think that we've got some avenues in terms of organic capital, in terms of expansion. So we're in the midst of increasing our capacity. I know you're gonna have a follow-on to this. For heat exchangers that go into a variety of markets, one of which is heat pumps. So that's a CapEx out, but again, once we're done, I think that we're done at the beginning of next year, that's a one-timer, right? We're not-
Yep.
We're not gonna do that again. So I would expect that, CapEx as a % of revenue to come down from here.
You know, I was gonna lean into the biopharma piece, but you brought up heat exchangers. You might as well chime in on the debate.
Right.
You know, Germany seems slowing, heat exchangers back and forth on the short-term dynamics. I don't know if there's a ton of upside out there on the opportunity over time, but...
Yeah, it's been really interesting. I mean, we were selling more than we could make for a couple years. There was a period which I don't think a lot of people paid attention to, about legislation in Europe, particularly the UK and Germany, about the subsidy rate that went on more or less in the first quarter and the second quarter that introduced some uncertainty into the market, while everybody was basically running to build units, because I think secularly or structurally, that we believe that there's long-term growth here. We can argue about the percent growth and, you know, what it is. We believe it's gonna grow, right? The technology is proven in a variety of ways, but I just think that there was just this chasing of a market that was growing in the teens, high teens.
If you go back and look at the amount of announced capacity additions in heat pumps, it's incredible. I don't think that's ever gonna happen, quite frankly, but the underlying demand is solid. And if I go back to what I started with this conversation, I think there was another realization that came of, wait a minute, we actually had a little bit of a pause of demand there waiting for the legislation, and holy crap, look how much working capital we have, and we got to close the year. So we kind of had a little bit of a hard stop. We'll hard stop right along with it to the detriment of Q4, but you know, I think that this, it's a business that we're very interested in.
I think that we're in a. It's almost a. Let's call it a triopoly, being fair to one of the competitors. We think we're in a pretty good position in terms of our ability to harvest earnings out of this over the next 10 years.
Yeah, it's probably more of a duopoly, if we're being honest. So maybe let's touch on some of the things that might be tailwinds in the next year. Biopharma piece, you guys are front end of the spear. You saw it first, talked about it first. It's dragged, but at least as you get to next year, comps do ease.
Yeah.
You should be at a point where sell and sell out match a little closer, maybe you get a little bit of a spread there for a period of time.
Yeah, look, you know, this is a business that we don't sell most of our product. You know, most of our product we sell to OEMs. So our visibility on inventory levels is what they tell us, to be perfectly honest, as opposed to a business where you've got a lot of distribution, 'cause then you can go do channel checks. You know, I with some dismay of reading the market participants, I think that we're getting to capitulation. We were being told by our customers that just released some pretty disappointing results, that they thought it was gonna pick up in the second half. I mean, that's the only place we can get our knowledge at the end of the day.
You know, whether it picks up in Q1, you know, I think it's gonna be order rates. So when we see order rates come up, that'll be the first sign. From what we do know, two things: we are a consumable product, so we don't need new skids to be built. We just need the product that's been sold to run, right? Because as it runs, we're a consumable part in there, number one. And number two, because this is FDA-regulated, you can't keep the consumable inventory forever. It's got a shelf life. You have to throw it away. So those are two positives, but, you know, I'm reticent to call 2024 in January, it picks up. I think the comps are easier, and I would expect no later than the second half of 2024 for it to pick up.
Yeah. No, that's fair. I mean, the pushouts keep coming. You do any channel work, and there's a lot of concern points out there still going into next year. What about the DEP side? You know, really strong backlog, chassis availability's coming. Could have some quarter-to-quarter variability, but it certainly feels like that's ready to be a pretty healthy contributor for you.
Yeah, I mean, we're essentially sold out in the environmental services business. It's chassis. You know, we don't need another UAW strike at Volvo. That would be nice. Then, to us, it's kind of execution. Part of the reason that we brought down our guidance was we thought we were gonna have a really big Q4, but because of chassis availability, we're not. Nonetheless, it's gonna be up in 2024 for sure. And that will drive. I think the military business should be up going into next year. Vehicle Services Group is really gonna be dependent on what happens in the Eurozone, because that's a business of ours that's kind of levered that way to a certain extent. So we'll see. Kind of wanna wait and see what's gonna happen there.
But the driver of ESG should carry the entire segment, along with MPG.
A lot of moving pieces in the fueling side. EMV comps, you roll off them.
Mm-hmm.
You're expanding in a lot of areas outside of just the traditional fueling piece. CapEx getting pushed out, but those guys need to deploy capital in order to keep those models moving. You know, how do you think about the dynamics on those pieces as you put them all together?
Yeah, I mean, it's very almost exclusively distribution, the entire segment, with a few differences on the cryogenic side, which is OEM-based. So on, like, kind of like the traditional, as we understand, fueling business. Under a lot of pressure now because of destocking, because of everything that we just talked about. The pipeline looks good. CapEx announced by the end user looks decent for next year, where the EMV story's over. We took a lot of restructuring out of that business. That's why you saw the margin moving up. So if we can go into a little bit of growth there, we've got a target to get to 25% margin, in that business, and I think that we've got a path to get there.
On the, let's call it the clean energy portion of the business, again, I'll, you know, I don't wanna keep saying destocking over, but we believe that this has got secular growth to it. I mean, if you look at the amount of CapEx that's been announced, we're spending a lot of time thinking about our own capacity and how to efficiently expand it, going from here.
Makes sense. Well, we're basically out of time. I'll let you out 30 seconds early.
Thanks.
Please join everybody in thanking me, thanking Rich for his time with us today.