A couple of days ago I spotted a company that struck me as identical to one Warren Buffett bought in 2007. Below I'll share with you the key elements of my investment thesis for this company. I hope you'll find it useful.
Business Description & Structure
In 2007 Berkshire Hathaway bought 60% of Marmon Holdings for $4.5 billion. Marmon is an industrial holding firm that has similar management structure to Buffett's Berkshire Hathaway (BRK.B). Its 150 subsidiaries operate like independent private companies while the parent company provides only supporting services like tax, accounting, legal and other. Whatever excess cash (FCF) Marmon's subsidiaries generate they give it to the parent company to allocate appropriately.
Dover (DOV) is an $11.5 billion industrial conglomerate and consists of 33 separate businesses which altogether, employ over 34,000 people. As with Marmon and Berkshire, Dover's structure is very decentralized and every subsidiary operates like an independent company owned by its own President of the Board of Directors.
(click to enlarge)(Source: Yahoo! Finance)
Dover has built over the years a wide "business moat" that allowed it for many years to compound its EPS at an average 16% annual rate. This moat has two main components, Dover's acquisition culture and its decentralized management structure.
Here are the main attributes Dover's acquisition targets must have:
- A manufacturing business of high-value-added (product design/intellectual property or manufacturing process) industrial components or systems whose performance is critical to customers and whose markets have high barriers of entry.
- A number one (or a strong two) position in their respective niche, with longer product life cycles and low or moderate market and revenue volatility.
- A broad customer base of industrial and/or consumer users with attractive aftermarket and recurring revenue opportunities.
- A strong ethic of focusing on customers, including excellent customer relationships and intimacy.
- A strong distribution network with existing or potential for global distribution.
- A Strong growth potential and the ability to achieve EBIT of 15% or better.
The above criteria are for businesses that will operate as stand-alone companies after the acquisition. In some instances Dover may acquire some business or product line to supplement and strengthen strategically one or more of its existing businesses. Dover refers to these acquisitions as "add-ons". Most of Dover's acquisitions are made with cash.
This acquisition strategy makes sure that every addition to the Dover family will strengthen the group's competitive position and increase its growth potential.
The other component of Dover's moat is its management structure. Dover shares the same management mentality that Buffett and the Pritzker family (Marmon's previous owners) has. Here it is:
Dover seeks to buy businesses that typically have strong management teams in place. The Dover culture and philosophy expects the operating management team to own product development, manage the customer relationships, and operate the business as if they own it. Dover will assist them by leveraging the strengths of the Dover organization (global sourcing, regional infrastructure, leadership and people development, and other support services). We have long-term financial incentives designed to encourage continued growth of the business.
Our judgment on the skill, energy, ethics, and compatibility of the top executives at each acquisition candidate is one of the key factors in our decision-making.
Dover buys companies for the long-term, with a focus on growing global platforms. We do not have a "portfolio" mentality.
Decentralization provides the necessary flexibility for Dover's businesses to adjust in a timely manner to their customer's needs. It also allows them to stay on top of business developments in their respective industries. Furthermore, this decentralized structure eliminates integration risk for newly acquired companies. And since almost every acquired company retains its own management and culture, integration causes no disruption to Dover or its subsidiaries, no matter how big the acquisition is.
How Much Does Dover Worth?
Dover management's guidance for 2013 is for 3%-5% organic growth, 4% growth through acquisitions and $5.05 to $5.35 earnings per share.
Dover has been very consistent in meeting its targets and creating shareholder value over the years. However, I will use the lower end of its organic growth projection and assume that growth-through-acquisition will be about half of what is expected. That leaves us with a 5% growth rate for 2013. For the long-term management estimates a growth rate of 7% which I will also cut to 5%.
All these "discounts" to management's expectations aren't made because I believe they aren't trustworthy or honest. This is a way to widen our margin of safety and account for the fact that sometime in the next decade Dover's increased size may start being a hindrance to growth.
Given these assumptions for 5% long-term growth, if an investor wants to earn at least 100% on his investment in a 10 year time frame, he should pay no more than 13 times forward earnings.
Dover essentially, is a collection of excellent manufacturing businesses and its management has a very good track record of capital allocation. It has also a very wide business moat that will protect its revenue and profit margins in case of adversity, and will ensure stable & predictable returns over the years.
At current price levels ($64.54) Dover's stock is exactly at our fair value estimate of $65 (13 times its estimated $5 EPS for 2013). An investor that buys Dover's stock at this price will likely enjoy annualized returns of 10% or more over the next decade.
This is a decent return to have and if Dover continues to allocate retained earnings as efficiently as they have done so far, chances are that your investment will have grown a lot more than 100% at the end of those 10 years.
However, I won't buy Dover now. I will keep it on my watch list, do some research to strengthen my conviction, and wait for a 10% to 20% decline to buy it at 10-11 times its 2013 projected profits.
This way I will have an even greater margin of safety to protect my capital in case something goes awry, either with the company or the economy.