Weaker 2Q13 & FY13 outlook, but this likely marks the bottom for this solid company.
Donaldson Co. (DCI) is the world's leading producer of air filters, with 14% market share in this $8 billion market. It serves the Engine and Industrial markets, providing filters for varied applications ranging from truck mufflers to gas turbines to disk drives.
Thesis & Catalyst For Donaldson Co Inc.
DCI reported FY2Q13 earnings [see transcript] that missed estimates and the Street's on margin due to weak cost absorption in Engine and negative mix from large Gas Turbine shipments. Revenue growth remains challenged in earlier-cycle Engine segment, with all end markets seeing y/y sales declines in the quarter, but it was already reflected in my model and the Street's expectations. Gas Turbine was the bright spot, exceeding my upbeat forecast. While lower outlook was somewhat of a negative surprise, most of it was driven by the miss in the quarter.
In my view, FY2Q13 marks the bottom of DCI's earnings with likely growth re-acceleration to double-digits in the 2H13, driven by improving N.A. & Asia and stabilizing Europe.
FY2Q13 EPS miss on margin, top-line beats on Gas Turbines
DCI's FY2Q13 EPS of $0.34 came below consensus of $0.38 and my low-on-the Street forecast of $0.35.
The downside to my model came at the operating line, due to weaker operating margin of 11.9% vs. my projection of 12.6% on cost under-absorption and negative mix from large gas turbine shipments. Top-line growth came in better than forecast (up 3% y/y vs. est. flat y/y), largely on stronger Gas Turbine (up 79% y/y vs. est. up 40% y/y). Engine sales met my cautious expectations at down 5% y/y.
EPS outlook cut on lower volumes, but higher Gas Turbine
DCI lowered its FY13 EPS outlook from $1.68-$1.88 to $1.61-$1.81, half of which was driven by the miss in the quarter. The new range still incorporates my old estimate of $1.78 and consensus of $1.76 at the upper end.
The company cut its revenue growth outlook from flat-up 4% to flat y/y on weaker growth expectations in both segments. The only sub-segment where DCI raised the outlook is Gas Turbines (from up 21-27% to 27-32%) on strength in large turbines and oil & gas.
The company also cut margin range from 14.2%-15.0% to 13.9%-14.7% on lower forecast volume and continued impact of negative mix. I am lowering my FY13E EPS from $1.78 to $1.77 for the miss but may review my model following the call.
My price objective (PO) of $41 is based on applying a 19.5x P/E to my Calendar Year 2014 Estimate EPS of $2.08.
19.5x is in line with the company's historical one-year out P/E range.
I think investors will be willing to continue paying a premium for the more stable high quality industrial name in the volatile macro environment.
Risks to my PO are:
1) A slower-than-expected global industrial upturn.
2) Significant US$ appreciation could provide a headwind to my EPS projections.