Dover Corporation: Light Yield, But Strong Dividend Growth And Prospects

Jan.16.14 | About: Dover Corp (DOV)

Today, Dover Corporation (NYSE:DOV) offers a relatively skinny yield (~1.6%) but big prospects for dividend growth (through both an expansion in the payout ratio and a positive outlook for EBITDA growth) making it a strong contender for consideration in a dividend growth portfolio.

I. COMPANY OVERVIEW

Dover is a mini-conglomerate of sorts that manufactures a range of specialized products and components and also offers related services and consumables. The Company operates in four segments:

1. Communication Technologies: providing acoustic components for the consumer electronics market (serving top OEMs).

2. Energy: providing products and services that serve the drilling, production and downstream markets.

3. Engineered Systems: providing products to two markets the fluid solutions market (general pump and fluid handling) and refrigeration markets.

4. Printing & Identification: providing integrated pricing, coding and identification equipment and related consumables.

II. HISTORICAL PERFORMANCE

2008 2009 2010 2011 2012
Revenue $7,568.9 $5,344.3 $6,109.5 $7,369.2 $8,104.3
% Growth n/a -29.4% 14.3% 20.6% 10.0%
Gross Profit 2,730.0 2,031.5 2,424.6 2,847.0 3,111.0
% Margin 36.1% 38.0% 39.7% 38.6% 38.4%
EBITDA 1,317.8 889.8 1,158.2 1,419.9 1,642.4
% Margin 17.4% 16.6% 19.0% 19.3% 20.3%
Net Income 590.8 356.4 700.1 895.2 811.1
Avg Diluted Shares 189.3 186.7 189.2 188.9 184.0
% Growth n/a -1.3% 1.3% -0.1% -2.6%
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Note: All figures are MM's (except per share data) unless noted otherwise

Dover has performed well over the past five years. The Company's revenue deflated only once at a rate of 29.4% in 2009. In spite of the one year contraction, the Company managed a positive compounded annual growth rate of 1.7% over the past four years. The gross margin has trended positively while also staying within a tight 3.6% range over the past five years (toughing at 36.1% and peaking at 39.7%). Similarly, EBTIDA Margins have expanded from 17.4% in 2008 to 20.3% in 2012, resulting in EBITDA expansion from $1,318MM in 2008 to $1,642MM in 2012 (25% expansion) over the five year period.

Per Share Data
2008 2009 2010 2011 2012
Revenue $39.99 $28.62 $32.30 $39.01 $44.05
% Growth n/a -28.4% 12.8% 20.8% 12.9%
Gross Profit 14.42 10.88 12.82 15.07 16.91
EBITDA 6.96 4.77 6.12 7.52 8.93
Net Income 3.12 1.91 3.70 4.74 4.41
Dividends 0.90 1.02 1.07 1.18 1.33
Payout Ratio 28.8% 53.4% 28.9% 24.9% 30.2%
Dividend Growth n/a 13.3% 4.9% 10.3% 12.7%
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Note: Per share data based on weighted average diluted shares outstanding.

The story on a per share basis is pretty much the same. The Company had relatively flat weighted average shares outstanding, only slightly decreasing from 189MM to 184MM over the period (a 2.8% decrease). EBITDA per share has expanded from $6.96 to $8.93 (a 28% increase as compared to a 25% increase at the Company level). The Company's dividends per share have been growing, increasing from $0.90 per share in 2008 to $1.33 per share in 2012 (a 48% increase or a 10.3% compounded annual growth rate) while maintaining a stable payout ratio in the 30% range (notwithstanding the spike in 2009).

III. CAPITALIZATION

Market / Par Value EBITDA Multiple
- Cash and Equivalents $740 0.4x
+ Total Debt $2,862 1.6x
+ Market Capitalization $16,403 9.2x
Total Enterprise Value $18,525 10.3x
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Note 1: Based on TTM EBITDA of $1,790MM as of 9/30/13.

Note 2: Market Cap based on 170.4MM shares outstanding and a $96.28 market price as of 1/15/14.

Dover has an under leveraged (and over equitized) capital structure. The Company is levered at 1.6x TTM EBITDA (1.2x net of cash) with a total enterprise value of 10.3x TTM EBITDA. Ideally, the Company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage the Company would have a low cost of debt and maintain significant financial flexibility while enhancing returns to the equity holders.

IV. PROJECTIONS

2013 2014 2015 2016 2017
EBITDA $1,735.5 $1,896.2 $2,029.1 $2,099.7 $2,198.2
% Growth 5.7% 9.3% 7.0% 3.5% 4.7%
Interest Expense 124.7 124.7 124.7 124.7 124.7
Taxes 255.1 281.1 302.7 314.1 330.1
Capital Expenditures 238.1 260.2 278.4 288.1 301.6
Dividends 255.5 255.5 255.5 255.5 255.5
Addl' FCF $862.0 $974.6 $1,067.8 $1,117.2 $1,186.3
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Note: All figures are MM's (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for Dover are reasonable, projecting a growth rate between 9.3% and 3.5% annually through 2017 at the EBITDA line. Under the consensus case the Company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

2013 2014 2015 2016 2017
Addl' FCF $862.0 $974.6 $1,067.8 $1,117.2 $1,186.3
Share Redemption Price $110.72 $127.33 $146.43 $168.39 $193.65
Shares Redeemed 7.8 7.7 7.3 6.6 6.1
Wtd Avg Diluted Shares 176.2 168.6 161.3 154.6 148.5
Dividends Per Share $1.45 $1.52 $1.58 $1.65 $1.72
Dividend Growth 9.0% 4.5% 4.5% 4.3% 4.1%
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The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The Company's share redemption would allow for a 4% to 5% increase in the dividend annually from the share redemptions alone. Additionally, the Company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the Company's earnings (using EBITDA as a proxy) would be increasing.

If the Company performs in line with the consensus estimates and pay dividends / redeems shares as outlined above, the Company would achieve the IRR / Cash on Cash returns illustrated below based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple
7.8x 8.3x 8.8x 9.3x 9.8x 10.3x
IRR 2.7% 4.5% 6.2% 7.8% 9.4% 11.2%
Cash on Cash 1.11x 1.18x 1.26x 1.34x 1.42x 1.51x
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V. RECOMMENDATION

While the yield today is on the lower end of the spectrum (~1.6%), the growth prospects are strong with the EBITDA projected to expand to $2.2B by the end of 2017. Also, I view the consensus estimates as relatively reasonable and definitely achievable. Further, the Company has significant room in the payout ratio to increase the yield on the stock today and still provide for plenty of cushion in the event of another economic down turn.

Dover is a great candidate for inclusion in a dividend growth portfolio that will provide plenty of growth in the future.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DOV, over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.