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Summary

  • Donaldson reported solid results for the final quarter, pleasing its investors.
  • Investors are furthermore comforted by a solid outlook for the upcoming year.
  • Management has a great track record in creating long-term shareholder value.
  • As such I am happy to pay a modest premium pegged at 20 times forward earnings for this very high quality business.

Investors in Donaldson Corporation (NYSE:DCI) have been rather pleased with the latest results of the filtration manufacturer.

The company ended the fiscal year on a strong note, issuing a solid guidance for next year. While shares appear to be "expensive" especially given the modest and even "boring" single digit growth, the long-term track record is very impressive making shares appealing on dips.

Strong End To 2014

Donaldson posted fourth quarter sales of $668.2 million, a 5.6% increase compared to the year before.

Despite the modest uptick in sales, the company failed to translate this topline sales growth into growing earnings. Net earnings came in at $73.0 million, a mere 0.5% increase compared to the year before.

Like many other businesses, Donaldson has repurchased shares as well over the past year, like it has done for a very long time. This resulted in earnings per share increasing by two cents to $0.51 per share. Analysts were anticipating a modest fall in earnings to $0.47 per share.

Looking Into The Performance

CEO Bill Cook was pleased with the results, but was quick to note that sales growth was aided by favorable tailwinds resulting from currency movements. This added 80 basis points in reported sales growth.

Overall gross margins compressed by 40 basis points to 35.7% of sales due to higher purchased material costs. Operating margins were actually down by a full percentage point to 14.8% of sales as operating earnings rose quicker than topline sales as well. Notably the ERP project and higher incentive compensation impacted reported margins which remained very healthy.

Sales of the engine filtration business rose by 6.7% to $423.1 million driven by strength in the engine aftermarket and on-road business. Despite the strong revenue growth, margins saw some severe pressure, being down nearly 2.5 percentage points to 14.9% of sales.

The industrial products segment posted a 3.8% increase in sales to $245.1 million. Strong general filtration results were offset by weak gas turbine filtration shipments. Despite the sluggish sales growth, operating margins were up by roughly 1.8% to 17.2% of sales.

Solid Outlook For 2015

Full year sales for the upcoming year are seen up between 4 and 8% resulting in sales of about $2.57 to $2.67 billion.

Full year earnings are anticipated to come in between $1.81 and $2.01 per share despite another $10 million in projected costs related to the global ERP project. Analysts anticipate earnings for next year to come in at $1.93 per share.

Important to note in this forecast, Donaldson does not assume any contribution from the acquisition of Northern Technical which is anticipated to close as soon as September. In the press release at the time, Donaldson anticipated that Northern Technical would add about $22 million in annual sales. This would grow annual sales by close to 1%.

Also noteworthy, Donaldson anticipates to repurchase between 2 and 4% of its outstanding share base in the coming year.

Valuation

At the end of the fiscal year, Donaldson held about $425 million in cash, equivalents and short term investments while its total debt position of some $431 million results in a flattish net cash position.

With nearly 145 million shares outstanding at the end of the quarter, equity in the business is valued at $6.1 billion based on a share price of $42 per share.

This values equity in the business at 2.5 times annual revenues and 23-24 times annual earnings.

Solid Long-Term Play

At the investor presentation held in May, Donaldson stressed the long term performance of the business. The company is a pure filtration program, used in a wide variety of end markets. Its products have great efficiency, are of a smaller size and they have a longer life resulting in lower operating and maintenance costs.

The company stresses the long-term performance since 1990, having raised the dividend from just two cents to $0.66 per share, while reducing the total share count by an average of two percent per annum. Also noteworthy, the company requires executive officers to hold 3-10 times their base salary in shares of the company, with employees and directors owning a combined 15% of the stock in the business.

Future growth is targeted with sales anticipated to reach $3 billion by 2016, while aiming for sales of $5 billion in 2021. This should be achieved by 3% global GDP growth, overall filtration market growth, market share gains and deals.

Final Takeaway

This is really a business to love. The performance over the past twenty-five years is great as the company has very steadily grown the business, paid out higher dividends, repurchased shares, while maintaining a rock solid balance sheet.

This has resulted in astonishing long-term returns with shares trading at just a few pennies at the time of the 1987 crash, steadily increasing to current highs in the low forties. This comes after this very high quality business traded at just $12 during the 2009 recession.

As such the 40% premium versus the wider equity market valuation is steep but probably warranted, especially if the company can hold onto its stellar track record. This is as the company aims to double the business in terms of sales by 2021.

The company continues to look expensive based on the current valuation metrics given the slow growth trajectory amidst a fair 1.6% dividend yield and share repurchases, but one should take into account the decades-long track record. As such shares continue to offer appeal, although I would be a buyer on dips hoping to get a chance to acquire this great business at 20 times forward earnings.

Source: Donaldson Corporation - I Am A Buyer On Dips In This Great Long-Term 'Boring' Business