Stock Analysis - Donaldson Company

| About: Donaldson Co (DCI)

Summary

Donaldson stock increased more than 43.1% over the last 12 months.

It delivered better-than-expected profits and increased FY17 sales and earnings guidance.

It has a current P/E multiple of 27.7x, compared to the industry average of 25.8x, because of better-than-expected profits and growth prospects in the near term.

The implied share price is $49.5, which is a 10% premium to the current price $45.1. The most likely implied value is between $43.1 and $58.1 based on DCF.

About half of Donaldson's sales come from outside the U.S., so investors should be aware that there are many factors that could affect the company.

Donaldson Company, Inc. (NYSE:DCI) is a worldwide manufacturer of filtration systems and replacement parts with headquarters in Delaware. In the last fiscal year, the company recorded $2,220.3 million in net revenue, with EBIT of $274.2 million (margin of 12%). It has grown its revenue at a three-year CAGR of -3.53%, and has maintained EBIT margins of 13% the entire time. Unfavorable foreign currency exchange rates and continued weakness in the global agricultural, mining, construction and gas turbine systems decreased sales. Its market cap is approximately $5.9 billion and its enterprise value is $6.1 billion.

Q2 2017 Performance

The company reported $0.35 EPS, beating the Thomson Reuters' consensus estimate of $0.31. During the same period in the prior year, the firm earned $0.29 EPS. The company recorded $550.6 million in net revenue for the quarter, compared to analysts' expectations of $521.99 million. Donaldson had a net margin of 9.41% and a return on equity of 27.42%.

EPS Summary

Source : Nasdaq.com

Analysts are expecting Donaldson's to post EPS of $1.65 in 2017. That represents a rise of 16% from $1.42 in 2016. The company's management has set its EPS guidance at $1.60-$1.68 for 2017. William Blair analyst B. Drab estimates FY2017 earnings at $1.64 (up from their prior estimate of $1.59) and FY2018 earnings at $1.81 EPS. Gabelli analyst B. Sponheimer estimates FY2018 earnings at $1.80 for the year (up from their prior estimate of $1.75), FY2019 earnings at $1.95 EPS, FY2020 earnings at $2.15 EPS and FY2021 earnings at $2.30 EPS.

Management Outlook

  1. The company forecasts its fiscal 2017 diluted earnings per share to be between $1.60 and $1.68.
  2. Donaldson expects fiscal 2017 sales will increase between 2% and 4% from last year.
  3. The company's fiscal 2017 operating margin is forecast to be 13.7% to 14.3%.
  4. The company's fiscal 2017 tax rate is anticipated to be between 27.1% and 29.1%.
  5. 2017 capital expenditures are forecast between $60 million and $70 million

Revenue Sources

The company has two reporting segments: Engine Products and Industrial Products.

Source : 10-K

In the last fiscal year, Donaldson's Engine Products segment contributed 62.7% and Industrial Products contributed 37.3% to the company's total revenue. The company operates in the U.S., Europe, Asia Pacific and other areas, but the bulk of its sales have been in the U.S. (42.2%), followed by Europe (28.5%), Asia Pacific (20.3%) and other areas (9.0%).

Price Performance

Source: Google Finance

Investors who took positions in Donaldson stock one year ago would have earned a solid return of 43.10% on their investments by March 17. During the same period, the S&P 500 earned 17.60% in capital gains. Among Donaldson's competitors and peers, CECO Environmental's (NASDAQ:CECE) returns of 64.23% have been stellar as well. Clarcor (NYSE:CLC) has managed returns of 60.53%.

Donaldson was trading at a P/E multiple of 27.7x, compared to the industry average of 25.8x. As things stand today, Donaldson is trading at a higher multiple and it looks as if that's probably because of better-than-expected profits and growth prospects in the near term.

Valuation Analysis

Investors should look at valuation methodologies when deciding whether to enter or exit a stock. Valuation is driven by perceived growth, risks and investors' willingness to pay. There are various methods available to assess the valuation of a stock. We used the DCF analysis over a five-year period, with the following assumptions:

  1. Revenue was projected to be in line with the Street's and management's expectations. Currently, analysts expect Donaldson to generate revenue of $2,278.72 million in fiscal 2017, $2,365.69 million in fiscal 2018, and long-term growth rate of 9.60%. Management expects fiscal 2017 sales will increase between 2% and 4% from last year.
  2. Operating margin was in line with historical levels and management's expectations. Management expects fiscal 2017 operating margin between 13.7% and 14.3%; the operating margins' five-year average is 13.54%.
  3. The company's fiscal 2017 tax rate is anticipated to be between 27.1% and 29.1%.
  4. D&A, capex and changes in WC were projected to be in line with historical levels.
  5. We used a baseline rate of 7.50% for WACC and a baseline terminal FCF growth rate of 2.5%

Here's the DCF analysis down to the unlevered FCF:

Donaldson's implied share price is $49.5, which is a 10% premium to the current price of $45.1. The most likely implied value is between $43.1 and $58.1 per share based on this analysis.

Catalysts to increase its share price in the next six to 12 months include possible better-than-expected profits and increases in FY17 sales and earnings. Considering that about half of Donaldson's sales come from outside the U.S., investors should be aware that there are many factors that could affect the company's ability to increase sales and earnings in the near term.

Analyst Recommendations

On March 17, 2017, Donaldson stock increased more than 43.1% over the last 12 months. Analysts' recommendations show a 12-month targeted price of $45 per share. Of the analysts covering Donaldson, 10 recommended it as a "hold" and one recommended it as an "underperform."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

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