Dover (DOV): 62 Straight Years of Dividend Growth and Double-Digit Total Return Potential

Dividend Kings, companies with 50+ straight years of dividend growth, are the epitome of dependable long-term income growth investments.

 

Dover (DOV), an industrial blue chip, is even more impressive having grown its payout 9% annually over the past 30 years, and the company is about to announce its 62nd consecutive annual dividend increase.

 

Let’s take a closer look at why Dover has proven to be such a consistent dividend grower, what investors can expect going forward, and if now could be a reasonable time to add this dividend king to a diversified income portfolio.

 

Investors seeking greater current income than the 2.3% yield Dover offers can review some of the best high dividend stocks here instead.

 

Business Overview

Founded in 1947 in Downers Grove, Illinois, Dover is an international industrial conglomerate whose 29,000 employees serve a global client base through four main business segments.

 

Energy: products include artificial lifts, pumps, sensors, and monitoring solutions for customers in the drilling and production markets. Dover essentially helps customers extract oil and gas more efficiently and safely.

 

Engineered Systems: Dover helps drive efficiencies for customers in printing, identification, vehicle service, and waste-handling equipment. Products in this segment include automation components, printing systems, hydraulic components, electronic components, 3D printing tools, and more.

 

Fluids: products include strategically engineered specialized pumps, tubing, fueling, vehicle wash, and dispensing systems. Dover’s components and equipment are used for fueling and vehicle wash and for transferring and dispensing critical materials in numerous end markets such as chemicals, food, and pharmaceuticals.

 

Refrigeration & Food Equipment: Dover’s products reduce customers’ total cost of ownership in refrigeration, electrical, heating and cooling systems, and food and beverage packaging. Products include commercial refrigerator and glass doors, lighting systems, food processing and packaging solutions, cooking preparation equipment, and more.

 

The company essentially delivers a wide range of equipment and components, specialty systems, and support services that are sold to thousands of customers across virtually every end market.

 

 

Over the past few years, courtesy of the worst oil crash in over 50 years, Dover’s sales have shifted away from its energy business which used to provide the largest share of its earnings.

 

 

The majority of its 2016 sales continue to be from the United States, although its largest growth markets are in emerging markets in Asia and Latin America.

 

 

Business Analysis

In order for a company to generate over six decades of continuous dividend growth, it must have both a stable and growing business, as well as some kind of moat to defend market share and margins over time.

 

In the case of Dover, the company has several competitive advantages in the highly fragmented industrial sector, where it competes for approximately $60 billion in annual global sales (11.3% total market share) across its four business segments.

 

Dover has largely built up its business through acquisitions over the course of many decades. The company maintains a decentralized organizational structure to stay nimble and entrepreneurial while implementing productivity measures across their businesses.

 

For example, the Dover Excellence program is its continuous improvement initiative. This creates a culture filled with problem solvers and solution providers for customers, helping Dover maintain its strong market share positions and stay ahead on the innovation curve while generating substantial free cash flow.

 

That being said, while Dover’s long-term growth has been steady, it does operate in highly cyclical industries that result in volatile sales, earnings, and free cash flow over the short-term.

 

 

Dover’s approach to this kind of volatility is to focus on specializing in highly engineered solutions to meet its customers needs.

 

Dover has built up a portfolio of mission-critical products that serve highly profitable market niches, establishing relationship for quality and excellent customer support and making it a top vendor that customers want to partner with to get their job done right.

 

Essentially, Dover wants to be a “one-stop shop” to provide entire systems to help its customers with their oil pumping, consumer goods printing, fluid handling, and refrigeration needs.

 

Dover’s global operations are another advantage and help it reliably serve multinational customers thanks to its strong distribution network.

 

For example, if an oil customer’s pump dies out, it needs a new one as soon as possible or its project will lose money. Dover’s distribution network alleviates this risk.

 

Since many of the industries in which Dover operates prize reliability above the absolute lowest cost, this allows it to create a sticky ecosystem, meaning high switching costs that give it decent pricing power, even during industry downturns (e.g. the recent oil crash).

 

 

However, while Dover’s margins and returns on shareholder capital have declined during the oil crash, we need to remember that because of the cyclical nature of this industry, so have those of its peers.

 

Thus, determine whether or not management is doing a good job of capital allocation (what investors pay them to do) requires keeping these metrics in context.

 

When we do so, we can see that Dover enjoys about average profitability, but slightly above average returns on capital. That’s actually impressive given that it has far more exposure to the energy industry than most of its peers, and its operating margin for that business unit in mid-2016 was 0%.

 

 

The good news is that with oil prices doubling off their January 2016 lows ($26 per barrel, now closer to $50), the shale oil & gas drillers have been ramping up drilling activity with a vengeance in recent quarters, which has resulted in very strong growth in orders and revenues.

 

 

 

Combined with far better operating margins since the oil recovery began in early 2016 (from 0% last year to 14.9% in Q2 2017), Dover’s overall sales, earnings, and free cash flow growth in its most recent quarters have been impressive.

 

 

Better yet? Management believes that the company is well-positioned to enjoy strong organic sales growth, especially in energy, as well as strong margin expansion going forward thanks to its ongoing cost cutting efforts, greater focus on automation and efficiency, as well as steadily rising economies of scale.

 

 

In addition to organic growth, Dover has become famous for strong growth via well-executed and disciplined acquisitions of smaller rivals.

 

 

In fact, over the last three years, during the industrial recession, management bought 17 peers for a total of $2.9 billion. The company’s goal with each of these is to further expand its moat by focusing only on fairly priced acquisitions that add to its global reach, expand its customer base, broaden its customer mix, and bring new intellectual property.

 

Or to put it another way, Dover prefers to forgo large, splashy, needle-moving acquisitions in favor of buying companies whose technology can be directly plugged into its own fully-integrated product portfolios, thus increasing switching costs for clients and helping it to meet its long-term goal of an 11% free cash flow margin.

 

That kind of profitability results in a steady stream of cash flow that has allowed Dover to increase its payout every year since it went public back in 1955 and is likely to keep its dividend growing strongly for years to come.

 

Despite its fast pace of deals, Dover’s management team has remained disciplined with capital allocation. The team is constantly trying to reduce Dover’s exposure to cyclical markets and focus on higher margin growth spaces, for example.

 

As a result, Dover has sold a few businesses for several hundred million dollars since 2012 and executed a spin-off of cyclical electronics component manufacturer Knowles.

 

These efforts help Dover maintain a strong return on invested capital and avoid growing too far beyond its core strengths.

 

Key Risks

There are three key risks to consider before investing in Dover.

 

First, remember that Dover operates in a highly cyclical industry, so its short-term growth is closely tied to global growth rates and especially to certain industries such as oil & gas production.

 

And since only about one third of its revenue is from recurring sources (quickly consumed products that need constant replacement), this means that its top and bottom lines aren’t as stable as some of its rivals, such as 3M (MMM), which gets close to 50% of its revenue from consumables.

 

Next, we can’t forget that while Dover’s history of acquisitions is a good one, with management remaining disciplined in its takeover targets, the majority of mergers & acquisitions fail to create long-term shareholder value due to a variety of factors, including overpaying and failing to achieve synergy targets.

 

The threat of such failed acquisitions is likely to increase now that the industrial recession has ended and the valuations of industrial companies have soared to much higher levels.

 

Finally, keep in mind that one of Dover’s biggest growth catalysts, expansion into fast-growing emerging markets, which now represent 28% of sales, is also a double-edged sword.

 

This is because it means greater currency risk, in which the change in the relative value of the dollar against local currencies can affect both its top and bottom line growth.

 

For example, when the U.S. dollar gets stronger (as it did in recent years), Dover’s products become more expensive for its clients, and its overall sales in foreign markets become less profitable.

 

 

Within the next year or two Dover’s foreign sales are likely to represent the majority of its overall business, meaning that major currency fluctuations in the future could generate even more sales, earnings, and cash flow volatility.

 

Other than unpredictable macro trends, there doesn’t seem to be much that threatens Dover’s long-term prospects. The company is well diversified by product, end market, and customer. Most of its markets evolve at a very slow pace, and it’s hard to imagine many of the company’s products becoming obsolete.

 

If anything, Dover’s biggest risk is probably itself. The company likes to acquire other businesses, which adds some risk to its strategy. Furthermore, although Dover has become less decentralized over the years, additional acquisitions could cause the company to reach a point where it needs to reorganize its segments or risk them becoming inefficient.

 

Overall, Dover has proven to be an extremely well-managed company. Macro trends in the energy market are likely the biggest challenge facing the business over the next few years, and sustained improvement could still be further away than many investors expect.

 

Dover’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Dover has a Dividend Safety Score of 88, indicating a highly secure and dependable dividend. That’s not surprising given the company’s impressive 61 (soon to be 62) year history of uninterrupted payout increases.

 

 

There are two main keys to this remarkable dividend security and clockwork-like growth.

 

First, management has been disciplined in maintaining very safe EPS and FCF payout ratios, ensuring that earnings and cash flow are able to insulate the dividend against short-term industry downturns.

 

You can see that Dover’s payout ratios have remained below 30% most years during the past decade, which helped it continue paying safe dividends during the financial crisis and throughout the recent oil crash when its EPS payout ratio spiked higher.

 

 

The second protective factor is Dovers’ strong balance sheet, which is important because this is a highly capital intensive industry.

 

It’s also important because a healthy balance sheet provides Dover with better financial flexibility to continue making opportunistic bolt-on acquisitions during downturns when prices are most attractive.

 

 

In fact, when we compare Dover to its industry peers we can see just how financially secure it is.

 

 

For example, Dover’s leverage ratio (Debt/EBITDA) is far below average, as is the debt/capital ratio. Meanwhile, the company’s interest coverage ratio is close to double-digits and should further strengthen as its energy segment sales and earnings improve.

 

Overall, Dover has a very strong balance sheet, as seen by its strong investment-grade credit rating, which allows it to borrow cheaply and continue growing aggressively while still paying out its impressive dividend.

 

While Dover’s business is sensitive to the economy, its dividend payment appears to be very safe. The company has conservative payout ratios, generates excellent free cash flow, and maintains a healthy balance sheet.

 

Dover’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Dover’s Dividend Growth Score of 78 indicates that dividend growth investors can likely expect stronger than average dividend growth (relative to the S&P 500’s 20-year median dividend growth rate of 5.9%) in the coming years.

 

That’s also not surprising given Dover’s strong track record of long-term dividend growth in the high single-digits.

 

 

Based on management’s long-term organic growth target of 3% to 5%, Dover could reasonably achieve total revenue growth (including acquisitions of 2% to 3%) of 5% to 6%.

 

Factoring in long-term margin expansion of 1% to 2%, as well as steady buybacks (2.9% annually over the past five years) of 1% to 2%, that should allow Dover to generate long-term EPS and FCF per share growth of around 7% to 12% (long-term analyst consensus is for 11.3%).

 

As a result, 8% to 9% long-term dividend growth (in line with its historical dividend growth rate) should be attainable, about equal to that of EPS and FCF per growth, if potentially a bit less. That’s to allow the payout ratios to reverse their recent increases during the oil crash.

 

Valuation

Over the past year, thanks to the strong recovery in the energy sector, Dover’s share price has performed about in line with the S&P, rising by about 12%. Unfortunately, its valuation doesn’t appear to be a bargain.

 

For example, Dover’s forward P/E ratio is now at 21.2, roughly matching its industry median and coming in much higher than the S&P 500’s 17.4. This shows that Dover, like most of its industrial blue chip peers, have priced in the end of the industrial recession and then some.

 

Meanwhile DOV’s dividend yield of 2.3% is a bit higher than the S&P 500’s 1.9% and the industry average of 1.7%. However, keep in mind that over the past 13 years Dover’s median yield has been 2.3%.

 

Overall, Dover’s stock seems about fairly priced, assuming industrial growth continues picking up and oil prices climb a little higher.

 

With that said, the best time to buy a cyclical stock is when its end markets are weak and expectations are low, such as the start of 2016 when Dover yielded 3.3%.

 

Regardless, if the business delivers as management expects and you have a long time horizon, Dover’s stock has potential to generate annual total returns of about 10% to 11% (2.3% yield + 8% to 9% annual dividend growth).

 

Conclusion

As far as diversified industrial conglomerates go, they don’t get much better than Dover, with its history of a long-term focused management team, strong balance sheet, excellent dividend security, and an unbeatable dividend growth track record.

 

While Dover could generate double-digit total returns, its current valuation looks fair at best, and the stock is not the best choice for high-yield investors, such as retirees looking to live off dividends.

 

Even for those with plenty of time before retirement, it may be best to wait for a cyclical pullback before considering adding this dividend king to your portfolio.