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Donaldson (DCI) Down 25.6% Since Last Earnings Report: Can It Rebound?

It has been about a month since the last earnings report for Donaldson (DCI). Shares have lost about 25.6% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Donaldson due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.

Donaldson Beats Q2 Earnings Estimates, Lowers View
 
Donaldson reported impressive bottom-line results for second-quarter fiscal 2020 (ended Jan 31, 2020), with earnings beating estimates by 6.4%. However, sales lagged estimates by 4.3%.

The company’s adjusted earnings in the reported quarter were 50 cents per share, surpassing the Zacks Consensus Estimate of 47 cents. Also, the bottom line increased 6.4% from the year-ago quarter’s figure of 47 cents on improved operating results and lower taxes.

Top-Line Results

In the fiscal second quarter, Donaldson’s net sales were $662 million, reflecting a year-over-year decline of 5.9%. The results suffered from lower volumes and the negative impact of 0.6% from forex woes, offset by a positive impact of 0.7% from pricing.

However, the top line lagged the Zacks Consensus Estimate of $692 million.

On a geographical basis, the company’s net sales in the United States decreased 7.6% year over year. Results also suffered from a 6.4% decline in Europe, Middle East and Africa’s sales, and a 3.2% dip in the Asia Pacific’s sales. Sales in Latin America declined 2.8% year over year.

The company reports revenues under the following segments — Engine Products and Industrial Products. A brief snapshot of the segmental sales is provided below:

Engine Products’ (accounting for 65.8% of net sales in second-quarter fiscal 2020) sales were $435.6 million, reflecting a year-over-year decline of 7.1%.

The results were adversely impacted by a 14.5% fall in Off-Road, 21.1% in On-Road and 4% in Aftermarket sales. This was partially offset by a 0.6% increase in Aerospace and Defense sales.

Revenues generated from Industrial Products (accounting for 34.2% of net sales in second-quarter fiscal 2020) were $226.4 million, decreasing 3.5% from the year-ago quarter.

Results suffered from a decline of 11.6% in Gas Turbine Systems and 5.9% in Industrial Filtration Solutions, partially offset by a 10.7% increase in Special Applications’ sales.

Margin Profile

In the reported quarter, Donaldson’s cost of sales decreased 8.2% year over year to $438.8 million. It represented 66.3% of net sales versus 68% in the year-ago quarter. Adjusted gross margin in the quarter was 33.7%, up 170 basis points (bps) year over year. Results gained from pricing, procurement, production and supply-chain measures as well as reduced raw material costs and favorable sales mix. However, lower sales in the quarter were a setback.

Operating expenses grew 2.1% year over year to $142.6 million. It represented 21% of net sales versus 19.9% in the year-ago quarter. Adjusted operating margin in the quarter under review was 12.8%, up 70 bps year over year. Adjusted effective tax rate in the quarter was 22.2%, down from 24.8% in the year-ago quarter.

Balance Sheet & Cash Flow

Exiting second-quarter fiscal 2020, Donaldson’s cash and cash equivalents were $211.1 million, up 0.5% from $210 million recorded in the last reported quarter. Long-term debt was down 0.2% sequentially to $595.8 million.

In the first two quarters of fiscal 2020, the company repaid long-term debt of $111.1 million, while raised $122.7 million from long-term debts.

In the first half of fiscal 2020, Donaldson generated net cash of $176.8 million from operating activities, reflecting an increase of 23.8% from the year-ago figure. Capital expenditure totaled $79.7 million versus $67.1 million in the year-ago quarter. Free cash flow in the reported quarter was $97.1 million, suggesting a year-over-year increase of 28.3%.

In the first half, the company used $65 million for purchasing 1.4 million shares and $53.2 million for paying out dividends.

Outlook

Donaldson revised down its projection for fiscal 2020 (ending July 2020), expecting soft market conditions. Sales in the year are now predicted to dip 3-7% as compared with a decline of 2% to increase of 4% mentioned previously.

It projects forex woes to have an adverse impact of 1-2% on sales, while pricing is likely to be positively impacted the same by 1%.

The company anticipates fiscal 2020 Engine Products’ sales to be down 5-9% year over year. Earlier, it had predicted a 4% decline to 2% increase for the segment. The results will likely suffer from declines in Aftermarket, Off-Road and On-Road sales. However, Aerospace and Defense sales are predicted to grow from the previous year.

Donaldson anticipates Industrial Products’ sales to be down 3% to grow 1% on a year-over-year basis. The change compares unfavorably with growth of 2-8% expected earlier. It expects sales from Industrial Filtration Solutions and Special Applications businesses to decline year over year. Flat results are expected from the Gas Turbine Systems business.

It predicts operating margin of 13.5-13.9%, down from 13.9-14.5% expected earlier. Notably, operating margin was 13.6% in fiscal 2019 (ended July 2019). On a year-over-year basis, the operating margin will likely benefit from gross margin improvement, reduced incentive compensation and expense management.

The company anticipates interest expenses of $18 million, down from $18-$20 million mentioned previously. Capital expenditure projection is maintained at $110-$130 million. It now expects effective income tax rate of 24.3-25.3%, lower than 25-27% stated earlier.

It projects earnings of $2.05-$2.19 per share for the year, down from previously stated $2.21-$2.37. Share buybacks in the fiscal year are likely to be 2% of the company’s outstanding shares.

How Have Estimates Been Moving Since Then?

It turns out, estimates revision have trended downward during the past month. The consensus estimate has shifted -19.21% due to these changes.

VGM Scores

Currently, Donaldson has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with a D. Charting a somewhat similar path, the stock was allocated a grade of C on the value side, putting it in the middle 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. It's no surprise Donaldson has a Zacks Rank #4 (Sell). We expect a below average return from the stock in the next few months.


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