Why Is Donaldson (DCI) Up 3.2% Since Last Earnings Report?

It has been about a month since the last earnings report for Donaldson (DCI). Shares have added about 3.2% in that time frame, underperforming the S&P 500.

Will the recent positive trend continue leading up to its next earnings release, or is Donaldson due for a pullback? 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 Misses Q3 Earnings Estimates, Lowers View

Donaldson reported weaker-than-expected results for third-quarter fiscal 2019 (ended Apr 30, 2019). Its negative earnings surprise of 6.45% in the reported quarter marked the third consecutive quarter of disappointing results.

The company's adjusted earnings in the reported quarter were 58 cents per share, lagging the Zacks Consensus Estimate of 62 cents. However, the bottom line increased 9.4% from the year-ago quarter's figure of 53 cents on sales growth and lower taxes, partially offset by higher raw material and supply-chain costs.

Engine Products Drive Revenues

In the fiscal third quarter, Donaldson's net sales were $712.8 million, reflecting year-over-year growth of 1.8%. Notably, the BOFA International acquisition added 1.4% to sales growth while pricing had a positive 1.5% impact and other items added roughly 0.5%. This was partially offset by 4.1% negative impact of unfavorable movements in foreign currencies.

However, the top line lagged the Zacks Consensus Estimate of $742 billion by roughly 4%.

On a geographical basis, the company's net sales in the United States increased 7.6% year over year. Sales in Europe, Middle East and Africa grew 0.8% while in the Asia Pacific it decreased 7.1%. Sales in Latin America expanded 1.9% 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 68.7% of net sales in third-quarter fiscal 2019) sales were roughly $489.4 million, reflecting year-over-year growth of 3.6%.

This improvement was primarily driven by growth of 11.1% in On-Road sales, 4% in Aftermarket sales, and 19.9% in Aerospace and Defense sales. Notably, Off-Road sales in the reported quarter declined 5.6% year over year.

Revenues generated from Industrial Products (accounting for 31.3% of net sales in third-quarter fiscal 2019) amounted to $223.4 million, decreasing 1.9% from the year-ago quarter.

Results suffered from a decline of 14.2% in Gas Turbine Systems' sales and 6.2% fall in Special Applications' sales. This was partially offset by 1.9% growth in Industrial Filtration Solutions' sales.

Gross & Operating Margins Fall Y/Y

In the reported quarter, Donaldson's cost of sales increased 2.6% year over year to $472.1 million. It represented 66.2% of net sales versus 65.7% in the year-ago quarter. Adjusted gross margin in the quarter was 33.8%, down 40 bps year over year. Results were adversely impacted by higher supply-chain and raw material costs. However, favorable pricing was a relief.

Operating expenses grew 0.3% year over year to $140.7 million. It represented 19.7% of net sales versus 20% in the year-ago quarter. Adjusted operating margin in the quarter under review was 14%, down 20 bps year over year. Adjusted effective tax rate in the quarter was 24.5%, down from 29% in the year-ago quarter.

Balance Sheet & Cash Flow

Exiting third-quarter fiscal 2019, Donaldson's cash and cash equivalents were $203.8 million, up 6.6% from $191.2 million recorded in the last reported quarter. Long-term debt was up 1.9% sequentially to $644.4 million.

In the first three quarters of fiscal 2019, the company repaid long-term debt of $24.8 million while raised $145 million from long-term debts.

In the reported quarter, Donaldson generated net cash of $80.4 million from operating activities, reflecting an increase of 64.4% from the year-ago figure. Capital expenditure totaled $45.3 million versus $27.3 million in the year-ago quarter. Free cash flow in the reported quarter was $35.1 million, up from $21.6 million in the year-ago quarter.

In the first three quarters of fiscal 2019, the company used $104.4 million for purchasing treasury stocks and $72.9 million for paying dividends.

Outlook

In the years ahead, Donaldson believes that its focus on driving operational excellence, investments in growth businesses — including air and fuel products — and process filtration and commitment of rewarding shareholders handsomely will work in its favor.

The company seems concerned about the difficult operating environment in the near term.

Sales in fiscal 2019 are projected to increase 3.5-4.5%, down from the previously stated 5-9%. Forex woes are predicted to have an adverse 3% impact (projection maintained). The BOFA buyout will add 1% to sales (maintained).

Engine sales will likely increase 3.5-4.5%, down from 6-10% mentioned earlier. Within the Engine segment, Off-Road sales are now predicted to decline in a mid-single digit versus growth in a low-single digit stated earlier (sales will likely fall in the fiscal fourth quarter as backlog from big customers decline).

Aftermarket sales are now predicted to grow in a mid-single digit (sales to grow modestly in the fiscal fourth quarter, forex woes remain) versus a high-single digit growth mentioned earlier. On-Road sales are still predicted to grow in the mid-teens range while Aerospace and Defense sales will likely increase in a mid-single digit.

Industrial sales are projected to increase 4-5%, down from 4-8% mentioned previously. Forex woes will likely adversely impact sales by 3% and BOFA acquisitions will add 4%. Industrial Filtration Solutions sales growth projection has been revised from a low-double digit to a high-single digit. GTS sales are still predicted to decline in a high-single digit and Special Applications sales are likely to fall in a low-single digit.

The company's operating margin is predicted to be 13.8-14.2%, down from the previously mentioned 14.2-14.6%. Interest expenses will likely be approximately $20 million, down from $21 million and capital expenditure will be $150 million, in the high-end of the previous projection of $130-$150 million. Effective income tax rate will be 24.4-25.4%, down from 24.4-26.4% stated earlier.

Earnings are expected to be $2.20-$2.24, down from previously mentioned $2.27-$2.41. Share buybacks in the year are likely to be roughly 2% of the company's outstanding shares.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed a downward trend in fresh estimates. The consensus estimate has shifted -11.08% due to these changes.

VGM Scores

At this time, Donaldson has a nice Growth Score of B, though it is lagging a bit on the Momentum Score front with a C. Charting a somewhat similar path, the stock was allocated a grade of B on the value side, putting it in the second quintile 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.