Donaldson (DCI): Earnings & Revenues Beat In Q3; View Dull

Premium filtration products provider Donaldson Company, Inc. (NYSE:DCI) made a rebound with an earnings beat in the fiscal third quarter of 2016 after a rare miss in the preceding quarter. The company reported adjusted earnings per share of 43 cents for the quarter, which comfortably surpassed the Zacks Consensus Estimate of 39 cents by 10.3%.

Moreover, adjusted earnings rose 16.2% from the prior-year quarter figure of 37 cents.

The bottom-line improvement can be largely attributable to robust operational efficiency gains resulting from restructuring and cost saving initiatives. Also, a decline in the cost of sales and operating expenses proved conducive to bottom-line growth. However, currency fluctuations posed as a headwind, thwarting growth to some extent.

Inside the Headlines

Donaldson reported total sales of $571.3 million, down 0.7% on a year-over-year basis. However, revenues topped the Zacks Consensus Estimate of $551 million by 3.7%. Poor performance of the Engine Products segment impacted the top-line performance. Also, currency fluctuations caused a $5.5 million decline in the fiscal third-quarter sales.

Revenues at the Engine Products segment declined 2.9% year over year to $357.3 million. Three of the four sub-segments under Engine Products — Off-Road, On Road and Aerospace & Defense — recorded declines, which led to the overall weak performance. Slowdown of class A truck production and softness in the U.S. proved detrimental to the on-road business (down 19.6%). Also, weakness in global agricultural and mining markets proved to be a drag on the Off-Road business (down 19%).

Revenues at the Industrial Product segment were up 3.1% year over year to $214.0 million. While unimpressive performance of the Special Applications (down 10.3%) business proved to be a drag, this was more than offset by robust performance of the other two sub-segments – Industrial Filtration Solutions (up 5.3%) and Gas Turbine Systems (up 9.7%). However, prolonged weakness in disk drives posed a significant headwind to this segment.

Donaldson’s adjusted operating margin increased 120 basis points (bps) year over year to 13.8%. Also, the company’s Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) came in at $96.7 million versus $89.8 million recorded a year ago.

Liquidity

Donaldson exited the quarter with cash and equivalents of $247.4 million versus $189.9 million as on Jul 31, 2015. The company had long-term debt of $391.8 million as on Apr 30, 2016, compared with $389.2 million as on Jul 31, 2015.

Guidance Cut

Based on the current market scenario, Donaldson has narrowed its guidance and adjusted the estimates for fiscal 2016. The company now expects revenues at the mid-point of the guided range of $2.2–$2.25 billion ($2.225 billion). This is also 6% below the last year level. Moreover, sales in local currencies are expected to decline approximately 3%, compared with the prior guidance of a year-over-year decline in the range of 1%–3%. Currency translation is expected to impact sales by $80 million in full-year fiscal 2016.

The company also narrowed its adjusted EPS guidance to $1.53–$1.59, from $1.51–$1.61. The company continues to expect fiscal 2016 GAAP EPS at around 9 cents, lower than adjusted EPS on account of restructuring charges and investigation-related costs.

For the segments, the company believes Engine Products sales will decline 6% year over year, largely led by the decline in heavy-duty on-road transportation business as well as sluggishness in the global agriculture, mining equipment and construction markets. Moreover, waning U.S. defense spending and softness in the commercial aerospace are expected to hurt the top line of this segment.

Also, sales of the Industrial Products segment are expected to decline 6% from the year-ago figure mainly on the back of dismal Gas Turbine Systems business. As a matter of fact, project deferrals and volatility in global demand are significantly undermining the performance of this segment. Moreover, the other two segments, namely, Industrial Filtration Solutions and Special Applications, are expected to fall low-single-digit and mid single digit, respectively. The pronounced decline of disk drive, membrane and semiconductor businesses is expected to pose a major drag on the Industrial Products business.

To Conclude

Despite these weaknesses, we believe Donaldson’s growth initiatives based on three core areas – expansion of core business through first-fit program wins and aftermarket growth; continued geographic expansion; and fostering innovative technology to secure first-fit program deals – will help it combat some of the weakness. Also, the company’s restructuring initiatives to align operating and manufacturing cost structure with current and projected customer outlooks look encouraging. This apart, the growing presence in the Latin American market adds to its strength.

Donaldson currently carries a Zacks Rank #2 (Buy). Other favorably ranked stocks in the broader sector include ESCO Technologies Inc. (NYSE:ESE) , Powell Industries, Inc. (NASDAQ:POWL) and Eaton Corporation plc (NYSE:ETN) . All these stocks carry the same Zacks Rank as Donaldson.