Stock Analysis

Here's Why Dover (NYSE:DOV) Can Manage Its Debt Responsibly

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NYSE:DOV
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Dover Corporation (NYSE:DOV) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

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What Is Dover's Debt?

The image below, which you can click on for greater detail, shows that Dover had debt of US$2.87b at the end of March 2021, a reduction from US$3.46b over a year. However, because it has a cash reserve of US$536.5m, its net debt is less, at about US$2.33b.

debt-equity-history-analysis
NYSE:DOV Debt to Equity History June 8th 2021

How Strong Is Dover's Balance Sheet?

We can see from the most recent balance sheet that Dover had liabilities of US$1.78b falling due within a year, and liabilities of US$4.00b due beyond that. On the other hand, it had cash of US$536.5m and US$1.24b worth of receivables due within a year. So it has liabilities totalling US$3.99b more than its cash and near-term receivables, combined.

Since publicly traded Dover shares are worth a very impressive total of US$21.8b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a debt to EBITDA ratio of 1.7, Dover uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.9 times its interest expenses harmonizes with that theme. Notably Dover's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Dover can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Dover generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Dover's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And that's just the beginning of the good news since its interest cover is also very heartening. Taking all this data into account, it seems to us that Dover takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Dover you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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What are the risks and opportunities for Dover?

Dover Corporation provides equipment and components, consumable supplies, aftermarket parts, software and digital solutions, and support services worldwide.

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Rewards

  • Trading at 20.4% below our estimate of its fair value

  • Earnings are forecast to grow 5.88% per year

  • Earnings grew by 23.5% over the past year

Risks

  • Has a high level of debt

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