Stock Analysis

Is Dover (NYSE:DOV) A Risky Investment?

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NYSE:DOV
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Dover Corporation (NYSE:DOV) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Dover

How Much Debt Does Dover Carry?

The image below, which you can click on for greater detail, shows that Dover had debt of US$3.08b at the end of June 2021, a reduction from US$3.51b over a year. On the flip side, it has US$601.4m in cash leading to net debt of about US$2.48b.

debt-equity-history-analysis
NYSE:DOV Debt to Equity History October 13th 2021

A Look At Dover's Liabilities

According to the last reported balance sheet, Dover had liabilities of US$1.90b due within 12 months, and liabilities of US$4.01b due beyond 12 months. Offsetting these obligations, it had cash of US$601.4m as well as receivables valued at US$1.33b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.98b.

Given Dover has a humongous market capitalization of US$22.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dover's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 11.5 times, makes us even more comfortable. Another good sign is that Dover has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Dover's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Dover generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Dover's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its interest cover is also very heartening. Looking at the bigger picture, we think Dover's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Dover you should be aware of.

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.

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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