Filtration equipment manufacturer Donaldson (NYSE:DCI) beat Wall Street’s revenue expectations in Q3 CY2024, with sales up 6.4% year on year to $900.1 million. Its non-GAAP profit of $0.83 per share was in line with analysts’ consensus estimates.
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Donaldson (DCI) Q3 CY2024 Highlights:
- Revenue: $900.1 million vs analyst estimates of $892.4 million (6.4% year-on-year growth, 0.9% beat)
- Adjusted EPS: $0.83 vs analyst estimates of $0.82 (in line)
- Adjusted EBITDA: $164.8 million vs analyst estimates of $164 million (18.3% margin, in line)
- Management reiterated its full-year Adjusted EPS guidance of $3.64 at the midpoint
- Operating Margin: 14.5%, in line with the same quarter last year
- Free Cash Flow Margin: 5.3%, down from 13.6% in the same quarter last year
- Constant Currency Revenue rose 5.5% year on year (-1.6% in the same quarter last year)
- Market Capitalization: $9.35 billion
Company Overview
Playing a vital role in the historic Apollo 11 mission, Donaldson (NYSE:DCI) manufacturers and sells filtration equipment for various industries.
Gas and Liquid Handling
Gas and liquid handling companies possess the technical know-how and specialized equipment to handle valuable (and sometimes dangerous) substances. Lately, water conservation and carbon capture–which requires hydrogen and other gasses as well as specialized infrastructure–have been trending up, creating new demand for products such as filters, pumps, and valves. On the other hand, gas and liquid handling companies are at the whim of economic cycles. Consumer spending and interest rates, for example, can greatly impact the industrial production that drives demand for these companies’ offerings.
Sales Growth
A company’s long-term sales performance signals its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Unfortunately, Donaldson’s 5.3% annualized revenue growth over the last five years was tepid. This fell short of our benchmark for the industrials sector and is a tough starting point for our analysis.
We at StockStory place the most emphasis on long-term growth, but within industrials, a half-decade historical view may miss cycles, industry trends, or a company capitalizing on catalysts such as a new contract win or a successful product line. Donaldson’s recent history shows its demand slowed as its annualized revenue growth of 3.6% over the last two years is below its five-year trend. 
We can dig further into the company’s sales dynamics by analyzing its constant currency revenue, which excludes currency movements that are outside their control and not indicative of demand. Over the last two years, its constant currency sales averaged 4.4% year-on-year growth. Because this number aligns with its normal revenue growth, we can see Donaldson’s foreign exchange rates have been steady. 
This quarter, Donaldson reported year-on-year revenue growth of 6.4%, and its $900.1 million of revenue exceeded Wall Street’s estimates by 0.9%.
Looking ahead, sell-side analysts expect revenue to grow 4.3% over the next 12 months, similar to its two-year rate. This projection doesn't excite us and suggests its newer products and services will not lead to better top-line performance yet.
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Operating Margin
Donaldson has been an optimally-run company over the last five years. It was one of the more profitable businesses in the industrials sector, boasting an average operating margin of 14%. This result isn’t too surprising as its gross margin gives it a favorable starting point.
Analyzing the trend in its profitability, Donaldson’s operating margin rose by 1.8 percentage points over the last five years, showing its efficiency has improved.
This quarter, Donaldson generated an operating profit margin of 14.5%, in line with the same quarter last year. This indicates the company’s cost structure has recently been stable.
Earnings Per Share
Revenue trends explain a company’s historical growth, but the long-term change in earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.
Donaldson’s EPS grew at a solid 10.1% compounded annual growth rate over the last five years, higher than its 5.3% annualized revenue growth. This tells us the company became more profitable on a per-share basis as it expanded.
We can take a deeper look into Donaldson’s earnings to better understand the drivers of its performance. As we mentioned earlier, Donaldson’s operating margin was flat this quarter but expanded by 1.8 percentage points over the last five years. On top of that, its share count shrank by 5.2%. These are positive signs for shareholders because improving profitability and share buybacks turbocharge EPS growth relative to revenue growth. 
Like with revenue, we analyze EPS over a shorter period to see if we are missing a change in the business.
For Donaldson, its two-year annual EPS growth of 11.3% was higher than its five-year trend. We love it when earnings growth accelerates, especially when it accelerates off an already high base.In Q3, Donaldson reported EPS at $0.83, up from $0.75 in the same quarter last year. This print beat analysts’ estimates by 1.1%. Over the next 12 months, Wall Street expects Donaldson’s full-year EPS of $3.50 to grow 8.2%.
Key Takeaways from Donaldson’s Q3 Results
It was a quarter with few surprises. The company reported roughly in-line results across the board and reaffirmed full year guidance. The stock traded down 2.3% to $76.25 immediately following the results.
So should you invest in Donaldson right now? What happened in the latest quarter matters, but not as much as longer-term business quality and valuation, when deciding whether to invest in this stock. We cover that in our actionable full research report which you can read here, it’s free.
