Thursday, October 15, 2009

Donaldson (NYSE:DCI): The Forgotten Blue Chip - Credit Suisse

Credit Suisse is upgrading Donaldson (NYSE:DCI) to Outperform from Underperform and raising price target to $41 from $28:

We are upgrading shares of Donaldson to Outperform from Underperform. Our upgrade is based on 1) upside from the engine aftermarket business driven by a bottoming out of utilization rates which the market is not baking in, 2) long term opportunity to increase aftermarket penetration rate, and 3) consensus forecasts for 2010 and 2011 appear low. The Credit Suisse Investment Policy Committee (IPC) is adding Donaldson to the U.S. Focus List.

Top-quality blue-chip company levered to a cyclical recovery. Donaldson has grown earnings and consistently earned high teens return on capital for 19 years in a row before this downturn and the extent to which they can benefit from a cyclical recovery is underappreciated. Global IP which is bottoming out has had a 0.7+ correlation to overall company sales. We believe the track record of earnings growth returns in FY2011 with earnings power of close to $3.00 by FY 2013.

2010 and 2011 consensus too low. We believe over 40% of Donaldson’s portfolio is early cycle (a number not many know) where signs of a recovery could lead to faster growth combined with a low US dollar which likely helps earnings come in higher than expectations.

We are raising our target price to $41 from $28 based on our FY 2013 EPS estimate of $2.80 at a 18.5x P/E multiple discounted back. The 18.5x P/E multiple is consistent with what DCI shares have traded at for almost a decade. The stock has lagged more cyclical industrial names, although it should see double-digit top-line growth and close to 2x that in earnings in a recovery.

Action: So many reasons to like this upgrade:

- Double upgrade from Underperform to Outperform is usually enough to move stocks on its own

- Addition to the Focus List means Credit Suisse is out there buying the stock

- Stock has been weak lately due to lackluster FY10 guidance given on 1st of September.. Note that Credit Suisse estimates are near the high end of the guidance range and also close to the original consensus prior to the guidance. This suggests CS views this guidance as conservative and expects upside. As CS points out, DCI might be more early cycle than the market gives it credit for and mgmt team of DCI is rather conservative.

- Stocks of some of the biggest customers (Caterpillar, Deere) are right at the highs

DCI isn't a stock that would make a huge gap up.. and even if some enthusiastic pre-market trader drives it too high, it will probably offer decent entry levels after the open - around 2..2.5% above yesterday's close, maybe even lower if the market stays red. That's where I would be buying as I expect to see shares up at least 5% at some point today.

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