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Donaldson Growth Machine Grinding To A Halt?

By Eric Fox

Tickers in this Article: EL, CL, REV, DCI

Donaldson Company (NYSE:DCI) reported fiscal fourth quarter diluted earnings per share of 60 cents on sales of $607.4 million. While the revenue and earnings number were a quarterly record for Donaldson, the issue for the company is whether it can continue its growth record while facing both a slowing global economy and a stronger dollar.

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Donaldson is an industrial company that manufactures products in two segments - Engine Products and Industrial Products. The Engine Products division sells air intake systems, liquid filtration systems, exhaust and emissions systems, and aftermarket automotive parts to original equipment manufacturers (OEMs) and independent dealers. The Industrial Products division sells air purification systems, liquid filters and other specialized air filtration systems for industrial use.

Currency Tailwind
The company received a lift in earnings and sales due to currency translation exposure, which increased sales by $37.9 million, or 7.2%, in the quarter. Net earnings increased by $3.3 million in the quarter due to currency translation. For fiscal 2008, the sales and earning benefits were $122.5 million and $12.9 million, respectively. (For more on this exposure to exchange rates, see Taking Advantage Of A Weak U.S. Dollar.)

The company acknowledges this benefit from currency translation, and management stated in the last 10-K filing that "the overall weakness of the dollar had a positive impact on the company's international net sales results because the foreign denominated revenues translated into more U.S. dollars." Sales outside the U.S. in fiscal 2007 were 57% of total revenue.

More Currency Winners
Other companies have benefited from a foreign currency translation due to a high percentage of sales denominated in non-U.S. currency. These include Revlon (NYSE:REV), Colgate Palmolive (NYSE:CL) and Estee Lauder (NYSE:EL). Revlon's stock is up more than 45% in the last three months and the company recently announced that it is retiring $170 million of its high cost debt. According to Revlon's CEO David Kennedy this will save $19 million in interest. The stock was trading around $1.25 at mid-day Thursday September 4, which is down from Tuesday's open of $1.40.

Guidance
Donaldson gave guidance for fiscal 2009 in a range of $2.30-$2.40 per share, and noted that the guidance was based on flat exchange rates and a minimum operating margin of 11%. The operating margin was 11% in the fiscal year 2008. If Donaldson achieves this guidance it would be strong growth from the $2.12 reported in fiscal 2008.

Macro Trends, Major Problems
The 13% reported growth in earnings for the quarter sits in strong contrast to the latest government report on the economy, which shows slowing manufacturing activity in the U.S. The Institute for Supply Management (ISM) report released on Sept 2, 2008, gave a reading of 49.9 for its index of manufacturing activity in August 2008, indicating a slightly contracting manufacturing sector from July's 50. For a comparison, the average reading associated with a recession is 41. New orders rose by 3.3%.

Donaldson also faces a slowdown in economic growth outside the U.S. The International Monetary Fund (IMF) projected in its latest report that the slowdown in world growth would continue throughout 2008, and into 2009. The report said “global growth is projected to moderate from 5% in 2007 to 4.1% in 2008 and 3.9% in 2009.” (Chances are you've heard of the IMF. But what does it do, and why is it so controversial? Read more in What Is The International Monetary Fund?)

Bottom Line
Donaldson has been a strong growth story over the past several years, and increases in sales and earnings during the turbulent economy and credit crunch is an impressive feat. However, it remains to be seen if this can continue as global economies slow down and the dollar strengthens.

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator. Mr. Fox also publishes a paid investment newsletter. Please visit The Unknown Stock Report for more details.

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