Shareholders of Dover Corp. as of April 30, 2018 shall, effective May 9, 2018, receive 1 share of Apergy stock (APY) for every 2 shares of Dover stock (DOV) that they own pursuant to a tax-free spinoff that was announced in February.
Dover is an industrial powerhouse. Apergy is an upstream oil sector equipment manufacturer. Before we discuss the specifics of this transaction, let us take a brisk walk through the history books of corporate America first.
The book “Private Empire” tells the tale of Exxon’s rise in developing countries around the world throughout the 20th century. Exxon, which was the successor to John Rockefeller’s prized Standard Oil of New Jersey spinoff after the United States Supreme Court broke up the colossal Standard Oil, inherited the best managerial talent after the spinoff. When reading about how Exxon’s management team systematically rebuilt Exxon into a juggernaut all over again, I kept coming back to how the management team talked about maximizing and stabilizing the cash flows from its upstream oil and gas division.
The word “upstream oil company” refers to companies that explore for oil and then extract it. The midstream companies transport it, and the downstream companies turn oil into the final product for retail sale.
Upstream oil companies are the most volatile in the industry. When the price of oil goes up, these are the people who are reaping the riches and building the 10,000 square foot mansions in Texas. When the price of oil goes down, the upstream companies bear the brunt of it. This is the swing for the fences area of oil investing.
For illustration purposes, look to Hess. When oil rose to above $100+ per barrel in 2007 and early 2008, the price of Hess stock rose to $137 per share as $4 billion profits rolled in. When the Great Recession happened and oil prices declined, the stock collapsed to $35 per share and the profits disippated. Then, oil rose, and by 2014, Dover’s price was up to $104 as profits came up to $2 billion. Then, oil fell to $30 per barrel, the company lost over a $1 billion, and the stock fell back down to $35 per share. You go up and down, bobbing excessively along with every market fluctuation.
The whole reason Exxon is a $400+ billion company is because it takes the profits during the good upstream years to diversify the company across chemical and other speciality divisions so that, when the inevitable collapse in oil occurs, there will be stabilizing cash generators to carry the company onward and even provide ballast for Exxon’s upstream subsidiaries to aggressively make acquisitions.
I believe this is the best way to manage an upstream company–as part of a diversified collection of non-correlated assets that can smooth out the extreme volatility associated with the upstream sector.
Which brings me to the news that, effective today, Dover (DOV) has officially spun off its Apergy (APY) subsidiary (formerly known as Wellsite) that sells equipment to upstream oil companies. In other words, Dover is doing the exact opposite of what made Exxon enormously successful.
And Dover, which manufactures all sorts of engineered components for just about every large-scale industrial and aerospace company, is one of the best stocks that never gets any attention. Since 1985, it has compounded at a rate of 12.5%, turning every $10,000 investment into almost $475,000 today. Part of the reason for this success is because it would take Apergy’s high profits during oil booms and buy companies that make microwave filters and flow meters. Oil booms were a great time to play offense and build this great collection of assets.
But, it seems that Dover got sick of plugging in Wellsite’s losses during the down years, and is spinning off the division to shareholders. I’m reading the investor presentation about how strong Apergy is already because it earns $100 million in profit while only carrying $700 million in debt with $25 million, and I cannot but roll my eyes. Last year, Apergy/Wellsite lost $10 million. It lost hundreds of millions during the recent oil price decline as the purchase of upstream equipment became non-existence as the upstream oil companies were actually idling and shuttling production.
I think Dover saw a window of higher oil prices in which Apergy could tout some momentum, and chose to strike quickly and divest of the assets.
Long term, I think Dover will continue to perform well, although I think the spin-off of Apergy is proof that management is choosing to lower the ceiling on absolute returns in exchange for more predictability rather than pursue higher returns with more volatility (i.e. I would say Dover lowered its long-term stock compounding rate from the 10-12% range down to the 8-10% range with this move).
As for Apergy, it is going to be a rollercoaster ride. It trades at $36. Next year, it could be at $75, or, it could be at $15. It is going to very volatile, and that $700 million debt burden with only $25 million in the bank might look awfully onerous if there were to be a dramatic downturn in the price of oil at any point within the next year.
If I owned the Apergy spinoff and it doubled to $70, I would sell it and move on. Usually, my advise is the opposite, as companies with high earnings and rising stock prices tend to build momentum on growth and continue it onward. But upstream is one of those exceptions that is the reason why my broad pronouncements use words like “usually” instead of “always”. If Apergy shoots up in value, I would sell it quickly because it is entirely possible that ten years from now it will see that price again. Conversely, if the stock falls quickly in the next year or so, I would hold onto it, as the damage had already been absorbed, and the quick 200% gain that is characteristic for firms participating in the upstream oil industry could very well be in the offing.
Unless it were a bottom during a recession for a conservatively financed upstream company or equipment manufacturer, I cannot imagine I would ever voluntarily purchase shares of a company that earns a supermajority of its income from the upstream oil sector. There is just too much see-sawing over the decades where the lows of 2009 can be revisited in the stock price a decade later–that is not enough rebasing of the company’s earnings power upward for my taste.
But if I were a long-term Dover shareholder that received some shares in a spin-off, I would wait it out.
Originally posted 2018-05-09 03:44:36.