Donaldson Could Clear the Air For Your Portfolio

Air filter maker Donaldson Corp. (NYSE: DCI) reported better than expected results in the second quarter in Monday's report. Is this the signal you need to buy the stock?

Donaldson's earnings for the quarter ending July 31 (also the end of its fiscal 2011) were ahead of expectations. Its $65.8 million in quarterly profit were 29% above the previous year's net income and its $0.84 cents a share EPS beat expectations by a nickel.

Donaldson's sales also grew fast -- by 21% to $625.5 million -- $5.5 million more than Wall Street expected thanks to 26% growth in its engine-products segment, which includes aftermarket, aerospace and defense products.

And Donaldson remains optimistic. It's forecasting 7% to 15% sales growth for FY 2012 and EPS between $3.15 and $3.45 a share on sales of $2.45 billion to $2.6 billion, "bracketing the $3.21 a share on $2.52 billion in revenue currently expected by analysts polled by Thomson Reuters," according to MarketWatch.

Is this enough of a reason to invest in Donaldson? Probably not. But here are three reasons to consider it:

• Strong earnings reports. Donaldson has been able beat analysts’ expectations consistently and in all of its past five earnings reports.
• Increasing sales and profits and cash-rich balance sheet. Donaldson has been increasing sales and profits. Its revenue has grown at a 4.9% annual rate from $1.9 billion (2007) to $2.3 billion (2011) while its net income has increased at a 10.6% annual rate from $151 million (2006) to $226 million (2010) — yielding a solid 10% net profit margin. It has $206 million in long term debt and its cash rose at an annual rate of 49.3% from $55 million (2007) to $273 million (2011).
• Out-earning its cost of capital and improving. Donaldson is earning more than its cost of capital – and it’s improving. How so? It’s producing EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In 2011, Donaldson EVA momentum was 2%, based on 2010 revenue of $1.9 billion, and EVA that rose from 2010's $49 million to 2011's $92 million, using an 11% weighted average cost of capital.

One reasons to hesitate:

• Expensive stock. Donaldson’s price-to-earnings-to-growth ratio of 2.38 (where a PEG of 1.0 is considered fairly priced) means its stock price is expensive. It currently has a P/E of 20 and its earnings per share are expected to grow 8.4% to $3.51 in FY 2013.

If Donaldson sustains its most recent earnings growth rate of 29%, then the stock is quite cheap. But if analysts' estimates are accurate, I would wait for a market correction to pick up shares of Donaldson.