Donaldson

Donaldson increased its fourth-quarter fiscal 2026 adjusted EPS by 12% from the prior-year period to $1.15. For the full year, the company reported record-high sales of roughly $3.9 billion, up 5% year over year thanks to solid growth across all three segments.

Why it matters: Donaldson is poised to carry its strong momentum into fiscal 2027. Management expects full-year revenue growth in the range of 5.5% to 9.5%, which we see as realistic considering robust demand across multiple end markets as well as the contribution from the Facet acquisition. Mobile solutions delivered fiscal fourth-quarter sales growth of 7.9%, fueled by high-single-digit growth in on-road and aftermarket sales. First-fit off-road sales were flat compared with the prior year, as strength in construction was offset by weakness in agriculture. The mobile solutions segment's sales in China were up 27% year over year due to 40% growth in replacement part sales. We see Donaldson's strong global reputation paying off as the company grew its full-year Asia-Pacific sales by 8.5% in fiscal 2026.

The bottom line: We maintain our fair value estimate of $79 and see shares as modestly overvalued. Although favorable end-market trends will likely buoy growth in fiscal 2027, we think these near-term tailwinds are already priced in, with shares currently trading roughly 20% above our fair value estimate. We forecast Donaldson growing its revenue at a roughly 6.5% CAGR while expanding its adjusted operating margins by roughly 200 basis points through fiscal 2030. We think the market is baking in revenue continuing to grow at a high-single-digit clip, which we see as overly optimistic. Given Donaldson's exposure to cyclical end markets, we expect current record demand to gradually moderate in the long run.

We are maintaining our $79 per-share fair value estimate following the company's fourth-quarter fiscal 2026 results. For fiscal 2027, management expects full-year revenue growth of 5.5% to 9.5% and adjusted EPS of $4.22 to $4.38.

We project roughly 6.5% compound annual organic revenue growth through fiscal 2030. We expect that Donaldson's research and development spending will remain elevated at around 2.5% of revenue through the cycle; this should help the company increase sales of innovative and proprietary solutions, which enjoy higher margins, faster sales growth, and greater customer retention rates than more commoditized products.

We project operating margin expansion of around 250 basis points from fiscal 2026 levels by fiscal 2029, driven by volume leverage, mix shift to higher-margin proprietary products, and the firm’s continuous improvement initiatives. For our midcycle assumption, we model a roughly 17.5% operating margin. We assume an 8.2% weighted average cost of capital and a 25% long-run effective tax rate in our model.

In our view, Donaldson has built a narrow moat based on intangible assets and customer switching costs. Donaldson has a large installed base of customers, which it leverages to sell replacement parts. Many of these customers partner with the company to develop proprietary solutions based on Donaldson’s intellectual property, as the company holds over 3,100 active patents (as of fiscal 2025). Donaldson’s customer relationships can be remarkably sticky as its solutions provide mission-critical functions and are leveraged in products that frequently have long life cycles, leading customers to prefer effective and reliable solutions over cheap alternatives. As of fiscal 2025, the company generated roughly 65% of its sales from replacement parts, up from 50% in fiscal 2012.

We believe the mobile solutions segment has built a narrow moat from intangible assets and switching costs. In 1915, Frank Donaldson Sr. invented the first effective air cleaner for a tractor engine, and the company has been an industry leader ever since, garnering a pristine reputation built on innovation and efficacy. The segment operates through the sale of first-fit parts sold to off-road and on-road heavy-duty equipment predominantly powered by diesel engines, resulting in a large installed base that drives relatively steady sales of replacement parts. We believe this razor-and-blade model is conducive to economic moats and has driven strong performance in the company’s aftermarket business. Depending on the complexity of the part, Donaldson’s aftermarket solutions can have very high customer retention rates. In the mobile segment, approximately 30% of sales are considered innovative and have retention rates of over 80% even 12 years after the first sale. We believe the strategic shifts made by the mobile solutions segment to focus on proprietary replacement parts have bolstered its moat, as well as driving solid revenue growth and operating margin expansion. In the long run, the mobile solutions segment will face headwinds due to electrification adoption reducing demand for diesel-powered transportation, but we expect the transition to be gradual. We think the mobile segment merits a narrow moat as we don’t anticipate a material impact from increased adoption of electrification over the next 10 years.

We assign a no-moat rating to the industrial solutions segment, largely on the back of secular headwinds that we expect to affect the business in the near- to medium term, including the shift toward renewable energy and the shift toward solid-state drives away from hard disk drives. These headwinds will affect the industrial solutions and life sciences segments, as demand for gas turbine systems and disk drive products will likely continue to decline. Additionally, management has categorized these solutions in the industrial solutions and life sciences segments (including disk drives and on-compressor solutions) as mature and said that cash flows from these low-growth and high-margin products will be used to help fund other initiatives in the business.

Finally, we assign a no-moat rating to the life sciences segment, which was formed in 2023. This burgeoning segment consists of Donaldson’s disk drive business unit along with the tuck-in acquisitions of Purilogics, Solaris, and Isolere Bio. The company has ambitious plans to leverage these acquisitions to target new end markets such as bioprocessing, food and beverage, and medical devices. Nonetheless, we believe the business does not currently have sufficient scale to warrant a moat, and the ramp-up in sales growth has been slower than management's original expectations. Additionally, we do not currently see sufficient evidence of intangible assets or customer switching costs to award the segment a narrow moat.

We believe that the narrow moat garnered by the mobile solutions segment is enough to provide the consolidated entity with a narrow moat. Donaldson continues to generate mid- to high-teens adjusted returns on invested capital, and we believe that it has built enough barriers in the business to prevent substantial margin erosion in the near to medium term. We think that increased investment in infrastructure, both in domestic and international markets, should provide a tailwind for the company’s off-road business unit and that expected weakness in the on-road business unit will be more than offset by healthy aftermarket demand, resulting in ROICs above the cost of capital for at least 10 years.

Donaldson generates a healthy stream of recurring revenue, as aftermarket parts and consumables account for over 60% of sales, which helps mitigate the firm’s exposure to cyclical end markets.

The firm has increased sales of its proprietary solutions, which enjoy higher customer retention rates than commoditized products.

Donaldson’s investments in connectivity can help reinforce the firm’s economic moat by combining its large installed base of equipment with complementary digital offerings to enhance customer loyalty.

In the long run, the advent of electric powertrains poses a threat to Donaldson’s engine segment.

The gas turbine end market has been in a downward cycle in recent years.

The disk drive end market is in secular decline, and sales are likely to continue contracting.