Executive Summary / Key Takeaways

• Donaldson Company leverages its technology-led filtration expertise and diversified portfolio, particularly its high-margin aftermarket and legacy businesses, to deliver record profitability and strong cash flow despite cyclical pressures in certain first-fit and capital-intensive end markets.
• Recent performance, highlighted by Q3 FY25 results, demonstrates the company's ability to achieve modest sales growth through pricing and volume, while driving significant operating margin expansion via expense discipline and strategic cost optimization initiatives.
• Investments in differentiated technologies, including advancements in bioprocessing reagents and connected industrial solutions, alongside strategic M&A like the Medica stake, are positioning Donaldson for long-term growth in higher-value markets, although the ramp-up in some newer areas faces market-driven delays.
• Management's updated FY25 guidance projects another year of record sales and adjusted EPS, supported by resilient aftermarket demand, strength in Aerospace & Defense, and benefits from cost management, while also increasing planned share repurchases.
• Key factors for investors to monitor include the pace of recovery in cyclical end markets, the successful commercialization and scaling of new Life Sciences technologies, the impact of global trade policies, and the execution of ongoing footprint optimization initiatives.

Setting the Scene: A Century of Filtration Leadership

Founded in 1915, Donaldson Company, Inc. has evolved into a global leader in technology-led filtration products and solutions. The company's journey has been marked by a strategic adaptation to diverse industrial and environmental needs, culminating in a focused structure comprising three core segments: Mobile Solutions, Industrial Solutions, and Life Sciences. This diversification, enhanced by an organizational redesign approximately two years ago, is fundamental to Donaldson's resilience, allowing it to navigate varied economic cycles and market demands.

At the heart of Donaldson's strategy lies a commitment to innovation and proprietary technology. The Mobile Solutions segment, for instance, thrives on a "razor-to-sell razor-blade" model, where initial equipment sales create a long-term stream of high-margin aftermarket revenue from replacement parts. This recurring revenue base, constituting between 75% and 80% of Mobile Solutions sales, provides a crucial buffer against volatility in new equipment production cycles. In Industrial Solutions, the strategy extends to a "create, connect, replace, service" model, emphasizing integrated solutions and ongoing service relationships to deepen customer ties and drive aftermarket growth. The Life Sciences segment represents a strategic expansion into high-growth, high-value markets, leveraging core filtration expertise for critical applications.

Donaldson's foundational strength lies in its deep engineering know-how and its ability to develop differentiated filtration media and systems. This technological edge is not merely academic; it translates into tangible performance benefits for customers, such as improved efficiency, reduced operating costs, and enhanced equipment longevity. These advantages form a competitive moat, enabling Donaldson to command premium pricing and maintain strong customer loyalty across its diverse end markets.

Technological Edge: The Engine of Differentiation

Donaldson's competitive position is significantly underpinned by its differentiated filtration technology. The company's expertise spans a wide array of applications, from heavy-duty engine air and liquid filtration to complex industrial air and gas purification, and increasingly, advanced separation and purification in life sciences.

At its core, Donaldson's technology often focuses on developing proprietary filter media and system designs that offer superior performance characteristics compared to standard alternatives. While specific, universally applicable quantitative metrics comparing all technologies across all competitors are challenging to ascertain, management commentary and segment performance highlight the impact. For example, the company's technology in Mobile Solutions contributes to the effectiveness of emissions systems and enables performance in demanding applications like mining and agriculture. In Industrial Solutions, its media and system designs are critical for capturing dust, fumes, and mists efficiently, purifying compressed air, and ensuring clean hydraulics.

Recent R&D initiatives underscore the company's focus on pushing technological boundaries, particularly in high-growth areas. In Life Sciences, significant developments include the launch of the scale-X nexo bioreactor by Univercells Technologies, designed for efficient cell culture process development, and the development of the IsoTag AAV reagent by Isolere Bio. The manufacturing-grade IsoTag AAV reagent, now available, is specifically aimed at addressing bottlenecks in Good Manufacturing Practice (GMP) processes, streamlining purification, and improving yield, purity, and quality for gene therapies. While precise, publicly disclosed target metrics for yield or purity improvement were not detailed, the stated goal is to accelerate the purification process and make biomanufacturing more cost-effective.

Beyond product-specific innovations, Donaldson is also investing in technology that enhances its service delivery and customer relationships. The connectivity strategy within Industrial Solutions, for instance, involves launching next-generation controllers and gateways. These technologies are designed to provide real-time performance monitoring, enabling predictive maintenance and reducing equipment downtime for customers. While specific quantifiable improvements in uptime or cost reduction were not provided, the strategic intent is clear: leverage technology to offer value-added services that strengthen the "create, connect, replace, service" model and drive aftermarket parts sales.

For investors, Donaldson's technological differentiation is a critical component of its long-term value proposition. It supports the high-margin aftermarket business, enables market share gains even in challenging environments, and is the foundation for entering and scaling in new, attractive markets like Life Sciences. Continued investment in R&D, even amidst cost optimization efforts, signals a commitment to maintaining this competitive edge and driving future profitability.

Competitive Landscape: Navigating a Fragmented Market

Donaldson operates within a competitive global filtration market characterized by a mix of large, diversified players and smaller, specialized companies. Key publicly traded direct competitors include Danaher Corporation (DHR), Parker Hannifin Corporation (PH), 3M Company (MMM), and Pentair plc (PNR), each with varying strengths and market focuses.

Compared to these rivals, Donaldson's market positioning is distinct. While companies like Danaher and Parker Hannifin possess broader industrial portfolios and often higher overall revenue bases, Donaldson maintains a focused expertise specifically in filtration. DCI's "razor-to-sell razor-blade" model, particularly strong in Mobile Solutions, provides a higher proportion of recurring aftermarket revenue compared to some peers, contributing to more stable margins and cash flow, even if overall profitability metrics like gross and operating margins (TTM Gross Margin: 35.17%, Operating Margin: 13.44%) may trail those of highly diversified, high-margin players like Danaher (TTM Gross Margin: 60%, Operating Margin: 20%).

Donaldson's technological differentiation provides a competitive edge in specific applications, such as its emissions systems or specialized industrial filters. Management commentary highlights consistent market share gains in areas like Mobile Solutions aftermarket, Industrial Dust Collection, Aerospace and Defense, and Disk Drive, suggesting that its technology and service execution resonate with customers. The NAPA partnership win, for example, was attributed to Donaldson's technology, comprehensive catalog, and strong customer service.

However, competitors also possess significant strengths. Parker Hannifin and 3M, with their scale and manufacturing footprint, may offer cost advantages in certain product categories. Danaher, through its Pall acquisition, is a formidable competitor in the high-growth Life Sciences filtration space, particularly in bioprocessing, where its established presence and R&D scale pose a challenge to Donaldson's newer ventures. The slower-than-expected ramp-up in Donaldson's bioprocessing businesses, leading to intangible asset impairment charges, underscores the competitive intensity and market-specific challenges in this area.

Indirect competition comes from alternative technologies and emerging players, including those leveraging IoT for predictive maintenance or developing novel filtration media. Donaldson's investment in connected solutions in the Industrial segment is a strategic response to this, aiming to leverage technology to enhance service offerings and maintain competitiveness.

Barriers to entry in the filtration market, such as the high cost of R&D, the need for specialized manufacturing capabilities, and stringent regulatory requirements (especially in Mobile Emissions and Life Sciences), favor established players like Donaldson. These barriers help protect existing market share and profitability from disruptive new entrants.

Overall, Donaldson's competitive strategy centers on leveraging its core filtration technology, building strong customer relationships through reliable execution and service (including connectivity), and expanding into higher-value markets like Life Sciences through targeted investments and M&A. While facing strong, well-capitalized competitors, its focus on recurring revenue and differentiated solutions provides a solid foundation.

Financial Performance: Resilience in a Mixed Environment

Donaldson's financial performance in the nine months ended April 30, 2025, reflects a company effectively managing through a mixed economic landscape. Net sales for the period increased by 2.2% year-over-year to $2,710.2 million, primarily driven by volume growth and pricing benefits, partially offset by unfavorable foreign currency translation. For the third quarter of fiscal 2025, net sales saw a more modest 1.3% increase to $940.1 million, also supported by pricing and volume.

Profitability metrics showed nuanced trends. Gross profit for the nine months was $947.4 million, with the gross margin slightly decreasing to 35.0% from 35.4% in the prior year period. This margin pressure was attributed primarily to higher manufacturing costs associated with ongoing footprint optimization initiatives. In the third quarter, the gross margin was 34.2%, down from 35.6% a year ago, reflecting the same dynamic.

Operating expenses saw a notable shift in the third quarter due to a $62.0 million loss on impairment of intangible assets related to the Life Sciences bioprocessing businesses (Univercells Technologies and Solaris). This charge reflected lower-than-anticipated capital spending and market demand declines in those specific areas. Excluding this non-recurring item, selling, general and administrative expenses decreased year-over-year in Q3, benefiting from a $6.2 million reduction in the Purilogics contingent consideration liability (due to a lower probability assessment for milestones) and disciplined expense management. For the nine months, SG&A increased slightly in absolute terms but decreased as a percentage of sales, benefiting from the contingent consideration adjustment and expense control. Research and development expenses decreased, reflecting focused project prioritization.

Operating income for the nine months ended April 30, 2025, was $343.7 million, down from $397.9 million, largely impacted by the impairment charge. The operating margin for the nine months was 12.7%, compared to 15.0% in the prior year. In the third quarter, operating income was $87.4 million, down from $143.6 million, with an operating margin of 9.3% versus 15.5% a year ago, again significantly impacted by the impairment. Adjusted operating margin, excluding the impairment and restructuring charges, would present a clearer picture of underlying operational profitability trends, which management commentary suggests showed expansion driven by expense leverage.

Net earnings for the nine months were $252.7 million ($2.09 diluted EPS), down from $304.3 million ($2.48 diluted EPS). For the third quarter, net earnings were $57.8 million ($0.48 diluted EPS), a significant decrease from $113.5 million ($0.92 diluted EPS) in the prior year, primarily due to the impairment charge and a higher effective tax rate (33.6% vs. 21.2%) influenced by the impairment and valuation allowance adjustments.

From a liquidity perspective, cash flow from operating activities decreased in the nine months ended April 30, 2025, primarily due to an increase in working capital, particularly inventory. Cash used in investing activities increased, driven by the $62.1 million equity method investment in Medica. Despite this, the company's balance sheet remains strong, with total debt representing 33.0% of total capitalization as of April 30, 2025. Available capacity under existing credit facilities, combined with expected operating cash flow, is deemed sufficient to meet near-term and long-term cash requirements, including capital expenditures, debt service, dividends, share repurchases, and potential acquisitions. The company is actively managing its capital structure, including increasing share repurchases and planning to renew its revolving credit facility.

Segment Dynamics and Strategic Focus

Each of Donaldson's segments contributed to the overall performance while facing distinct market conditions:

• Mobile Solutions: This segment, the largest contributor to sales ($1,702.6 million for the nine months, +1.6%), demonstrated the power of its aftermarket business ($1,353.4 million, +6.0%). Aftermarket growth, driven by solid market demand and market share gains, offset declines in the cyclical Off-Road ($264.9 million, -9.0%) and On-Road ($84.3 million, -21.1%) first-fit businesses, which were impacted by weak global equipment production in agriculture and transportation. Profitability remained relatively stable year-to-date (17.9% pretax margin), although Q3 saw a slight dip due to manufacturing costs from footprint optimization. Management sees particular strength in Mobile Solutions China aftermarket and Off-Road first fit, benefiting from a structural shift towards larger equipment.
• Industrial Solutions: Sales for the nine months were $794.6 million (+2.0%). This growth was led by the Aerospace and Defense business ($142.8 million, +24.2%), which continues to outperform with record sales driven by robust market conditions. The larger Industrial Filtration Solutions (IFS) business ($651.8 million, -1.8%) saw lower sales volume due to weak market conditions in Industrial Air Filtration and Industrial Gases, as well as Power Generation project timing, partially offset by strength in Industrial Services. Segment profitability decreased year-to-date (16.8% pretax margin) due to unfavorable mix and operating expense deleveraging, although it improved sequentially in Q3. The company is focused on its connectivity strategy and expanding its services business, which are seen as key growth drivers.
• Life Sciences: This segment, while the smallest, is strategically important for future growth. Sales for the nine months were $213.0 million (+8.3%), driven by strong demand in legacy businesses like Disk Drive and Food and Beverage. Profitability improved significantly year-to-date (0.2% pretax margin vs. -4.8% loss), benefiting from cost optimization actions and the Q3 contingent consideration adjustment. However, the bioprocessing businesses continue to face headwinds from weak capital spending and elongated drug development timelines, leading to the Q3 impairment charge. Management is focused on scaling acquired businesses and bringing new products like the manufacturing-grade Isotag AAV reagent to market, despite the challenging near-term market backdrop.

Outlook and Future Trajectory

Looking ahead, Donaldson Company projects fiscal year 2025 to be another record year. Management forecasts full-year total sales to increase between 1% and 3%, with pricing contributing approximately 1% and negligible impacts from currency and tariffs. This guidance reflects continued strength in Mobile Aftermarket (low single-digit increase), Industrial Solutions (2-4% growth driven by Aerospace & Defense and IFS), and Life Sciences (high single-digit growth). Cyclical headwinds are expected to persist in Mobile Off-Road (mid-single-digit decline) and On-Road (high teens decline).

Profitability is expected to reach record levels, with the full-year adjusted operating margin forecast between 15.6% and 16.0%. This anticipated margin expansion, despite modest sales growth, is a testament to the company's focus on expense discipline and operational efficiency. Adjusted EPS is guided between $3.64 and $3.70, implying solid year-over-year growth built on the expected margin leverage.

Capital deployment priorities remain consistent: investing for growth (organically through CapEx of $75-$90 million and R&D, and inorganically through M&A focused on Life Sciences and Industrial Services), paying and increasing dividends (aiming for the 30th consecutive annual increase), and repurchasing shares. The company increased its full-year share repurchase expectation to between 3.5% and 4% of outstanding shares, reflecting confidence in its cash flow generation (80-90% conversion expected) and future prospects.

The updated fiscal 2026 targets reflect a recalibration based on recent market dynamics. While the consolidated sales CAGR target over the three-year period was slightly lowered (3-7% vs. 4-8%), primarily due to the slower ramp-up in Life Sciences biopharma markets, the consolidated operating margin target range was slightly increased (15.8-16.6% vs. 15.6-16.4%). This reflects stronger-than-expected performance and increased margin targets in the Mobile and Industrial segments, offsetting the elongated path to profitability in Life Sciences.

Risks and Challenges

Despite a strong foundation and positive outlook, Donaldson faces several risks. Macroeconomic uncertainty could further impact demand in cyclical end markets like agriculture, transportation, and industrial capital expenditures. Global trade policies and potential new tariffs, while currently expected to have a negligible net impact due to mitigation strategies, remain a fluid risk that could disrupt supply chains and increase costs.

The timing and pace of recovery in the bioprocessing market within Life Sciences are critical. The recent impairment charge highlights the risk associated with slower-than-expected customer capital spending and drug development timelines. Successfully scaling the acquired bioprocessing businesses and commercializing new technologies like the Isotag AAV reagent are key to achieving the segment's growth and profitability potential.

Supply chain constraints, particularly noted in the Aerospace and Defense business, can impact production and shipment timing, introducing lumpiness and potentially delaying revenue recognition. The pace of electrification in the automotive sector also presents uncertainty, as it has impacted some related capital projects more than initially anticipated.

While the company's balance sheet is strong, increased debt levels due to share repurchases and acquisitions, combined with potential increases in interest rates (given exposure to variable rate debt), could impact interest expense. Fluctuations in foreign currency exchange rates and commodity prices also pose ongoing market risks that could affect sales and margins.

Management is actively addressing these risks through operational execution, expense discipline, supply chain management, and strategic prioritization of investments.

Conclusion

Donaldson Company's recent performance and updated outlook underscore the strength of its diversified, technology-led filtration business model. Despite navigating persistent headwinds in key cyclical end markets and facing a slower-than-anticipated ramp-up in its promising bioprocessing ventures, the company has demonstrated remarkable resilience. The power of its high-margin aftermarket businesses, coupled with disciplined expense management and strategic cost optimization, has enabled it to translate modest sales growth into record levels of profitability.

The investment thesis for Donaldson remains centered on its foundational filtration expertise, its ability to develop differentiated technologies that drive market share gains, and its strategic expansion into higher-value markets like Life Sciences and Industrial Services. While challenges persist, particularly in the timing of recovery for certain segments and the successful scaling of newer technologies, management's commitment to investing for growth, returning cash to shareholders, and maintaining a strong balance sheet provides a compelling case. The slightly improved consolidated operating margin target for 2026, even with a moderated sales outlook, highlights the company's focus on profitability and operational efficiency as key value drivers. Investors should continue to monitor end market conditions, the progress in Life Sciences commercialization, and the execution of strategic initiatives as key indicators of Donaldson's ability to sustain its trajectory of profitable growth.