We Expect Donaldson’s Growing Sales of Proprietary Solutions to Reinforce Its Narrow Moat

Donaldson, a leading manufacturer of air and liquid filtration systems, has built a narrow moat around its large installed base of equipment coupled with a razor-and-blade business model that continues to generate a relatively steady and high-margin stream of recurring revenue from aftermarket parts and consumables. The firm generates an increasing portion of its sales from proprietary solutions, which enjoy higher margins and greater customer retention rates. As a result, recurring revenue has steadily increased, from roughly 50% in 2012 to over 60% in fiscal 2021. We expect this trend to continue, as the firm is ramping up its research and development spending from 2%-3% to 3%-4% and management has prioritized investments in connectivity solutions to complement the company’s large installed base of equipment. We view this strategy favorably and expect that offering customers a comprehensive solution will help reinforce customer switching costs.