Donaldson Company: A High-Conviction Buy as It Positions for Fiscal 2026 Margin Expansion and Shareholder Returns

Donaldson Company (NYSE: DCI) stands at a pivotal inflection point as it transitions into fiscal 2026, armed with a trifecta of strategic advantages: operational efficiency gains, resilient demand in high-margin filtration sectors, and disciplined capital allocation. For investors seeking a long-term, high-conviction play in the industrial filtration space, Donaldson's current trajectory—marked by margin expansion, shareholder returns, and a robust pipeline of innovation—makes it an increasingly compelling case.

Strategic Operational Efficiency: The Foundation for Margin Expansion

Donaldson's footprint optimization initiatives in fiscal 2025 laid the groundwork for a significant margin expansion in 2026. By rationalizing its expense structure, the company reduced operating expenses as a percentage of sales by 110 basis points to 19.1%, with adjusted operating expenses dropping to 18.3%. This discipline, combined with higher sales leverage, drove an adjusted operating margin of 16.4% in 2025—a modest but meaningful improvement from 16.3% the prior year.

The company's focus on structural efficiency is not just about cutting costs. It's about reengineering operations to sustain profitability in a volatile macroeconomic environment. For instance, Donaldson's gross margin faced headwinds from tariffs and inventory valuation challenges, declining to 34.5% in 2025. However, the company's ability to offset these pressures through operating leverage and cost discipline underscores its operational resilience. Management has signaled confidence in achieving record operating margins in 2026, a target that appears achievable given the momentum in its efficiency initiatives.

Resilient Demand in Filtration Sectors: Life Sciences as a Growth Engine

While industrial filtration markets face cyclical headwinds, Donaldson's Life Sciences segment has emerged as a standout performer, driven by secular trends in bioprocessing, pharmaceuticals, and clean energy. In Q4 2025, the segment grew 14.1% year-over-year, fueled by robust demand for high-margin filtration solutions in the Food & Beverage and Disk Drive industries.

The Life Sciences segment's growth is not just a function of current demand—it's a reflection of Donaldson's strategic alignment with global decarbonization and ESG-driven innovation. For example, the company's Isotag AAV reagent, a breakthrough in gene therapy purification, represents a critical step toward commercializing high-margin bioprocessing solutions. Despite a $62 million impairment charge in 2025 for underperforming upstream bioprocessing businesses, management remains committed to this sector, citing its long-term potential as gene therapies scale.

The segment's resilience is further bolstered by its razor-and-blade business model, where high-margin replacement parts and consumables drive recurring revenue. This model has already pushed Donaldson's recurring revenue to 65% of total sales, up from 50% in 2012. As the Life Sciences segment matures, its contribution to this recurring revenue stream is expected to grow, insulating the company from cyclical downturns in industrial markets.

Disciplined Capital Allocation: Fueling Growth and Shareholder Returns

Donaldson's capital allocation strategy in 2025 was a masterclass in balancing reinvestment and returns. The company returned $465 million to shareholders through dividends and share repurchases, while simultaneously investing in R&D and strategic acquisitions. For example, the acquisition of EasyFlow in 2025 exceeded sales expectations, expanding the company's footprint in the southeastern U.S. and enhancing its capabilities in high-margin filtration markets.

Looking ahead, Donaldson's 2026 guidance of $3.8 billion in sales and 16.4% adjusted operating margins reflects a disciplined approach to capital deployment. The company is prioritizing R&D in areas like gene therapy and bioprocessing, while also optimizing costs through targeted cost management. This dual focus ensures that Donaldson is not only capturing near-term profitability but also building a durable competitive moat for the long term.

Investment Thesis: A High-Conviction Buy for 2026

Donaldson's positioning for 2026 is underpinned by three pillars:
1. Margin Expansion: Operational efficiency gains and cost discipline are set to drive record operating margins.
2. Resilient Demand: The Life Sciences segment's growth in high-margin, ESG-aligned markets provides a buffer against industrial sector volatility.
3. Shareholder Returns: A combination of dividends, buybacks, and strategic reinvestment ensures that capital is allocated to maximize long-term value.

For investors, the key question is whether Donaldson's current valuation reflects these tailwinds. At a forward P/E ratio of ~18x (based on 2026 guidance), the stock appears undervalued relative to its peers in the industrial filtration space. Moreover, the company's strong balance sheet and consistent free cash flow generation provide flexibility to navigate macroeconomic risks while maintaining its aggressive growth trajectory.

Conclusion: Positioning for a 2026 Win

Donaldson Company is a rare industrial play that combines operational rigor with innovation in high-growth sectors. Its footprint optimization initiatives, Life Sciences momentum, and disciplined capital allocation create a compelling case for long-term investors. As the company moves into 2026, the alignment of its strategic priorities with macroeconomic trends—clean energy, biotech, and ESG—positions it to deliver outsized returns. For those willing to hold through near-term volatility, Donaldson offers a high-conviction opportunity to capitalize on a well-positioned industrial leader.