Danaher Corporation Rarely Cheap, But A Proven Winner

Danaher is no bargain, but the turnaround in the diagnostics business has been impressive.

Feb 11, 2014 at 9:37AM

If you're looking for a well-run conglomerate trading at a significant discount to fair value, you're probably going to pass over Danaher (NYSE:DHR). That's typically the case, though, as this company's demonstrated strength in generating margins, cash flow, and returns on capital makes it a perennial favorite with institutional investors.

Even if the expected returns from the stock don't meet your hurdle rate today, Danaher looks like a good name for a watch list. Management has over $8 billion in dry powder for M&A activity and a clear desire to do a large deal (or two). Combine that with a turned-around diagnostics business and underappreciated growth opportunities in product ID and water treatment, and this is a company with solid long-term prospects.

Growth seems to be picking up a bit
When Danaher reported earnings in January, the company delivered 3.5% "core" revenue growth, a slight acceleration from the 3% growth seen in the third quarter. All of the major reporting segments were up, with test & measurement providing its best performance in quite some time. Life sciences & diagnostics also continues to perform well, with strong sale performance in clinical automation and the Chinese diagnostics business.

Danaher saw a slight pick up in gross margin and managed to leverage the 6% reported revenue increase into a slightly greater than 6% operating income improvement, excluding a $31 million pre-tax impairment charge. Test and measurement did well on that revenue growth (with segment income up 11%), and the LS&D business was a major contributor to earnings growth as operating income rose more than 23% on a 2.5% improvement in operating margin.

Diagnostics is healthy again
Danaher has done an excellent job of turning around Beckman Coulter, and this division's operating margins are now basically in line with the norms of the industry. Now the question is more about where the company wants to take this business in the future.

Amidst Roche, Abbott (NYSE:ABT), and Siemens, Danaher is one of the largest players in immunoassay, a $4 billion-plus/year segment of diagnostics. Danaher is also quite strong in clinical chemistry, where it competes with a similar roster of rivals. One of the key factors here is the ongoing automation of the diagnostics space. Roche is quite strong in automation, but Abbott and Siemens have been lagging – giving Danaher a real opportunity to gain share (particularly in clinical chemistry). If Abbott does not improve its automation efforts, there is a real chance for Danaher to grab share in the large lab market, and Siemens' commitment to this space has been questioned as management continues a seemingly endless review of the businesses in which it wants to compete for the long term.

Molecular diagnostics is a different story, though. Roche has an exceptionally strong presence in this market, and Abbott has a credible footprint, while Danaher does not. As this is a large market (over $3 billion today) and one of the fastest-growing segments of diagnostics, this could be a focus for future growth, whether internally driven or through M&A.

Several internal growth opportunities
Danaher is a highly acquisitive company, and that is not likely to change. While the prospects for a large deal are tantalizing, I wouldn't sleep on the company's prospects for internally driven growth as well.

Ballast water treatment could be a multibillion dollar opportunity for the company's Environmental segment. Likewise, the product ID space is a multibillion dollar market where Danaher already appears to have about 20% share, even as it competes with Dover in the printing sub-market. Given the opportunities to strengthen its hand in hardware and software, I would not be surprised if this were an area of focus for M&A, but there is ample room for internal growth as well.

The bottom line
I expect Danaher to post mid-single digit revenue and FCF growth over the long term, with M&A likely to continue to factor as a major part of the company's strategy. That leads to a DCF-based fair value of around $71 today. Although that is below the current stock price, I calculate my discount rates on a required return basis, so the worst I can say about Danaher is that it is not so likely to beat the market year in and year out at today's price. Were the stock to pull back into the $60's, I would seriously consider adding shares with the intention of holding for many years.

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