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Even With A Change At The Top, Danaher Corporation Will Roll On

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Multi-industry conglomerate Danaher (NYSE: DHR  ) definitely buried the lede this quarter, as news of the unexpected retirement of well-liked CEO H. Lawrence Culp next year overshadowed an otherwise "OK ... but not great" quarter. Losing a good CEO is also a risk for a company, but Danaher is a consummate example of a company that reloads instead of rebuilds. These shares are not particularly cheap and they rarely ever are, but an overreaction to this news could perhaps create a window of opportunity.

A decent start to the year
Danaher did basically as expected, but investors often seem to expect a little extra from this company. Revenue rose 5% as reported, with core revenue growth of 3.5%. Results were rather balanced across the businesses. Test & Measurement was the laggard with just 1% core growth, Industrial Tech rose 3%, Environmental and Life Sciences & Diagnostics rose 4%, and Dental rose 6%. Dental and Industrial Tech were the only units to come in higher than expected, with a minor 1% beat for IT and a 3% beat for Dental.

Profitability was just slightly below sell-side targets, but not to a truly meaningful extent. Gross margin improved 30bp from last year. Operating income rose 8% on a 9% increase in segment income, with all units showing growth. Dental led the way with 20% growth, IT and LSD were next at 12% and 10%, while Environmental rose 8% and TM rose 3%. Overall operating margin rose half a point and every unit saw margin expansion.

Diagnostics not fully back up to speed
Danaher has made a lot of progress with its Beckman diagnostics business, but this quarter would suggest that the work isn't over just yet. Danaher couldn't match the high single-digit growth of either Abbott or Roche, even though this looked like a pretty solid quarter for immunoassay and clinical chemistry across the group. Danaher has been gaining share on Siemens (NASDAQOTH: SIEGY  ) , but the company is going to need to improve its automation and molecular diagnostics if it wants to close the gap with Abbott and Roche.

Still waiting on test, while motion remains weak
As investors in Agilent (NYSE: A  ) know all too well, test & measurement can be an erratic business. Danaher is a little more focused than Agilent and it leads in oscilloscopes and handheld equipment, but push-outs in communications and weakness in government/military weighed on results. Agilent continues to sound bullish about an eventual recovery in communications-related T&M spending, and that should lift demand for Danaher's instruments as well.

I was a little more surprised to see ongoing weakness in Danaher's motion business (part of IT). Automation-related orders at Rockwell, Siemens and other players had been showing some strength (up around 7%), but that doesn't seem to be helping Danaher yet. This business should improve as the year goes on, but in the meantime business like retail petroleum and product ID are doing reasonably well.

A changing of the guard, but probably not the approach
Analysts and investors were definitely surprised to learn of CEO Culp's plan to retire next year, with EVP Thomas Joyce taking the position. Culp has done a fine job as CEO of Danaher and while this looks like an unusually young age to retire (he'll be 52 at the time), he will have been in the job for around 14 years. As Danaher is often lauded for its bench strength, there are good reasons to expect a lot from Mr. Joyce in the years to follow.

It seems safe to count on this move driving speculation about Danaher's ongoing business plan. Some analysts have advocated a major change in the company's approach, breaking up into smaller businesses and eschewing the conglomerate approach. I doubt that will happen. Danaher may have missed out on some M&A opportunities (Life Technologies, JNJ's diagnostics business, and Ashland's water tech business), but an unwillingness to overpay for assets does not argue for a radical strategic shift.

With $8 billion in financial resources, Danaher can still make some M&A moves, though a big move during this CEO transition period may be less likely. I would like to see Danaher add to its diagnostics business (particularly MDx), but a larger move in life sciences like Agilent (after it spins off the test and measurement business) or a bigger deal in industrial automation could make sense.

The bottom line
Danaher's business does not change much from quarter to quarter and neither does my valuation. I'm still looking for long-term revenue growth around 5% and FCF growth around 6%, and the shares do appear priced for only a mid-single digit return at this price. I'd be very reluctant to sell Danaher if I held the shares, but there are cheaper names to choose from today in my opinion.

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Stephen D.

I'm an ex-Wall Street sell-side and buy-side analyst who has spent most of the last 10 years writing on a wide range of industries and investment ideas.

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