3 Reasons Danaher Corporation's Stock Could Fall

The bearish case for Danaher Corporation.

Sep 1, 2014 at 5:39PM

There is no doubt that Danaher Corporation (NYSE:DHR) is one of the highest-quality names in the industrial sector, but with the stock underperforming the S&P 500 by around 7.7% year to date, there is a sense that the market is losing a little patience with Danaher. In addition, the company is facing a significant amount of unpredictability about its future prospects -- an unusual situation for Danaher. It's time to look at three reasons Danaher could fall in 2014.

Temporary or structural weakness?
Danaher's second-quarter results disappointed the market, and Fools already know that it was mainly due to softness in two product lines. Communications (the test and measurement segment) and dental consumables both disappointed in the quarter, and Danaher CEO Larry Culp said he expected "negative growth" for the communications platform for the rest of the year. Fools can read about the other main conclusions from the conference call here.

While there's a case to be made for a bounce-back in both of these product lines in future quarters, the following chart of segmental sales reveals that these problems may be something structural.


Source: Danaher Corporation presentations.

Clearly, the dental and test and measurement segments haven't grown over the past three years, and it's not clear whether the current weakness is merely part of a deteriorating end market.

Emerging markets could disappoint
The company has been actively engaging in investing in emerging markets, or what Danaher's management calls "high-growth" markets. Indeed, at the end of 2013, high-growth markets made up more than 25% of its revenue, and international revenue made up 58% of Danaher's 2013 total revenue.

Moreover, Danaher is becoming increasingly reliant on these markets for growth. For example, in the second quarter, Beckman Coulter, the company's life sciences and diagnostics segment, generated "mid-teens growth in China, while the developed markets grew at a low-single-digit rate," according to Culp. Fools need only to look at the preceding chart to see the importance of the life sciences and diagnostics segment. The point here is that GDP growth estimates for countries such as Brazil, India, and China have been coming down this year, and this could put pressure on Danaher in future quarters. Given its exposure to emerging markets for growth, this is something to worry about.

The market might fall out of love with Danaher Corporation
Some companies -- by way of their management, history, or other factors -- acquire a certain reputation. It's fair to say that Danaher is known for being a highly cash-generative company that uses its cash to make earnings-enhancing acquisitions. The acquisitions then enter into the Danaher Business System, or DBS, and, just as with Beckman Coulter, management goes about improving operational performance. That's why the market loves Danaher. Indeed, Larry Culp reaffirmed that it had $8 billion worth of firepower to make acquisitions.

Unfortunately, it's been a couple of years since Danaher made an acquisition worth $500 million, although it has made a number of small deals recently. The intended acquisition of Siemens' clinical microbiology business (possibly for a figure in the $500 million range) is a step in the right direction, but with equity markets rising, Danaher may find it hard to make the more significant purchases at attractive prices.

All of this is not a problem in itself. After all, what's wrong with walking away from deals that aren't a good value? However, if the company loses its reputation for being a deal-maker, then the market's sentiment could turn negative. Danaher is not a company that investors buy for its 0.5% dividend yield; they buy it for its management's ability to apply the DBS to new businesses. If its management loses the reputation of being able to do that, then the stock could suffer a negative rerating.

The bottom line
All told, Danaher has some uncertainty surrounding it this year. It's not clear that the dental and test and measurement segments aren't in some kind of structural decline. Moreover, relying on emerging markets for growth in 2014 could prove a disappointment, and the company is under pressure to deliver on its acquisition strategy. Much to think about.

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