Danaher Corporation's (DHR 4.51%) second-quarter results were almost an investing trivia question: Which company beat earnings expectations and raised full-year guidance, but still managed to disappoint investors? The answer: Danaher. Its earnings were good, but the company is tracking behind its full-year revenue guidance, and there are question marks on its dental segment. Is Danaher still worth investing in?
Earnings good, guidance raised, revenue weak
Management's guidance going into the second-quarter was for core revenue growth of around 2.5% and adjusted diluted non-GAAP EPS in the range of $0.95 to $0.98. The good news is that adjusted diluted noon-GAAP EPS came in $0.99 in the quarter and management subsequently raised its full-year adjusted diluted non-GAAP EPS guidance range to $3.90-$3.97 from $3.85-$3.95.
Weakness in dental consumables has hurt Danaher Corporation. Image source: Danaher Corporation.
So what's the bad news? Well, that comes down to the disappointing revenue performance and guidance. Going back to outlook meeting in December, management set a target of 3%-4% full-year core revenue growth. Unfortunately, Danaher delivered just 2.5% in the first-quarter and 2% in the second. Turning to core revenue guidance for the rest of year, CEO Tom Joyce prompted toward 3% in the third-quarter, and then said he was looking for " some better numbers than that in the fourth quarter."
Clearly, Danaher is going to have to struggle to meet its original core revenue growth target. The reason? Ongoing weakness in its dental segment.
Dental problems at Danaher
Danaher's management had expected flat core revenue growth for dental in the quarter, but it actually reported a decline of 1%. Joyce said that "really represented" why Danaher's core revenue growth of 2% in the quarter fell short of his expectation for 2.5%
The following chart shows the ongoing disappointing in the dental segment and how it's dragged down total revenue growth.
Data source: Danaher Corporation presentations. Chart by author
Joyce put it down to continued inventory destocking by its distribution partners, notably in the case of Danaher's "traditional consumables". And it gets worse: Joyce expects "core growth rates in the second half of the year to be consistent with the results we've seen so far in the first half."
Given that the Danaher's competitor in the dental consumables space, 3M Company (MMM 3.67%), is winning market share in the dental consumables space, it's hard not to think that this a company-specific issue. On the company's last earnings call, 3M CEO Inge Thulin said, "we took market share on the consumable part into the oral care, and I think there's momentum there. So we had 5% growth." It's part of the reason why 3M hiked its full-year organic sales growth forecast.
Danaher's Joyce claimed that if any market share had been lost it would be "very marginal" -- but that doesn't wash with 3M's commentary. Moreover, Joyce also spoke of making investments in growth initiatives in order to improve operational performance. Clearly, Danaher has work to do to get the segment back on track.
Growth is still good
As is often the case with a company with a strong track record of operational excellence, any disappointment can be blown out of proportion. As noted earlier, the full-year EPS guidance range was actually raised on the earnings call, and analyst estimates are still calling for 9% EPS growth in the next two years. Free cash flow growth -- long a strong point at Danaher -- is expected to grow in the double-digits for the full-year. In addition, the dental segment was the smallest contributor to operating profit in 2016, contributing just 15% of segment operating profit.
Thinking longer-term, there is a strong case for positively re-rating in Danaher's stock on the grounds that it's now better compared to higher-rated life sciences & diagnostics peers, rather than the industrial stocks it's traditionally bench-marked against by analysts.
The following chart shows how Danaher is on a cheaper valuation than life sciences and diagnostics companies like Thermo Fisher and Agilent, but more expensive than multi-industrials like 3M and Illinois Tool Works.
DHR EV to EBITDA (Forward) data by YCharts
What to do with the stock?
All told, the difficulties in the dental segment are obviously a cause for concern -- look out for 3M Company's upcoming earnings for more color on the dental consumables market -- but ultimately the key long-term consideration is still almost a philosophical question.
If you see Danaher as a cheaply rated life sciences & diagnostics company then the disappointment is creating a buying opportunity. If you think it's an expensively rated industrial stock, then any hiccup is a reason to sell.
