The usual rule of investing is that safe stocks usually offer low or no growth, but that's not the case with Danaher Corporation (DHR +1.81%). The company, which has a $71 billion market cap, offers a combination of relatively recession-resistant earnings and long-term growth potential from its diagnostics, life sciences, and environmental solutions businesses. Here's why you can consider the stock as an option for your portfolio.
Image source: Getty Images.
A look at Danaher's history
You don't have to take my word for it -- let's look at the trading history of the company. Or rather, at the parts of Danaher that existed before the spinoff of Fortive Corporation (FTV +4.06%). In a nutshell, the Fortive separation took out most of the cyclical parts of Danaher and left the remaining company with four segments, namely life sciences, diagnostics, dental, and environmental & applied solutions.
In order to best judge how safe the new Danaher is, it's good to analyze how these businesses might perform during a recession. The good news: We can do just that by simply going back and looking at sales growth during the last recession. Admittedly, it's not an exact comparison -- since then, Danaher has made significant acquisitions in life sciences and diagnostics (including Beckman Coulter, Pall Corp and Cepheid) and dental (Nobel Biocare) -- but it serves to demonstrate how end markets perform in a downturn.
As you can see below, Danaher's life sciences and diagnostics segment (the two were combined back then) and the environmental segment only declined 1% in the recession-hit year of 2009. Similarly, the dental segment only declined 8.5%. Compare this with the test & measurement and industrial technologies businesses (now mostly part of Fortive), which declined 22% and 17% respectively.
Data source: Danaher Corporation presentations. Chart by author.
Simply put, the new Danaher's businesses are relatively recession resistant.
Is it a growth stock as well as a safe one?
There are three reasons to believe Danaher has strong earnings growth prospects:
- The company is increasing its share of revenue from sales of higher-margin consumables.
- Management has a strong track record of acquiring businesses and then expanding margins using its so-called Danaher Business System (DBS).
- Full-year 2018 guidance was raised on the first-quarter earnings presentations, and Danaher has strong earnings momentum behind it; analysts are predicting high-single-digit growth for the next couple of years.
Going back to the end of 2015, the post-separation Danaher business had 60% of its business in recurring revenue (consumables); fast forward to the end of 2017, and the percentage of consumables is up to 65%. The change has helped margin expansion and profit growth.
In addition, margins have been enhanced by the ongoing application of DBS to acquisitions. In a nutshell, DBS is the application of a set of core principles involving lean manufacturing processes and continuous improvement. The Beckham Coulter acquisition was a huge success, and on the 2017 investor-day presentation, management outlined margin improvements with the most recent major acquisitions.
| Acquisition |
Month Acquired |
Operating Profit Margin at Acquisition |
Operating Profit Margin End 2017 |
|---|---|---|---|
|
Nobel Biocare |
Dec. 2014 |
Low double digits |
Above 20% |
|
Pall Corp |
Aug. 2015 |
High teens |
Around 25% |
|
Cepheid |
Nov. 2016 |
Flat/Low single digits |
Mid-teens |
Data source: Danaher Corporation presentations. Table by author.
The improvements in gross and operating margin can be seen in the charts below. And given Danaher's track record of using its excellent free cash flow generation -- $2.9 billion in 2017, representing nearly 16% of revenue -- in order to make earnings-enhancing acquisitions, investors can feel confident about future growth.
DHR Operating Margin (TTM) data by YCharts.
Finally, Danaher has good earnings momentum in 2018 with total core revenue growth -- a measure excluding currency effects and acquisitions -- in mid-single digits, driven by strong growth in life sciences and diagnostics. In fact, after a strong set of first-quarter results, management raised its full-year non-GAAP EPS guidance to $4.38 to $4.45, compared to previous guidance of $4.25 to $4.35. At the midpoint, the new guidance represents growth of 9.5% compared to 2017.
Data source: Danaher Corporation presentations. Chart by author.
The bottom line
Danaher offers investors a rare combination of defensive safety plus secular earnings-growth prospects through things like increased use of clinical diagnostics and life science research. It's an attractive mix for long-term investors looking for a stock that's likely to outperform in a slowdown but still grow when the economy is doing well.
