Danaher (DHR 0.10%) has had a great 2019 so far, with the stock up nearly 32% at the time of this writing. That said, its recent results presentation led to a dip in the share price due to the disappointing guidance. Moreover, there are some concerns that Danaher is now trading at an expensive valuation as investors have piled into the more-defensive stocks in the market. Is it still worth holding for the long term or is it now time to bail out?
The investment case for Danaher
There are four core themes behind buying and holding the stock over the long term:
- The company's core life sciences and diagnostics solutions offer mid-single-digit growth prospects over the long term and, as demonstrated in 2019, they are largely independent of the economy.
- Around 70% of Danaher's revenue comes from recurring sources (consumables), and this provides a combination of stability in a slowdown and the ability to improve margin and cash flow generation if the ratio of revenue from recurring sources increases.
- Its track record of making earnings enhancing acquisitions -- built up by former CEO Larry Culp, now head of General Electric (GE 0.06%), and ably continued by current CEO Tom Joyce -- stands the company in good stead for the future.
- The deal to buy General Electric's biopharma business looks like a good value and is set to transform the company's long-term growth prospects.
Going back to the investor day presentation at the end of 2018, management outlined long-term expectations for a combination of mid-single-digit revenue growth and margin expansion leading to earnings growth in the high single digits or more, and the results this year have only confirmed that outlook.
There's a lot to look forward to with Danaher in the future, and even though the stock is expensive on most valuation methods, it should be noted that the GE biopharma deal will boost earnings and cash flow. For example, Danaher's management estimates that the biopharma business will generate $1 billion of free cash flow (FCF) in 2019. And if you add this figure to Danaher's trailing FCF of $3.35 billion, it gives a price-to-FCF multiple of 22.5 times.
Similarly, analysts have the deal boosting EPS growth by 19% to $5.66 in 2020 -- putting Danaher on a forward P/E of 24.
With all this in mind, why did the stock sell off after the recent third-quarter earnings?
Danaher's third quarter
The reason can be demonstrated in the following chart. As you can see, the guidance for the fourth quarter -- core revenue growth is only expected to be 4.5% -- implies the lowest total company core growth rate since the third quarter of 2017. It's all the more surprising because the company spun off its poorly performing dental segment, Envista, in the recent third quarter, so the fourth-quarter guidance now excludes a business that previously dragged down the overall growth rate.
Why it's nothing to worry about
Obviously, if this implies a slowing in Danaher's growth, and the company is set to add GE's biopharma business in due course, then investors would have a right to question the growth and valuation assumptions made above -- probably the reason the stock sold off after earnings.
However, digging into the details of the results and guidance, it appears any fears are overblown. For example, Joyce outlined that it came down to a timing impact, with some orders being pulled forward into the third quarter from the fourth. Indeed, the third-quarter core revenue growth of 5% was ahead of management's guidance for 4.5%.
Moreover, discussing the matter on the earnings call, Joyce said "when you then look at our fourth-quarter guidance in light of the full year, we're still talking about a full year of 2019 at 5.5% to 6%, and that's very consistent with what we've talked about for the last couple of quarters."
In addition, the environmental and applied science segment came up against a very difficult comparison in the third quarter of 2018, but the life science and diagnostic segments put in a very strong performance -- which bodes well as Danaher prepares to add GE's biopharma business. All told, end-market conditions remain strong in the areas that really matter for Danaher.
The bottom line
The recent sell-off shouldn't overly worry long-term investors. In fact, if it continues, then many investors will be tempted to buy into an exciting long-term growth story. Danaher continues to appear to be well set for 2020 and beyond.