Danaher Is One of the Big Winners From COVID-19

Another quarter, and yet another great set of results from Danaher (DHR 0.24%). The company had a blowout quarter, with 14% core revenue growth driven by very strong growth in its COVID-19 related solutions in life sciences and diagnostics. Moreover, there's reason to believe the pandemic has enhanced the company's long-term growth prospects. Let's take a look at what's going on and whether it's enough to make the stock a buy.

Three reasons Danaher stock is attractive

The investment case for the healthcare-focused stock is based on three interconnected factors:

• Danaher's long-term growth prospects have been enhanced by the pandemic, and management believes it can grow more than its recent trend of 5%-6% core revenue growth.
• The company has a high degree of recurring revenue streams that tend to be higher margin and are growing as a share of revenue.
• The acquisition of GE's biopharma business, now called Cytiva, has significantly improved Danaher's cash flow profile.

To put some color on the discussion below, here's a look at where the growth came from in the third quarter. As you can see in the chart, it's the medically focused segments that have led the recovery, so let's focus on them.

Data source: Danaher presentations. YOY = year over year. 

Growth prospects in diagnostics

Danaher has a double exposure to the COVID-19 pandemic within its diagnostic testing and life sciences segments, respectively.  In fact the COVID-19 related business within those segments were responsible for all but 4% of the 14% revenue growth in the quarter. First, Danaher's diagnostics segment includes a leader in molecular testing, Cepheid, which grew its core revenue by 100% in the quarter and led the diagnostics segment to 17.5% year-over-year core revenue growth.

Moreover, Cepheid recently launched a four-in-one test (COVID-19, flu A, flu B, and respiratory syncytial virus) and, according to CFO Matt McGrew on the earnings call, it's expected to generate 40% of COVID-19-related test activity in the fourth quarter, with the other 60% being a COVID-19 only test. Given that the COVID-only test costs $20-$40, and the four-in-one costs $55-$60, Danaher could receive a growth boost from the new test.

In addition, another Danaher diagnostics business, Beckman Coulter, now has a test to detect COVID-19 antibodies and another to detect severe inflammatory response in COVID-19 patients.

Thinking longer term, the demand for Cepheid's tests has led to a 35% increase in its installed system base, meaning it has the potential to improve its long-term recurring revenue from the tests sold into the new clients with systems. As such, CEO Rainer Blair said on the earnings call, "we really see this as a long-term improvement."

The COVID-19 pandemic is creating growth opportunities for Danaher. Image source: Getty Images.

Growth prospects in life sciences

Second, Danaher's life sciences segment is seeing strong growth due to demand from customers working on COVID-19 vaccines and therapies. In addition, the reopening of academic and research labs has increased demand. Management estimates that 60%-70% of global research labs are now a least partly open. As more labs open up, Danaher's life sciences revenue can receive a further boost.

All told, the life sciences segment grew year-over-year revenue by 18.5% in the quarter, with a whopping 35% growth rate at Cytiva. More and more, the Cytiva acquisition is looking like a great deal for Danaher.

Buying Cytiva made Danaher a leading player in the bioprocessing market, and Blair's commentary on the earnings call suggests that its long-term growth rate will be higher than originally anticipated when the deal was done. " ... that 6% to 7% growth assumption that we had here prior to the pandemic was likely conservative, and that for the long term we really can think high single-digit there as well," Blair said. 

Just as with the diagnostics segment, it's a case of near-term growth receiving a boost and the increased likelihood of a step-up in long-term growth expectations too.

Recurring revenue and cash flow

If Danaher is set to see a boost to growth in life sciences and diagnostics, and notably with Cepheid and Cytiva, then it's likely to improve the investment profile of the company.

One key way this will happen is through an increase in its recurring revenue -- something that should boost margin and free cash flow generation. As you can see below, the addition of Cytiva did help boost the life sciences share of revenue from recurring sources.

In addition, when it was part of GE, Cytiva generated $1.3 billion in free cash flow (FCF) in 2019, and given that Danaher's FCF was just $3.3 billion in 2019, it's clear that Cytiva is going to significantly boost Danaher's FCF generation. In fact, total FCF improved by 110% in the third quarter to $1.5 billion.

Data source: Danaher presentations.

Is Danaher a stock to buy?

Trading on a forward P/E ratio of 33 times earnings and a forward price-to-FCF multiple of 34, Danaher is definitely not a superficially cheap stock. On the other hand, investors should be willing to pay a premium for a high quality company, and it looks likely that Wall Street analysts will be upgrading long-term earnings expectations for the company after the third-quarter results.

If investors aren't tempted to buy in on such a valuation, then at the very least, Danaher deserves to be top of a watch list for investors looking to buy stock given any significant market dip.