Is Danaher Stock a Buy?

When Danaher's (DHR -1.84%) former CEO, Tom Joyce, took over from Larry Culp in September 2014, he managed a $41 billion market cap company -- dwarfed by the $250 billion market cap of industrial giant General Electric (GE 1.30%). Joyce left the role this past September, while Culp is now at the helm of GE. Meanwhile, Danaher's market cap of $166 billion is now almost double that of GE's $84.6 billion.

The change is the all the more remarkable, considering Danaher spun off its industrial business, under the name of Fortive, in 2016 and floated its dental products business, Envista, this year. It's been an incredible period for Danaher, but after a 52% rise in 2020, is the stock still a good value?

The coronavirus pandemic has created growth opportunities for Danaher. Image source: Getty Images.

Why Danaher stock has soared in the past six years

To understand if Danaher is a good value, it's a good idea to look at just why the healthcare company's stock price has soared. There are probably three main reasons.

First, the separation of the Fortive and Envista businesses has helped the market along its path of gradually rerating Danaher in line with the life sciences and diagnostics sector.

Danaher's valuation, using price to free cash flow (FCF), only broke out of the bottom of the life sciences and diagnostics sector range in 2020, and for long periods from 2017-2019 it traded toward the bottom.

Data source: YCharts

The following table shows how more than three-quarters of revenue now comes from life sciences and diagnostics. Moreover, Danaher has made at least two highly profitable acquisitions in recent years: medical-diagnostics company Cepheid in 2016, and the former GE biopharma business, now called Cytiva, in 2020. More on these deals in a moment.

It's all resulted in a significant rerating in line with its peers. Here's a look at operating profit by segment.

Data source: Danaher presentations.

Strong underlying growth

Second, it's not just a story of portfolio restructuring and acquisitions, because Danaher's core revenue growth has been excellent in recent years. In fact, total core revenue growth has been in the mid-single-digit range since the fourth quarter of 2017, with a whopping 14% reported in the latest quarter.

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

In addition, the quality of Danaher's revenue has also been increasing as the share of revenue coming from recurring sources -- consumables that run on Danaher's instrumentation and platforms -- has been increasing. For example, in the first nine months of 2020, Danaher generated 72.5% of revenue from recurring sources, compared with 69.6% in the same period of 2019.

Danaher is a big winner from the coronavirus pandemic

As noted, Cepheid and Cytvia have both been great acquisitions for the company. In particular, the deal Joyce made to buy the former GE biopharma business, Cytiva, from his former boss at GE looks like a fantastic deal.

For a net price of $20 billion, Danaher got a business that generated $1.3 billion in FCF in 2019, meaning a price-to-FCF multiple of just 15.4. That's a valuation significantly below Danaher's current multiple, so it looks like a great deal for Danaher.

The acquisition also filled a gap in Danaher's bioprocessing portfolio and turned it into a leader in the industry. Meanwhile, the COVID-19 pandemic is creating strong demand for life sciences equipment to create vaccines and therapies. Cytiva's sales grew a whopping 35% in the third quarter, and Danaher CEO Rainer Blair believes the 6%-7% long-term growth estimate for Cytiva should now be raised to high single digits.

Image source: Getty Images.

Similarly, the pandemic has led to a surge in demand for Cepheid, with revenue up 100% in the third quarter, because of its COVID-19 test. Moreover, Cepheid's global installed system base is up 35%, meaning the company has an opportunity to expand other diagnostic test sales to new owners of its systems.

Is Danaher a buy?

A combination of mid-single-digit growth prospects and growth opportunities from the pandemic make Danaher a highly attractive company for investors. However, it's hard to argue that the market doesn't know this right now. Indeed, a valuation of 34 times estimated FCF for 2021 means Danaher is trading at a price that can't afford any mishaps.

While a lot of things have gone right for Danaher in recent years, the current stock price is assuming a lot of things will go right for Danaher in the future as well. Given that it's very difficult to know how the pandemic will be subdued, it's also hard to know the level of life sciences research and diagnostic testing that will take place on it in 2021 and onward. As such, a forward multiple of 34 times FCF isn't leaving much margin of safety.

All told, Danaher is a great stock, and definitely one to look to buy on any weakness, but on a risk/reward basis there are probably better stocks to buy right now.