It's hard not to like diversified industrial Danaher Corporation (NYSE:DHR). Its management tends to underpromise and overdeliver on earnings, which is usually a good thing for investors. Meanwhile, its model of reinvesting cash flow to make earnings-enhancing acquisitions continues to serve investors handsomely. If you are looking for a solidly growing company, on attractive valuation, then Danaher might fit the bill. The recent fourth-quarter results confirmed many of these themes, so let's take a look.
Danaher's fourth-quarter results
A brief summary of the results:
- Fourth-quarter adjusted diluted earnings-per-share growth of 8.3%; revenue growth of 3%
- Full-year adjusted diluted EPS growth of 7.6%; revenue growth of 4%
- Full-year free cash flow growth of 4.2% to $3.16 billion
- Full-year core revenue growth of 3.5% versus internal guidance of 2%-4%.
- First-quarter 2015 adjusted diluted EPS of $0.90-$0.94.
- Full-year 2015 core revenue growth of 3%-4%.
- Full-year 2015 adjusted diluted EPS of $4.30-$4.40.
("Core" numbers simply mean the impact of acquisitions and divestitures has been taken out for a better measure of underlying growth.) The results are solid enough; let's see what takeaways investors should focus on.
Five things you need to know about Danaher's results
First, core operating profit margin grew 70 basis points (where 100 basis points equals 1%) in the fourth quarter. Three of the company's five business sectors also reported an increase in core margin growth.
The decline in core environmental segment margin is obviously a concern. However, on the earnings call, management said it had taken the "opportunity to accelerate" research and development investment in the quarter, in order to aid future growth.
Two weak areas
The decline in test and measurement segment margin leads me to my second takeaway. Danaher faced weakness with two higher-margin businesses in 2014: communications (test and measurement) and dental consumables (dental). In fact, operating profit declined by 1.7% for test and measurement in 2014, and CEO Tom Joyce did not indicate that conditions were improving.
"Our communications platform core revenues decreased at a double-digit rate," Joyce said during the earnings conference call, "[due to] a decline in network management solutions where we continued to experience delays from our North American wireless carrier customers."
On a more positive note, in the next few quarters Danaher will come up against the weakness reported in communications in 2014, so comparisons will get easier for the test and measurement segment. As for dental consumables, Joyce stated, "On the consumables side, we see it really as a continuing relatively modest growth market." Essentially, Danaher needs the average U.S. consumer to feel better about the economy, and thus make more trips to the dentist, therefore boosting consumables demand.
Third, as you'll see in the numbers above, Danaher beat the midpoint of its full-year core revenue growth by bringing in a 3.5% boost. Fast-forward to this year, and the full-year guidance is for 3%-4% growth. However, management expects first-quarter core revenue growth of "4% or better." Perhaps Danaher's full-year guidance will prove too conservative?
Free cash flow and acquisition strategy
The last two takeaways relate to Danaher's business model of using its free cash flow generation to make acquisitions. Free cash flow came in at $3.16 billion for the full year, representing a conversion rate (from net earnings) of 122%.
Joyce said this was the "the 23rd consecutive year in which our free cash flow exceeded net income." It's a remarkable achievement, and the free cash flow will undoubtedly contribute to future acquisition activity. Indeed, Joyce asserted that Danaher has "$8 billion-plus of acquisition capacity." In other words, even after the company made 18 acquisitions totaling nearly $4 billion in 2014 (with the centerpiece being the $2.2 billion acquisition of dental implant manufacturer Nobel Biocare), investors can expect more in 2015.
Where next for Danaher?
Margin expansion and free cash flow generation remains good, and the company is set to come up against some easier comparisons in its test and measurement segment. Meanwhile, its guidance looks reasonable and management has a history of generating value for shareholders with acquisitions.
Danaher trades on a current free cash flow-to-enterprise value (market cap plus net debt) yield of 5.4%. This figure indicates the cash flow an owner would take out of a business if he bought it. Given its mid-single-digit revenue growth prospects and ongoing margin expansion, Danaher is forecast to generate underlying earnings growth in the high single digits for the next few years.
Provided the economy holds up, and management can make some earnings-enhancing acquisitions -- arguably what the company needs to compel the share price higher -- then Danaher is an attractive investment proposition.