It's been a curious sort of year for Danaher (NYSE:DHR) investors as they watched the stock underperform the S&P 500 for much of 2014, only to come roaring back toward the end of the year. In fact, in the last six months, the stock rose 13.2% versus the S&P 500's gain of just 6.3%. What's behind the rise, and why would you want to buy Danaher stock right now?
To help answer these questions, let's take a look at the company's recent presentations and underlying trends.
It's not an oil-related stock
First, ever since oil prices started falling in July 2014, investors in the industrial sector have been increasingly asking, "who has exposure to oil?"
As oil prices have risen over the years, more and more industrial companies chose to invest in the sector in order to get exposure. Danaher wasn't one of them, and its relative underexposure to oil prices has caused fund managers to start favoring the stock versus many of its peers.
So, if you are looking for a non oil-related industrial stock then Danaher could fit the bill.
Cyclical risk is decreasing in the stock
Second, Danaher's revenue has seen an increasing contribution from consumables and services in recent years. Increasing consumables revenues matter, partly because they help de-risk the company in bad times. You can think of consumables as being the blades in the razor/razorblade business model. When times are difficult, consumers are likely to cut back on new razor purchases, but not so likely on blades. It's the same principle with Danaher's consumable sales.
According to CEO Tom Joyce, speaking at the recent Barclays Select Industrial Conference, consumables share of revenue has increased to 45% from just 30% five years ago.
Moreover, the biggest contribution from consumables is coming from its largest, fastest growing, and, arguably, least cyclical businesses. At the analyst day presentation in November, management predicted low-to-mid-single digit growth for every segment except life sciences and diagnostics.
Both businesses in the segment are expected to generate mid-single digit growth, and readers should note around 24% of total 2014 revenue came from diagnostics (of which 80% of revenue comes from consumables), with around 12.5% from life sciences.
Good geographic exposure
Third, Danaher appears to have a good mix of geographic end market exposure. North America was the biggest contributor to sales in every business in 2014, while "high growth markets" contribute more than the EU in the majority of businesses.
Underlying growth is strong
Fourth, management's guidance for full-year-adjusted EPS of $4.30-$4.40 implies a growth rate of 6%-8% from 2014's adjusted EPS of $4.06. However, Danaher's earnings are being hit by the stronger dollar. U.S. exporters suffer when the dollar strengthens, because its foreign currency revenue is now worth less in U.S. dollars.
Stripping out foreign currency effects reveals a much stronger growth rate. At the analyst day presentation in November, management predicted adjusted EPS of $4.35-$4.45 for 2015 with a $0.11 negative contribution from foreign currency. Fast forward to the fourth-quarter results in January and guidance was reduced to $4.30-$4.40, with Joyce outlining:
The strengthening of the U.S. dollar since our December investor meeting is expected to reduce 2015 earnings by approximately $0.10 per share. We anticipate offsetting approximately $0.05 per share of this headwind from savings.
All told, adjusting for foreign currency effects means that Danaher's earnings are forecast to be 11%-13.5% ahead of 2014 -- an impressive figure.
Very strong free-cash flow generation
Fifth, Danaher remains a prodigious cash generator. The following chart shows how well it converts net income to free cash flow and free cash flow from sales has grown in the last 10 years. Free cash flow generation is important because it allows the company to increase dividends or, more in Danaher's case, make earnings enhancing acquisitions in future.
The 10-year average of free cash flow to net income is 119%, so at the midpoint of guidance for 2015 Danaher could generate $5.17 in free cash flow per share, representing nearly 6% of its current market cap -- not bad for a business with double-digit underlying growth.
Is Danaher a stock to buy?
All told, Danaher is a highly cash-generative company that offers investors minimal exposure to oil prices. In addition, its geographic end markets are attractive, and its growing health care and consumables revenues are helping reduce cyclical risk. So, if you are looking for these sorts of qualities, Danaher would be a good addition to your portfolio.
Lee Samaha has no position in any stocks mentioned. My Irish grandfather (because we've all got one) would turn in his grave to hear Danaher pronounced "Dayna-hur". I believe it's "Dan-a-Her" instead.
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