Foreign exchange matters to most companies, but it matters to more to a company like Danaher Corporation (NYSE:DHR). In truth, its underlying earnings and revenue generation were good, but the market is in no mood to forgive companies that reduce estimates, even if the downgrade was due to currency effects. Let's take a look at the five key conclusions from last week's results, and try to gauge the underlying direction of Danaher's progress in 2015.
Danaher Corporation gives earnings
A brief look at the headline numbers:
- First-quarter non-GAAP EPS of $0.93 versus company guidance of $0.90-$0.94, and analyst estimates of $0.93
- First-quarter core revenue growth of 5% versus management guidance of "4% or better," given on the previous earnings call
- Second-quarter non-GAAP EPS guidance of $1.01-$1.05 versus analyst estimates of $1.05
- Full-year non-GAAP EPS guidance of $4.23-$4.33 versus previous guidance of $4.30-$4.40
- Full-year core revenue (meaning from existing operations) growth target maintained at 3%-4%
Earnings came in at the top end of guidance, and core revenue growth was solid. However, the second-quarter earnings guidance looks a little light.
Currency takes its toll
First, it's clear that the stronger U.S. dollar is hurting Danaher. For example, back at its analyst day presentation in November, management predicted $4.35-$4.45 in EPS for 2015. The target was reduced to $4.30-$4.40 in January due to a $0.10 negative contribution from currency -- for those following the math, there was a $0.05 positive contribution from cost savings. Fast-forward to the first-quarter results, and a further $0.07 was taken off full-year 2015 estimates.
In other words, the strength of the U.S. dollar has reduced its full-year 2015 EPS estimates by $0.17 since November. A somewhat frustrating experience for investors, particularly given that core revenue growth for the quarter came in ahead of estimates, and at a rate higher than management's guidance for 2015.
Core revenue stronger than expected
It's usually a good thing when management underpromises and overdelivers, and Danaher seems to be making a habit of doing it. For example, last year's core revenue growth came in at 3.5% -- ahead of the midpoint of guidance of 2%-4%. Furthermore, first-quarter core revenue growth came in at 5% versus management's estimation of "4% or better" given on the last earnings call.
The 5% core revenue growth figure is also ahead of the 3%-4% target for the full year, although the first-quarter figure was positively affected by some extra sales days. In answering a question on the subject on the earnings call, Danaher CFO Daniel Comas replied, "And probably I think the five is probably closer to a four, when you look at days adjusted, which again would be consistent with what we put up in Q4."
Nevertheless, the "four" is still at the top end of the full-year target, and Danaher's management obviously knew about the extra sales days (which led to the "five") when they gave the "4% or better" commentary. Whichever way you cut it, core revenue growth was ahead of guidance.
The remaining three points relate to the performance of various segments. In order to better understand the importance of each, take a look at this graph of segmental operating profit for 2014.
Turning to margins, overall operating margin declined 100 basis points (where 100 basis points equals 1%), but core operating margin actually increased 25 bp. The 125 bp negative contribution to operating margin came from the impact of acquisitions. The core segmental margin breakout is given below.
The third key conclusion is the welcoming return to margin expansion in the Environmental segment. The segment's core revenue increased 8.5% in the quarter, with Comas disclosing on the earnings call that water quality revenue was "up almost double digits."
Dental and Test & Measurement segments
Fourth, core Dental margin fell notably, with management blaming inventory destocking within its U.S. distribution channels, as many of its higher-margin products were hit. Of course, this sort of effect tends to be temporary; after all, its distribution partners will need to replace the inventory that they eventually sell, so Dental could bounce back strongly. Indeed, CEO Tom Joyce spoke of "improving growth trends throughout the course of the year" -- something to look out for.
Fifth, Test & Measurement saw core revenue decrease by double digits in its communications platform (a higher-margin product line that is a large contributor to the margin decline in the chart above). On a more positive note, Joyce disclosed that "platform orders grew over 20% in the quarter, which gives us confidence that we will achieve positive core growth in 2015." So, again, things could be about to turn around in 2015.
All told, it was a decent quarter for Danaher, but the company is definitely being hit by the stronger U.S dollar. However, its underlying sales and margin trends are good, and the Dental and Test & Measurement segments look set to improve profitability in 2015.The underlying trends auger well, and if the U.S. dollar weakens, Danaher could start to see earnings upgrades.