It's no secret the industrial sector is experiencing difficult times, but one stock has notably outperformed in the last year. Danaher Corporation's (NYSE:DHR) mix of non-energy-related end markets coupled with upside potential from corporate actions have led the stock to outperform the both the S&P 500 and the industrial sector -- as measured by the iShares US Industrials ETF.
The question is, can it continue? Here are three reasons it could.
End markets and business mix
History shows that the economy goes through cycles, but each one is slightly different. In the current iteration, Danaher comes out relatively well for the following reasons:
- Minimal energy exposure.
- Exposure to weakening emerging markets, such as China, is largely in defensive industries like life sciences and diagnostics.
- Relatively defensive overall exposure with more than 68% of 2015 segmental operating profit coming from life sciences and diagnostics (33.2%), environmental (23.8%), and dental (11.3%).
- Danaher claims that 60% of its revenue comes from recurring sources, such as consumables, giving the company relatively secure earnings streams.
Thermo Fisher Scientific, Inc grew its life sciences solutions revenue by 5% in the fourth quarter (2.1% reported). Meanwhile, Abbott Laboratories grew worldwide diagnostics sales by 7% operationally in the fourth quarter. Danaher's core life sciences and diagnostics segment grew revenue at a more mundane rate of 2% in the fourth quarter.
All of this demonstrates the growth opportunity in the sector, and Abbott Laboratories' $5.8 billion deal to buy diagnostics company Alere for a 50% premium to the stock price indicates confidence in the marketplace from one of its leading players.
Synergy from split
Danaher also has upside emanating from the planned separation of the company into two parts in the third quarter of 2016:
- The remaining company will comprise Pall Corp, Danaher's existing life science and diagnostics segment, its dental segment, the water-quality businesses (Hach, Trojan, and ChemTreat) from its environmental segment, and the product ID businesses from its industrial technologies segment.
- The new company, Fortive, will comprise Danaher's existing test and measurement segment, the remaining industrial technologies businesses, and a fuel dispenser business (Gilbarco Veeder-Root) from the environmental segment.
The new Danaher will be a fast-growing technology company with a medical focus, while Fortive will be a highly cash-generative industrial business. The idea is that management can better focus on releasing value in the two companies -- differentiated by end markets and operational prospects -- post separation. In addition, the increased focus will encourage investors looking for specific investment profiles.
All told, the upcoming split should lead to the market pricing in an increase in valuation for the two companies.
Integrating Nobel Biocare and Pall Corp
For investors looking for companies delivering earnings growth through acquisitions -- not a bad idea in a slow-growth environment -- Danaher's 2014 acquisition of dental technology company Nobel Biocare and last year's $13.8 billion acquisition of Pall Corp offer ample opportunity.
Danaher's core business focus is acquiring companies, and then applying its so-called Danaher Business System in order to wring every last bit of margin expansion and sales growth management can get out of the businesses. It's been a hugely successful strategy over the years (see the chart below), and Danaher is already off to a good start with Pall Corp. For example, management's initial expectation for cost savings from Pall Corp was $60 million in 2016, only to be upgraded to $100 million at the analyst day in December.
All told, Danaher's upside comes from a combination of corporate action, internal execution, and favorable end-market exposure. It's not a stock to set the world on fire in 2016, but you could have said that about the stock for the last 20 years. The proof is in the price chart above.
Moreover, there's nothing wrong in buying more defensive stocks and trying to protect the downside to your portfolio performance in what looks like a difficult investing year.
Lee Samaha has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.