Danaher Company (NYSE: DHR) is a well-diversified conglomerate with an attractive cash flow profile. Its portfolio is exposed to secular growth drivers such as increasing environmental, health and food safety regulatory requirements. Further afield, China offers Danaher many opportunities for expansion. We also applaud Danaher free cash flow conversion efforts (we define free cash flow as net operating cash flow less capital expenditures) because its free cash flow consistently exceeds net income. Readers should keep Danaher on your radar as a potential capital appreciation idea. Shares of DHR are yielding a modest ~0.3% at the time of this writing, as the company’s management team has always prioritized investing in the company over allocating capital to the program. dividends from Danaher.
Danaher Key Investment Considerations
Danaher manufactures innovative products and provides services to professional, medical, industrial and commercial customers. Its portfolio of leading brands, including Pall, Cepheid and Beckman Coulter, is among the most recognized in each of the markets it serves. The company was founded in 1969 and is based in Washington, D.C.
The company spun off its “Dental” segment from an independent, publicly traded company in the second half of 2019 into a new company, Envista Holdings Corp (NVST). In 2020, Danaher purchased the BioPharma unit of General Electric Company (GE) (a leading provider of instruments, consumables and software supporting biological production workflows) for approximately $21 billion and annualized cost savings of more than $0.1 billion are expected within three years of closing.
Danaher has a strong portfolio of brands and a large installed base that enable it to generate recurring revenue. Recent portfolio optimization efforts have created a company with an excellent cash flow profile, as ~70%-75% of Danaher’s revenue is recurring, providing great visibility into the company’s future financial performance. business (in 2021, ~74% of Danaher’s $29.5 billion in total revenue was considered recurring in nature).
On July 21, Danaher announced earnings for the second quarter of fiscal 2022 (period ended July 1, 2022) that exceeded consensus high and low estimates. Its GAAP revenue rose 7% year-on-year to $7.8 billion last fiscal quarter, with management citing its life sciences and environmental and applied solutions segments as key growth drivers for Danaher last fiscal quarter. appeal to the results of the company. Please note that recent US dollar strength has weighed quite negatively on Danaher’s reported revenue, although underlying demand for its offerings remains strong.
Danaher’s GAAP operating profit increased 10% year-over-year in the last fiscal quarter. Economies of scale caused its GAAP operating margin to increase by approximately 65 basis points year-over-year to 28.4% in the second quarter of the fiscal year, with its GAAP gross margin being broadly stable during this period. Unfavorable non-operating items and a slightly higher provision for corporate taxes saw Danaher’s diluted GAAP EPS of $2.25 in the last fiscal quarter, down 1% year-on-year on the other.
Looking at its non-GAAP organic sales performance (removing foreign currency headwinds and A&D activities from the table), Danaher’s core sales were up 9.5% year over year. another in the second fiscal quarter. This includes an 8.0% year-over-year growth in its core business and a 1.5% increase in COVID-related testing business. As the worst of the COVID pandemic fades, sales from its COVID-related testing business will also fade, although Danaher’s core business is holding up incredibly well. In our view, its growth track remains firmly intact once pandemic-related effects are removed from the picture.
Danaher expects its core businesses to record high single-digit revenue growth in the current fiscal quarter, with its core businesses recording low-single-digit growth and its COVID-related testing businesses recording mid-single-digit growth over the current fiscal quarter. a year. basis of the year. We appreciate the company’s confidence in its near-term performance.
The company generated $3.4 billion of free cash flow in the first half of fiscal 2022 while spending $0.4 billion to cover its dividend obligations. It left the fiscal second quarter with $16.1 billion of net debt on the books (including its negligible short-term debt position). As Danaher had $4.0 billion in cash-like assets at the end of this period, the company has sufficient liquidity to meet its short-term financing needs.
Danaher Economic Profit Analysis
The best measure of a company’s ability to create value for its shareholders is expressed by comparing its return on invested capital [‘ROIC’] with its weighted average cost of capital [‘WACC’]. The gap or difference between ROIC and WACC is called the economic profit gap of the firm. Danaher’s historical 3-year return on invested capital (excluding goodwill) is 24.6%, which is higher than its cost of capital estimate of 8.4%.
In the chart below, we show the likely trajectory of ROIC in the coming years based on the estimated volatility of the main drivers of the metric. The solid gray line reflects the most likely outcome, in our view, and represents the scenario that results in our estimate of fair value. Danaher has always been a strong driver of shareholder value and we expect this to continue to be the case going forward, aided by its recent portfolio optimization efforts.
Danaher Cash Flow Valuation Analysis
Our discounted cash flow process evaluates each business based on the present value of all future free cash flows, net of its balance sheet considerations. Please be aware that our business cash flow models assume that Danaher will achieve significant margin expansion and nice revenue growth over the next several years, and if the business were to stumble for any reason, its intrinsic value would be facing serious headwinds. We think Danaher is worth $302 per share with a fair value range of $227.00 to $378.00. Shares of DHR are trading just below the midpoint of our fair value estimate range at the time of this writing.
The short-term operating forecasts used in our business cash flow model, including revenues and earnings, do not differ materially from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 6.5% over the next five years, a slower pace than the company’s historical 20% compound annual growth rate over 3 years.
Our valuation model reflects a projected 5-year average operating margin of 33.8%, which is above Danaher’s 3-year average. Beyond year 5, we assume that free cash flow will grow at an annual rate of 4.9% for the next 15 years and 3% in perpetuity. For Danaher, we use a weighted average cost of capital of 8.4% to discount future free cash flow.
Danaher Margin of Safety Analysis
Although we estimate Danaher’s fair value at approximately $302 per share, each company has a range of likely fair values that is created by the uncertainty of key valuation factors (such as future revenue or earnings, for example). . After all, if the future were known with certainty, we wouldn’t see much volatility in the markets, as stocks would trade precisely at their known fair values.
In the chart above, we show this likely range of fair values for Danaher. We think the company is attractive below $227 per share (the green line), but quite expensive above $378 per share (the red line). Prices that fall along the yellow line, which includes our estimate of fair value, represent a reasonable valuation for the business, in our view.
Danaher is a strong company with an attractive cash flow profile and a portfolio of assets exposed to business supported by secular tailwinds that should drive significant demand growth for its long-term offerings. At the right entry point, Danaher represents an attractive idea of capital appreciation for investors with its potential for dividend growth offering additional upside potential. We appreciate Danaher’s focus on recurring revenue streams.