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Danaher Corporation (DHR) has completed several acquisitions and divestitures over the years and now operates 3 business segments: diagnostics, life sciences, and environmental and applied solutions.
DHR consists of ~69 associates employed at 20+ operating companies and it has research & development, manufacturing, sales, distribution, service and administrative facilities located in 60+ countries.
In March 31, 2020, DHR announced the completion of its acquisition of the Biopharma business from GE; the business was named Cytiva and is a standalone operating company within DHR's Life Sciences segment. This acquisition is the largest DHR has ever completed in its entire history.
Summary
- Danaher Corporation employs its Danaher Business System to create long-term shareholder wealth.
- The company is very active on the M&A front and now focuses on the following 3 business segments: diagnostics, life sciences, and environmental and applied solutions.
- FY2020 marked the 29th consecutive year in which the company's annual free cash flow exceeded net income.
- An investment in DHR is made solely for the purpose of generating capital gains as funds are primarily retained in the company for growth purposes.
- I intend to initiate a position in DHR but given the current valuation and frothy market conditions I am electing to patiently wait for a better entry point.
Introduction
In my recent Fortive Corporation (FTV) article I indicated how FTV had been spun off from Danaher Corporation (DHR) and that the manner in which FTV creates long-term shareholder value is similar to how DHR has created shareholder value over the years by employing the Danaher Business System.
Mergers and acquisitions have been the driving force behind DHR's growth for decades with the company having acquired hundreds of businesses since it adopted its new name (Danaher Corporation) in 1984. In the past several years, notable additions to the DHR portfolio have been made and in excess of 50% of DHR's current revenue is derived from companies it acquired in the past 7 - 8 years.
Business Overview
DHR was formed in the late 1960s but, as noted above, in 1984 it adopted a new name and refocused on manufacturing and being exposed to kaizen, the Japanese business philosophy of continuous improvement.
In its early days, DHR consisted of a group of discrete, manufacturing businesses but in the mid-1990s, this fragmented structure was transformed into one built around strategic platforms, each with sustainable competitive advantages in sizeable global markets. Over time, DHR established leadership in specific markets beginning with water in 1998 and followed by product identification (2001), diagnostics (2006) and life sciences (2009). In July 2016, DHR separated into two independent, publicly traded companies (DHR and FTV) with many of DHR's industrial businesses being spun out into FTV.
In late 2019, DHR completed the spin-off of its dental segment which represented ~14% of DHR's 2018 revenues, into Envista Holdings Corporation (NVST). Details can be found here.
DHR is now a global science and technology innovator committed to helping customers solve complex challenges and improving quality of life around the world. Its trusted brands hold unparalleled leadership positions in diagnostics, life sciences, and environmental and applied solutions.
DHR now designs, manufactures and markets professional, medical, industrial and commercial products and services. It consists of ~69,000 associates employed at 20+ operating companies, and it has research & development, manufacturing, sales, distribution, service and administrative facilities located in 60+ countries.
In FY2020, DHR generated 47.5% of its annual revenue from its Life Sciences business segment, 33.2% from Diagnostics, and 19.3% from Environmental & Applied Solutions. By comparison, DHR generated 38.8% from Life Sciences, 36.6% from Diagnostics, and 24.6% from Environmental & Applied Solutions in FY2019.
On February 25, 2019, DHR announced that it had entered into a definitive agreement with General Electric Company's (GE) to acquire the Biopharma business of GE Life Sciences for a cash purchase price of ~$21.4B. Details can be found here.
On March 31, 2020, DHR announced the completion of its acquisition of the Biopharma business from GE; the business was named Cytiva and is a standalone operating company within DHR's Life Sciences segment. This acquisition represents the largest DHR has ever completed in its entire history.
It is evident from the degree to which DHR has acquired and divested businesses in the last few years that a comparison of DHR's future potential with its past performance is far too complicated to make. One thing that is reasonably certain is that the Danaher Business System has proven to be extremely successful at creating long-term shareholder wealth and there is little reason to doubt that DHR will continue to generate long-term shareholder wealth. In fact, the Danaher Business System has enabled the founders of DHR (Steven Rales and Mitchell Rales) to achieve billionaire status and to be ranked by Forbes as the 274th and 494th wealthiest individuals in the Forbes Billionaires 2020 ranking.
Q4 and FY2020 Results
As at the time this article is being composed, DHR's 10-K has yet to be released. We can, however, find the Q4 and FY2020 Earnings Release, Earnings Presentation, and Non-GAAP Reconciliation here.
In FY2020, DHR delivered ~10% core revenue growth, 170 bps of core operating margin expansion, 43% EPS and $5.426B of free cash flow (FCF); FCF to net income conversion was 149% for the full year and marked the 29th consecutive year FCF exceeded 100% net income.
The acquisition of Cytiva in March 2020, DHR's largest acquisition in the company's history, has played a major role in supporting the development and production of COVID-19 vaccine and therapeutics. In 2020, Cytiva generated more than 25% core revenue growth and over $4B of revenue.
In Q4, DHR generated ~$6.76B of sales with 15.5% core revenue growth. Management has indicated it thinks DHR can continue to capture market share across many of its businesses through accelerated investment in new product innovation and enhanced commercial execution and by deploying new customer engagement techniques during the pandemic.
COVID related revenue tailwinds contributed ~1,200 bps to core revenue growth, while the underlying base business was up ~3.5%.
Geographically, DHR saw broad-based and consistent revenue growth during Q4 with developed markets up in the mid-teens with similar growth in the U.S. and Western Europe. High growth markets were up low-double digits, driven by another excellent quarter in China.
Gross profit margin of ~58.5% and operating profit margin of ~23.7% was up 390 bps, including 360 bps of core margin expansion. This was driven by a combination of higher core revenue growth and the impact of the Danaher Business System on productivity and operations across all platforms.
Q4 adjusted diluted net EPS of $2.08 was up 63% versus last year. In addition, DHR generated in excess of $1.9B of FCF in Q4 and $5.426B of FCF in FY2020.
The combination of strong FCF generation and strong balance sheet gives DHR more degrees of freedom earlier than anticipated after the Cytiva closing and positions the company to actively pursue strategic M&A opportunities.
Credit Ratings
Moody's and S&P Global (SPGI) have assigned a Baa1 and BBB+ long-term unsecured credit rating, respectively. Both are the top tier of the lower medium grade category meaning DHR has ADEQUATE capacity to meet its financial commitments. Adverse economic conditions or changing circumstances, however, are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.
An investor should not look to DHR for dividend income. Although it distributes a quarterly dividend, the dividend yield is currently less than 0.5%. The company does not even have a dividend history section on its website; a dividend history can be found here. We see from this track record that dividend increases have been negligible. In addition, DHR lowered its quarterly dividend when FTV was spun off in 2016.
In my FTV article under '
In order to finance the GE Biopharma Acquisition, DHR issued ~$3.0B of proceeds from the March 1, 2019 underwritten public offerings of its Common Stock and MCPS. Details can be found on page 82 of 335 in the 2019 10-K.
Holders of the MCPS are entitled to receive cumulative dividends at the rate per annum of 4.75% of the Liquidation Preference of $1,000/share of the MCPS ($47.50 per annum per share), Declared dividends on the MCPS are payable quarterly on January 15, April 15, July 15 and October 15 of each year, commencing July 15, 2019 and continuing to, and including, April 15, 2022 (see page 139 of 335). DHR distributed $0.136B in MCPS dividends in FY2020.
I certainly do not expect DHR will change its policy of retaining funds in the company as opposed to significantly increasing its quarterly dividend as the retention of funds in DHR has proven to be a highly effective way of increasing long-term shareholder value.
From an average common stock and common equivalent shares outstanding perspective in 2011 - 2020 we see the following: 701, 713, 711, 716, 709, 700, 706, 710, 735, and 736 (in millions); the 2019 and 2020 shares outstanding include the number of converted shares assuming the conversion of all MCPS and issuance of the underlying shares applying the "if-converted" method of accounting and using an average 20 trading-day trailing volume weighted average price ("VWAP") of $223.43 and $150.10 as of December 31, 2020 and December 31, 2019, respectively (see Q4 2020 earnings release).
Valuation
As noted earlier, comparing the DHR of old with the DHR of the present and the future does not seem to make much sense given the extent to which the company has changed in recent years.
In FY2020, DHR generated $4.89 in diluted net EPS from continuing operations. With shares currently trading at ~$231.25 we get a historical PE of ~47.3.
Using Adjusted Diluted Net EPS from Continuing Operations (Non-GAAP) of $6.31 and the current share price we get an adjusted diluted PE of ~36.7.
FY2020 results did not include a full year of Cytiva within the DHR family of companies so we can certainly expect FY2021 results to be somewhat different from FY2020. In the January 28, 2021 Q4 and FY2020 earnings release management indicated:
- For Q1 2021 DHR anticipates that non-GAAP core revenue growth including Cytiva will be in the mid to high-teens range.
- For FY2021, DHR anticipates non-GAAP core revenue growth including Cytiva will be in the low-double digit range.
Furthermore, guidance from 19 brokers calls for adjusted diluted EPS of $7.19 - $8.25 with a mean of $7.62. Using the high and low earnings estimates we get an adjusted PE ranging from ~28 to ~32 with a mean level of ~30.4.
DHR has certainly demonstrated its ability to generate attractive long-term shareholder returns but I think its current valuation is somewhat rich. I do not expect to derive much of a return in the form of dividends so all my returns would be by way of capital gains. I, therefore, need to ensure I acquire shares at a reasonable valuation so I can benefit from EPS growth and valuation expansion. If I acquire shares with a forward valuation in the low 30s on an adjusted basis I am not giving myself much of a margin of safety.
It is for this reason that based on FY2021 adjusted diluted EPS estimates I would like DHR's share price to drop to at least $200. At this level and using the upper end of analyst estimates I would be acquiring shares at an adjusted diluted PE of ~24.2. I do not envision DHR generating $7.19 which is at the low end of analyst estimates but the mean of $7.62 is not out of the realm of possibility. At $200 and earnings of $7.62 we end up with an adjusted diluted PE of ~26.2. This is certainly not inexpensive but I recognize that DHR is operating in high growth lines of business. This is not some 'stodgy' utility company so I would be prepared to pay up a bit for a company with strong growth potential and for a proven system of wealth creation.
Final Thoughts
DHR has certainly proven itself to be a company that can increase shareholder wealth over the long term; look at the magnitude to which a $10,000 investment made at the turn of the 21st century has dramatically rewarded DHR's shareholders!!!
I fully appreciate that the past in not indicative of the future but DHR has a proven track record of creating long-term shareholder wealth and the formula it is currently using is not changing so I take some comfort that DHR will continue to create shareholder wealth. Naturally, an investor needs to be careful they do not overpay when investing in a company otherwise it becomes difficult to make money.
As much as I think DHR is a wonderful company, I am concerned that shares are currently richly valued. I also think we have an overheated North American stock market and a broad market correction within the next few months should not be ruled out. Although DHR is certainly a high quality company I don't think its stock price will be insulated if/when we get a broad market 'shock'. I fully intend to initiate a position in DHR but have decided to patiently wait for a better entry point.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long FTV but do not currently hold a position in DHR. I have no intention of initiating a position within the next 72 hours unless DHR's share price experiences a sudden sharp pullback.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
