Danaher: Compounder Starts To Look Attractive
Contributor since 2011 / 23107 Followers
Summary:
- Danaher has benefited from the Covid-19 period.
- The company has seen strong (earnings) growth, and it’s positioned to maintain this.
- Interesting deals have been pursued and leverage is very reasonable.
- Appeal is luring here at a 22-23 times earnings multiple, although that it is hard to compete with current interest rate levels.
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In the summer of 2021 I called shares of Danaher (NYSE:DHR) simply impressive. Danaher is a long-term value creator, with long-term shareholder value creation and business success being the result of superior capital allocation skills and a sound positioning of the business.
The Former Thesis
Danaher made a huge move when it acquired the biopharma activities of GE (GE) in 2019 in a $21 billion deal, adding more than $3 billion in very profitable sales to its line-up of the business.
Danaher posted $20 billion in sales as the deal with GE would grow pro forma sales by about 15%, as EBITDA numbers would grow towards $6 billion. Shares of Danaher rose from $113 to $123 upon the deal announcement, adding $7 billion in value on the back of a $21 billion deal. With pro forma leverage coming in quite high and pro forma earnings multiples seen around 27 times, I was a bit cautious.
Through the summer of 2021, shares had advanced to nearly $300, more than doubling from 2019. The company posted 2020 sales at $22.3 billion early that year, albeit that the fourth quarter run rate revealed a revenue number closer to $26 billion, with organic growth coming in around 10%. Full year earnings rose to $6.31 per share, increasing in a rather spectacular fashion, as the reconciliation looked largely fair. Net debt of $15 billion worked down to a 2.5 times leverage ratio based on $6 billion in EBITDA.
The company kept on benefiting from the pandemic, posting a 58% increase in first quarter sales of 2021 to $6.9 billion, with earnings trending at $10 per share. On the back of this momentum, Danaher reached another deal, acquiring privately-held Aldevron in a $9.6 billion deal to obtain manufacturing capabilities of plasmid DNA, mRNA, protein and other applications.
Believing that the $10 in earnings power might normalize to let’s say $7 per share in a more normal environment, the resulting 30-40 times earnings multiple was a bit too expensive, as pro forma leverage of about $24 billion would result in higher leverage ratios as well.
Stagnation – In The Shares
After shares hit a high at $330 later in the summer of 2021, shares have largely traded in a $250-$300 range ever since. Now trading at $253, shares are down about $20 since the summer of 2021, a near two-year period.
Early in 2022, the company posted its results for the year before with sales advancing to $29.5 billion, a very strong result. Net results based on GAAP accounting to come in at $6.3 billion, or $8.50 per share as net debt had fallen to just below the $20 billion mark already. Adjusted earnings just topped the $10 per share mark at $10.05 per share.
The company was off to a good start in 2022 with first quarter sales up 12% on a reported basis although that some tough comparables and a strong dollar made that second quarter sales growth slowed down to 7.5%, and to 6% in the third quarter. Fourth quarter growth recovered to 7.5%. For the year, the company posted a solid 7% increase in sales to $31.5 billion with operating earnings increasing nicely to $8.7 billion and net earnings reported at $7.1 billion.
Reported earnings on a GAAP basis rose to $9.66 per share with non-GAAP earnings reported at $10.95 per share, again looking like quite a reasonable number as net debt fell to $13.7 billion, resulting in a very moderate leverage ratio with EBITDA rapidly improving to the 10 billion mark here.
With 745 million shares trading at $253 per share, the market value stands at $188 billion, for an enterprise valuation of $202 billion. This valuation comes down to just over 6 times sales and 23 times adjusted earnings based on the 2022 results, as continued growth is anticipated of course with revenues expected to grow by high single digits.
A Revamp
Danaher reports its results across four segments. A near $11 billion diagnostics business is the largest business which posts margins in the lower thirties. Biotechnology is the second-largest business with $8.8 billion in sales, being the most profitable segment (on a relative basis) with margins seen in the mid-thirties. Life science revenues of $7.0 billion mark the third-largest segment, but its margins of 20% are the lowest.
The smallest division is the environmental & applied solutions business with $4.8 billion in sales and margins of 23%. Danaher aims to create a standalone business of this segment, to be called Veralto.
Since the summer 2021, we have established two things. For starters is that a 30 times multiple based on $10 in earnings power per share has changed in two ways. I feared a reversal of at the time peak earnings to about $7 per share, but these have recovered to $11 now. This meant that I no longer fear a shortfall in earnings, as the resulting 30 times multiple has fallen from 30 times to 23 times, as leverage has come down a bit.
This remains an interesting story as leverage is low, although that the environmental solutions spin-off creates a bit of an uncertain situation. The unit is responsible for about 15% of sales and a slightly lower percentage in terms of earnings. There could be a wildcard as well as Danaher reportedly is interested in contract manufacturer Catalent (CTLT) in a deal which could be valued around $20 billion.
Final Thought
While there are some moving parts with the potential deal for Catalent and the separation of its environmental business, the reality is that Danaher has grown into the valuation over the past two years. A current 23 times multiples has come down, but only works down to a 4.5% earnings yield which is basically at par with risk-free interest rates here, as Danaher has proven to be a solid steward of capital which has posted solid growth over time.
Hence, I am slowly warming up to the shares here, looking to initiate and add on dips sub the $250 mark.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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