In a pretty lackluster industrial environment, Danaher (NYSE:DHR) continues to hold its own. The company's organic revenue and segment profit growth are squarely in the middle of the pack, but that's fine – Danaher is almost always in the middle, while the leaders and laggards move all over the board through the economic cycle. More to the point for investors, Danaher seems pretty modest about the prospects for a second-half rebound, but a combination of reinvested expense restructuring and sizable potential M&A could leave Danaher in solid shape for a stronger 2014.
Another Danaher-Like Quarter
Danaher seldom offers a lot of earnings drama, and this quarter was no exception. Management had previously guided the Street above its prior range and the reported quarter was pretty solid all around.
Revenue rose 4%, with core revenue growth of under 3%. While that was weaker than Dover's (NYSE:DOV) result, almost everyone in the large industrial sector had weaker revenue growth than Dover's 5%. Compared to the likes of Eaton (NYSE:ETN) (down 2% organic), Emerson (NYSE:EMR) (down 1% organic), GE (NYSE:GE) (down 1% organic), and 3M (NYSE:MMM) (up 2% organic), I'd say Danaher did just fine.
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By segment, test and measurement remained weak (up less than 1%), while environmental and life sciences delivered solid mid-single digit growth. Dental was a bit softer (up 2.5%), while industrial technologies dropped almost 3% on very weak results in motion control (down by mid-teens).
Still, this is Danaher we're talking about, and solid margin/profit performance isn't too surprising. Gross margin improved a full point from last year, while reported operating profit increased 4%. Segment-level profits improved more than 7%, though, which again put Danaher in good standing with its industrial conglomerate peer group. By segment, test and measurement saw a modest margin decline, environmental was flat, and all other units saw margin expansion of a full point or more.
Time To Turn On The M&A Machine Again?
Danaher closed some additional deals in the quarter (worth about $300 million), as they always do, but it's been a little while since the company has done something big. With roughly $8 billion in dry powder, I wouldn't be surprised if a large deal (or two) could be on the way.
That could be particularly true given the current state of things. Management's guidance isn't calling for any big improvement in the second half of 2013, and the company is likewise reinvesting its outperformance into further cost-cutting and restructuring (in other words, the second quarter was a beat, but management is maintaining full-year guidance at the midpoint). In addition, Danaher seemed a little cautious about China, although revenue growth here was up in the low double digits.
So where will Danaher cast it's M&A glance? It seems like the sell-side wants the company to add to its life sciences business, but management has previously said that they didn't want that business to be disproportionately large (life sciences and dental are together nearly half of revenue). Still, the acquisition of Johnson & Johnson's (NYSE:JNJ) diagnostics business could be a very Beckman-like deal were some simple TLC and operating leverage could lead to strong returns on investment.
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More likely, the company will look for additional deals in the industrial technologies space. Danaher has used M&A to build its product ID business into a 20% to 25% market share-holder, and I can see room for additional deals. At the same time, I would rule out the possibility of the company entering an entirely new segment, as $8 billion can buy quite a bit of revenue and scale.
The Bottom Line
Danaher remains a popular pick in the industrial space, and that may be the only bad thing I can say about the company and the stock. Still, with valuation multiples in the industrial and health care/life sciences space a little high, there could be room for disappointment here if management chooses to maintain price discipline and forego any major deals. Long-term shareholders shouldn't mind this, but it does seem like expectations are building to a point where Danaher runs the risk of disappointing the Street with fewer/smaller M&A transactions than expected.
Danaher seldom looks cheap and today is no exception. Long-term growth of 5% to 7% can drive a fair value into the mid-to-high $60s, leaving the shares looking fairly priced. Paying fair price for a well-run industrial conglomerate with a history of out-earning its cost of capital and outgrowing the market is fine, just so long as investors don't think they're buying a quick double or anything.
Disclosure – At the time of writing, the author owned shares of MMM