Danaher Delivers On High Expectations

By Stephen D. Simpson, CFA | July 27, 2011 AAA

Ordinarily it is no big deal when someone is walking along and has a slight stumble. Put that same person on a mountainside, though, and that stumble is suddenly quite a bit more serious. That might be one way to think about Danaher's (NYSE:DHR) second quarter earnings - there was not all that much to object to, but Danaher carries a hefty premium due in part to a reputation for excellent execution. That may just be something to keep in mind if investors find themselves reading about a "disappointing" quarter.

TUTORIAL: How To Analyze Earnings

Solid Second Quarter Results
While Danaher did report a fairly gaudy growth rate of over 15% for the second quarter, organic growth was a more modest 7.5%. Organic growth was led by test/measurement and industrial tech, while the environmental unit saw a small organic revenue decline. Danaher's dental business looked like a bit of a laggard (but still up more than 6%) and life sciences was relatively solid.

Danaher has a reputation for relentlessly squeezing costs out of its systems and this quarter was no exception. Because of the company's frequent acquisitions, it can be difficult to assess the "true" operating margin ("one-time" charges cease to be such when they happen year after year). Nevertheless, margins improved by something on the order of 70 to 80 basis points irrespective of those adjustments and GAAP operating income growth of 21% is a good enough approximation of the underlying profit growth at Danaher.

Moving Parts Left, Right and Center
Danaher is largely in the business of acquiring other solid businesses and letting them run with some degree of independence (not too unlike Berkshire Hathaway (NYSE:BRK-A) in many respects). What that means for investors is that there is not necessarily a lot of rhyme or reason to how the businesses fit together and Danaher has a laundry list of competitors and peers.

Take the dental business - Danaher's largest competitor is another well-known conglomerate and that limits how much visibility a dedicated dental company like Dentsply (Nasdaq:XRAY) can offer. Likewise, companies like Siemens (NYSE:SI), Thermo Fisher (NYSE:TMO) and Verifone (NYSE:PAY) compete in some of Danaher's significant markets, but it is a narrow range of overlap.

Modest, But Consistent, Core Growth
The lack of easy comparables means that a Danaher earnings report can have a few more surprises than the average industrial company's release. Nevertheless, Danaher tends to be pretty consistent when it comes to underlying core growth. Some investors will fret that the intrinsic growth is not so strong and is less than what a company like Dover (NYSE:DOV) is currently seeing, but it stacks up pretty well over the course of a full business cycle and compares well to the likes of United Technologies (NYSE:UTX) and General Electric (NYSE:GE).

The Bottom Line
The downside to Danaher is that it is hardly undiscovered country; this is a company that is well-respected in the analyst and institutional investor community and the valuation reflects that. The stock looks like it is in the middle of that tricky no-man's land where there is enough potential for current shareholders to hang on for more, but perhaps not enough margin of safety for new investors. With high expectations in place, though, this is a good name for the watchlist, as high expectations can often transition to unreasonable expectations and stocks can slide as analysts make much ado over rather little. (For additional reading, check out Take On Risk With A Margin Of Safety.)

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