Danaher's Growth Machine Keeps On Roaring, With No Slowdown In Sight For Bioproduction

 

The COVID-19 pandemic continues to generate significant revenue and profit tailwinds for Danaher (DHR), but base revenue growth is also accelerating into the recovery, boosted not only by more cyclical recoveries in the product ID/marking and water businesses, but also normalization (and leveraging COVID-19-driven system placements) in diagnostics, and torrid ongoing bioproduction growth. Really, everything keeps going Danaher’s way, and it remains to management’s credit (current and past) that they positioned the business to leverage such significant acyclical growth opportunities like bioproduction and diagnostics.

Valuation remains just as problematic. What’s a fair price for an acyclical growth machine leveraged to the burgeoning bioproduction market and the strong-and-steady diagnostics market, as well as a more cyclical but high-quality industrial business in product ID and water? Relative EV/EBITDA could argue for a high enough multiple to drive some upside, but I’m sure I’ll hear some whinging about how that approach lacks rigor. Long-term discounted free cash flow suggests a more modest mid-single-digit return from here, but I wouldn’t bet against this compound growth machine doing better than that.

 

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Danaher's Growth Machine Keeps On Roaring, With No Slowdown In Sight For Bioproduction

Danaher: No Need To Fix What Isn't Broken

Danaher's (DHR) multiyear shift away from industrial end-markets and towards life sciences and diagnostics continues to benefit shareholders, with the stock continuing to outperform its former industrial peer group, while performing more or less in line with newer peers like Thermo Fisher (TMO). Although an upcoming CEO transition holds some modest risk, Danaher has amply demonstrated that it has a deep management bench and that it reinvests in internal executive talent development.

The only real issue, and this will be no surprise to most readers, is the valuation. Even though I assume that Danaher will actually grow faster over the next decade than the trailing 10-15 years (growing FCF at a compounded rate of around 10%), that still only suggests mid-single-digit total returns. Maybe that's enough given the above-average quality of this company, but I remain concerned about relatively limited prospects for positive re-rating with what is already a widely-loved company.

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Danaher: No Need To Fix What Isn't Broken

Danaher Has Set The Table For A Brighter, Faster-Growing, And Higher-Margin Future

Danaher (DHR) has been busy this year. In addition to the transformative acquisition of General Electric’s (GE) Biopharma business (which Danaher will rename “Cytiva”), Danaher has executed an efficient disposal of the Envista (NVST) dental business, a move that immediately improved the company’s growth rate and margins. These developments have hardly gone unnoticed, as the already-popular Danaher stock has shot up more than 50%, trouncing the roughly 26% year-to-date performance of its industrial peer group (which really isn’t a peer group anymore) and keeping pace with Thermo Fisher (TMO).

Danaher isn’t cheap now, but that’s nothing new, as there have been only a relatively few windows of opportunity in recent years where Danaher looked meaningfully undervalued. Although I’m disinclined to be all that negative on the stock of a company that I think will generate mid-single-digit core growth in a 2020 where many industrials will still be struggling, the shares are already trading at over 20x my 2020 EBITDA estimate (adjusted for Cytiva).

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Danaher Has Set The Table For A Brighter, Faster-Growing, And Higher-Margin Future

Strong Acyclical Growth Burnishing Danaher's Growth Star Status

As short-cycle industrial end-markets weaken further, Danaher’s (DHR) exposure to acyclical growth markets like life sciences and diagnostics looks better and better. A decent top-line beat and acceleration in those two segments certainly helps bolster the argument for Danaher as a company and a stock that has much less to worry about as the global economy slows, and margin growth across most of the business certainly doesn’t hurt either.

This is the broken record part of the show, but valuation remains the prime issue with Danaher. I have no doubt that I’ll hear again from the “you buy this and hold forever” crowd, but there are a number of stocks where that argument has been made before and investors ended up seeing big losses as circumstances changed. Danaher looks priced for a mid-single-digit annualized return on par with Honeywell (HON) or Dover (DOV), and with what I see as a high likelihood that industrial/mulit-industrial earnings estimates and multiples will be heading lower in the second half, Danaher’s valuation could continue to remain elevated as the company is poised to offer a lot more core growth than many of its peers.

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Strong Acyclical Growth Burnishing Danaher's Growth Star Status

Ongoing Excellence And Premium Valuation Mean Loving IDEX From Afar

Playing a "I like it, but the shares are expensive" drinking game with my articles in the industrial sector would probably be lethal right now, but the fact remains that the market continues to reward many companies with robust valuations even though there are some pockets of weakness in short-cycle markets. IDEX (IEX) is one of my favorite companies, a disciplined deployer of capital with strong niche-based businesses and excellent margins, but it's hard to see how IDEX shares can keep generating attractive returns from this high level.

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Ongoing Excellence And Premium Valuation Mean Loving IDEX From Afar

Roper's Growth Engine Keeps Humming

As a multi-industrial increasingly driven by its high-margin, asset-light software businesses, Roper (ROP) continues to diverge from the broader multi-industrial category in generally positive ways. Management has built a solid value-compounding engine here, and Wall Street is quite well aware of that, with the shares up another 30%-plus over the trailing twelve months. I do expect Roper to continue to deliver better-than-average organic growth with improving margins, and I believe Roper has a repeatable formula here for successful M&A, it’s increasingly difficult for me to see value in the shares. Yes, there are investors in companies like Roper and Danaher (DHR) that will argue for buying irrespective of valuation, but that’s not my approach and I think shareholders should at least be aware of the risks if Roper’s engine ever has a hiccup along the way.

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Roper's Growth Engine Keeps Humming

ITW's Margins Seem To Be Holding Up Well As Growth Slows

With the blizzard of earnings reports from April 25, and those that came before, it seems clearer to me that shorter-cycle industrial companies are facing a much more challenging growth environment. In addition to the surprisingly weak revenue number from 3M (MMM) (down 1.1%), Sandvik’s (OTCPK:SDVKY) SMS business saw a 1% decline, and Stanley Black & Decker (SWK) saw a 3% decline in its Industrial segment, while all of the discrete automation companies have seen growth slow.

Considering all of the above, the 1.5% contraction at Illinois Tool Works (ITW) this quarter isn’t so shocking or alarming. Perhaps even more important, particularly relative to 3M and Sandvik’s SMS business, is that ITW’s margins held up better – lending some support to the idea that ITW is a company built more for margins and returns than growth, which isn’t such a bad thing when growth gets scarce.

Industrials have rallied since I last wrote about Illinois Tool Works on growing optimism that 2019 growth will be stronger than expected, and ITW has actually outperformed its peer group. Although I don’t have any particular objections to ITW as a hold, I don’t find the valuation exciting enough to start a position here and I still see more risks that growth in North America will slow as 2019 moves on.

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ITW's Margins Seem To Be Holding Up Well As Growth Slows

3M Decimated On Autos, Electronics, And Execution

Thursday’s first quarter earnings report was the worst day for 3M (MMM) shareholders in a long, long time, as a huge double-digit miss at the segment profit line drove a double-digit decline in the share price. While 3M is not going to burn down, fall over, and sink into the swamp, the shares are going to be in the penalty box for a while, and management needs to prove convincingly that they can not only improve margin execution, but restructure the business in the direction of both great margins/returns and at least decent growth.

3M’s valuation is much more reasonable than it has been in some time, but it’s fair to ask and wonder if turning around this supertanker is going to be a longer process. If the problems really are confined primarily to auto and electronics, this is a name to investigate further, but I don’t think investors need to make a snap decision for fear of missing out, as the concerns about 3M’s growth and execution capabilities have been building for a while and won’t go away in quarter.

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3M Decimated On Autos, Electronics, And Execution

Strong Life Sciences Continuing To Drive Danaher

Danaher (DHR) remains a great case-in-point of the challenge of balancing quality and opportunity with some semblance of value discipline. There’s no real argument I can see that Danaher isn’t a premier player in life sciences alongside Thermo Fisher (TMO) once the deal for General Electric’s (GE) Biopharma business closes, and if anything, the quality of Danaher’s Diagnostics and Environmental/Applied Solutions may be a little overshadowed now.

Still, it’s hard to call Danaher undiscovered or undervalued. I believe the shares are priced to return a solid annualized 7% or so to shareholders, and though that’s below what I’d normally accept for an equity investment, this is a case where maybe the quality argues for accepting a lower rate of return to have a solid core holding like Danaher in a diversified portfolio.

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Strong Life Sciences Continuing To Drive Danaher

Dover Starts 2019 Right, But Can It Follow Through?

Dover (DOV) has been on a good run so far this year, up about 36% since the start of the year on a wider rally in industrials, but the performance gap has narrowed a bit over the three months. Still, Dover got off to a strong start in the first quarter, but margin leverage and order growth weren’t all that bulls might hope for, and it remains to be seen whether the general industrial/discrete manufacturing sectors that account for a lot of Dover’s revenue base will hold up as 2019 rolls on.

There aren’t so many bargains left in the multi-industrials now, and I include Dover in that group. I’ve liked the shares in recent months/quarters, but the strong move has soaked up the undervaluation that I saw and I’m still concerned about the level of expectations for the economy and corporate earnings going into the second half. I like the healthy results in fluids, product ID, and industrial businesses, not to mention the longer-term potential from restructuring, but I think the shares factor that all in now.

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Dover Starts 2019 Right, But Can It Follow Through?

Danaher Adds A Jewel To Its Crown

It's not too often that you see an M&A transaction that sends the shares of both companies meaningfully higher, but Danaher's (DHR) acquisition of most of General Electric's (GE) Life Sciences business is a good move for both companies. For GE, the deal brings badly-needed cash that will help shore up the business as CEO Larry Culp tries to turn that hamstrung behemoth around. For Danaher, this is a crown jewel acquisition that meaningfully enhances the company's life sciences business (particularly in bioproduction/bioprocessing) and gives it even more exposure to a fast-growing acylical business with strong margins.

Although pricey, the GE Biopharma deal boosts Danaher's long-term growth rate and margins, and I believe management's synergy/accretion expectations are credible if not conservative. It's hard to say that Danaher is cheap, but considering the enhanced exposure to a very attractive market, I understand why the shares trade where they do.

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Danaher Adds A Jewel To Its Crown

A Tug Of War With Alfa Laval Between Weak Sentiment And Post-Peak Growth

The market definitely didn’t like Alfa Laval’s (OTCPK:ALFVY) fourth quarter earnings, and particularly the parts of the call where management said things like first quarter demand being “somewhat higher” than the fourth quarter and that demand was “nearing the peak” for the cycle. Although Alfa shares are up slightly from my last update on the company, the shares lost about 10% of their value in the immediate aftermath of the fourth quarter report and have since recovered about half of that.

Operationally, I like Alfa Laval. I think this is a well-run company with good exposure to late-cycle end-markets, but I also know that orders are likely to slow dramatically in 2019, with revenue and earnings following in 2020 and 2021. These shares do look undervalued now, and I think the market may be overlooking opportunities in HVAC, power gen, life sciences, and ballast water treatment, but the reality is that fighting the tape is tough and investors are going to need to have some patience with this one.

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A Tug Of War With Alfa Laval Between Weak Sentiment And Post-Peak Growth

Roper Getting Its Due As A Differentiated Value-Creator

Exclude valuation from the conversation, and I’m not sure how many negatives you can really come up with for Roper (ROP). Not only has Roper shown that it can identify, execute, and integrate acquisitions just as well as peers like Danaher (DHR) but management has used M&A to transform the business into a self-funding, niche-focused, asset-light multi-industrial with a very strong recurring revenue component driven by a diverse SaaS and medical/healthcare business. Although the ROIC is lower than you might otherwise expect, that doesn’t trouble me much given the strong demonstrated cash flow generation ability.

Roper isn’t cheap by any approach I use, but I do like the company’s end-market exposures and business model for this point in the cycle, as well as the “dry powder” the company has to make further value-enhancing acquisitions. And while the shares aren’t cheap, they’re not too far from my DCF-based fair value and this would be a very tempting name on another market sell-off.

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Roper Getting Its Due As A Differentiated Value-Creator

Parker Hannifin: Long-Term Opportunity At The Cost Of Short-Cycle Risk

I thought the valuation at Parker Hannifin (PH) was getting interesting back in August, and the shares outperformed a bit relative to multi-industrial peers until reporting fiscal second quarter (calendar fourth quarter) earnings. Not unlike Eaton (ETN), Parker Hannifin offers some challenging trade-offs between a relatively bullish management team, further opportunities for margin improvement, and interesting valuation against what I think is a tricky short-cycle set-up that could see weaker results and expectations as 2019 rolls on. I think investors will sleep better in general with names like Honeywell (HON) and Emerson (EMR) (and maybe Ingersoll-Rand (IR) ), but the valuation on Parker Hannifin could make those short-term risks worth taking for investors with a longer-term orientation.

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Parker Hannifin: Long-Term Opportunity At The Cost Of Short-Cycle Risk

High Expectations Mitigate Some Of Rockwell Automation's Outperformance

A lot is expected of Rockwell Automation (ROK), a seemingly perennial favorite in the industrial space, and those high expectations may be the biggest challenge for the company as 2019 looks to be a year of slowing capex investments across a range of industries. Although I think mid-single-digit revenue and free cash flow growth are attainable over the long term, I’m not sure Rockwell’s share price today really reflects the risk of slower spending as 2019 goes on.

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High Expectations Mitigate Some Of Rockwell Automation's Outperformance

When It Comes To Danaher, 'More Of The Same' Is Usually Pretty Good

With Danaher’s (DHR) strong leverage to life sciences and diagnostics, and recurring revenue, the company is in a good place as the economy goes through its cyclical shifts. Moreover, the company has the luxury to invest for growth without really compromising its core quality, and the balance sheet leaves open the possibility for further growth-driving M&A. The “but” is that the company’s shares are typically richly valued and today is no exception. Although Danaher’s valuation isn’t so unreasonably by the elevated standards of life science tool companies, investors should at least realize they’re paying a premium for Danaher’s perceived quality and cyclical resilience.

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When It Comes To Danaher, 'More Of The Same' Is Usually Pretty Good

Reputation Alone Won't Do It For 3M

As a long-term owner of 3M (MMM), there’s certainly a lot I like about this company, but the fact remains that 3M’s exposure to autos, electronics, China, and non-residential construction are not assets right now, and the company lacks the exposure of peers like Honeywell (HON), Danaher (DHR), and Emerson (EMR) to more attractive end-markets like aerospace, process automation, life sciences, and diagnostics. What’s more, I have some long-term concerns about the corporate strategy that I want to address later.

Weaker short-term growth performance and prospects have done their damage, with 3M lagging many/most of its industrial peers in 2018. Even so, the shares aren’t all that cheap on either a DCF or EV/EBITDA basis and there are other names with more interesting near-term stories in the industrial space.

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Reputation Alone Won't Do It For 3M

Danaher's Mix Likely To Be A Real Asset In 2019

It doesn’t seem like there’s as much disagreement now that industrial activity is slowing, and particularly in the so-called early-cycle sectors. Two years into this cycle, autos and electronics have weakened, and there are growing concerns about upstream oil/gas equipment, non-residential construction, trucks, and “general industrial” going into 2019. Challenging as that may be for companies like MMM (MMM) and Illinois Tool Works (ITW), it doesn’t really mean all that much for Danaher’s (DHR), and this multi-industrial’s strong leverage to less cyclical businesses like life science equipment, diagnostics, and water quality should add to the popularity of what is already a very well-regarded company.

Given Danaher’s end-market exposures, I think there’s a good chance that Danaher can continue to report healthy earnings growth trends in quarters where many of its industrial peers won’t. Although the valuation here is hardly cheap, that stronger relative growth could drive “flight to safety” investment decisions, though I do believe Danaher’s high valuation does create a risk of a sharper sell-off if its 2019 results disappoint and its end-markets don’t prove to be quite as safe as commonly thought.

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Danaher's Mix Likely To Be A Real Asset In 2019

As Expected, Evolution, Not Revolution, From 3M

When I previewed 3M’s (MMM) capital markets day in my last article on the company, I said that I expected a presentation that was more or less “more of the same”. It’s not really in 3M’s corporate DNA to make major course corrections, and besides, I think there is a lot of wisdom in following an approach of “if it’s not broken … don’t break it”. 3M more or less fulfilled those expectations, laying out a five-year plan that looks a lot like the company’s recent history, albeit with what I believe is a more growth-conscious focus.

Between a “steady as she goes” investor day and a disappointing third quarter hurt by what I’d call non-structural issues, there’s not a particularly strong case for liking 3M if you didn’t already like it. The valuation is not really in bargain territory and next year looks challenging given slowdowns in a lot of significant markets (including autos, electronics, and “general industrial”). Still, as a high-quality name and one of the most R&D-focused multi-industrials, I have no problem with holding on to 3M today as part of a long-term core portfolio.

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As Expected, Evolution, Not Revolution, From 3M

ATS Automation Is A Service-Enhanced Play On A Major Multiyear Trend

Automation is a popular theme, particularly in the industrial sector, but it is also a rather broad term that can encompass everything from the most advanced robots, machine vision systems, and control technologies to relatively basic motors and conveyor belts. At the end of the day, though, it’s about equipping business owners with tools that enhance productivity. As a provider of both systems and services, Canada’s ATS Automation (OTCPK:ATSAF) (ATS.TO) sits in an interesting middle ground that could prove increasingly valuable as more and more business look to automate, including smaller operators that don’t have teams of engineers to design and guide the process.

Valuation is my biggest hang-up with the shares now, as the stock has risen almost 100% over the past year and trades at a level that already anticipates some meaningful operational improvements in the years to come. Investors should also note that the U.S. ADRs are not liquid on any consistent basis, though the Toronto-listed shares are.

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ATS Automation Is A Service-Enhanced Play On A Major Multiyear Trend