NEWS

Danaher: Best Healthcare Company In Inflationary Environment

Mar 7, 2022
asian chinese female doctor working on medical report with laptop and document file

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Investment Thesis

Danaher Corporation (NYSE: DHR) designs, manufactures, and distributes healthcare products. They have been a powerhouse in the life science, diagnostics, and healthcare industry for several decades by this point, and they are known for carrying high quality and technologically superior products. Revenue growth has been outstanding (both organic and inorganic growth), and profit margins remained substantially above competitors thanks to their economic moat. Recent market wide volatility created a great opportunity to grab some shares of Danaher at a discount, and I believe Danaher presents a great investment opportunity for a long-term investor because:

  • Danaher had a blowout 4Q 2021. Revenue and profit grew substantially over the quarter and through 2021.
  • While a lot of companies across various industries are seeing compressed profit margins due to inflation, labor shortage, and supply chain disruptions, Danaher's profit margin actually improved.
  • New products (SCIEX ZenoTOF 7600, Triple Quad 7500, etc.) are performing very well, so I expect Danaher's growth trajectory to remain solid for the foreseeable future.

Outstanding 4Q 2021 result

Danaher reported 4Q 2021 results in late January, and it was another blowout quarter. Their 4Q revenue grew 20.5% YoY, and overall 2021 revenue grew 32% YoY. Most importantly, as a long term investor, the majority of revenue growth came from their core business, instead of from temporary non-recurring revenue (e.g. Covid-related products). Core business revenue grew 25%, core operating margin improved by 560 basis points, and the company generated over $7 B free cash flow.

2021 Financial Performance of Danaher

2021 Financial Performance of Danaher (Danaher Investor Relations)

Also, this strong performance was observed across all of their segments. This was not a case of one segment carrying the team. Revenue for the Life Sciences segment grew 20.5% YoY, Diagnostics segment grew 29.5%, and Environmental Applied Solutions grew 4.0%. This diversified portfolio with leadership positions across multiple industries is one of the biggest draws for the long-term investor. Danaher's growth comes from many different products and is reliable in any kind of economic environment or market cycle. Their 4Q 2021 result (and overall 2021) illustrate this business strength.

Strong economic moat

In the past year, a lot of companies across various industries are seeing eroding profit margins due to increasing costs from labor, materials, and the supply chain. If a company doesn't have a strong competitive edge and pricing power, they have no choice other than to eat up the rising cost. That certainly is not the case for Danaher. Their profit margins actually improved substantially in 2021, demonstrating their strong economic moat.

Danaher Profit Margin Expansion

Danaher Profit Margin Expansion (Danaher Investor Relations)

Their operating margin and net income margin were already far above the industry average (operating margin: 2.14% and net income margin -1.51%), and Danaher still found ways to extend the gap. Their operating profit margin expanded from 19% to 25.3%, and net income margin increased from 16.3% to 21.8%. The timing of this margin expansion, even as many other companies are losing their margins, clearly demonstrate Danaher's superior technology, brand recognition, and switching cost that allow Danaher to maintain pricing power.

Continuing growth trajectory

Danaher has been a strong growth company for the past couple of decades (5 year average revenue growth of 13%), and this will be the case for the next couple of decades. During the last earnings call, the CEO mentioned that their new products (SCIEX ZenoTOF 7600 and Triple Quad 7500, Leica Biosystems Aperio GT 450, etc.) are performing very well, and expanding market share in their respective spaces. Also, Danaher deployed $11 B of capital on acquisitions during 2021 and closed 14 deals, while increasing an already impressive RD budget by 30% to improve their products and boost organic growth.

Combining the organic growth with all of the inorganic growth through acquisitions, I expect their growth trajectory to remain solid for the foreseeable future. Given they just spent $1.3 B on capital expenditures in 2021 to increase their production capacity across business units, it's pretty clear to see the management's confidence and commitment towards company growth. Due to their superb cash generating ability, they have plenty of financial resources to support such growth, along with an impressive RD team to provide the technological resources to achieve this goal.

Intrinsic Value

I used the DCF model to estimate the intrinsic value of Danaher. For the estimation, I utilized EBITDA ($10,336 M) as a cash flow proxy and the current WACC of 7.0% as the discount rate. For the base case, I assumed EBITDA growth of 12% (5-year average revenue growth) for the next 5 years and zero growth afterward (zero terminal growth). For the bullish and very bullish case, I assumed EBITDA growth of 14% and 16%, respectively, for the next 5 years and zero growth afterward. Given the recent acquisitions and capital expenditure on expansion of Danaher, I expect 14-16% growth is within reach.

The estimation revealed that the current stock price represents 15-25% upside. Given the strong organic and through-acquisition growth, I believe that Danaher will achieve this upside easily. The current volatility created a rare opportunity to grab shares of Danaher below their intrinsic value.

Price Target

Upside

Base Case

$313.09 15%

Bullish Case

$338.27 24%

Very Bullish Case

$365.18 34%

The assumptions and data used for the price target estimation are summarized below:

  • WACC: 7.0%
  • EBITDA Growth Rate: 12% (Base Case), 14% (Bullish Case), 16% (Very Bullish Case)
  • Current EBITDA: $10,336 M
  • Current Stock Price: $272.54 (03/06/2022)
  • Tax rate: 20%

Risk

Due to heavy spending on acquisitions and capital investment, Danaher does not have a strong balance sheet at this point. Their cash position is $2.6 B against $23 B of total debt. Also, their liquidity measures (current ratio of 1.43x and quick ratio of 0.89x) are lower than peers. Given their strong cash generating ability and track record of profitability, I don't think they are in any kind of financial danger, but the investor should keep an eye on their debt level going forward.

The acquisitions of new business and technology certainly have a positive impact on their growth trajectory, but it comes with a cost. To justify the investment, the company should be able to realize synergistic effects with increasing revenue and decreasing costs. Also, they need to be able to assimilate new companies' employees and their cultures successfully. None of these tasks are easy to achieve and impose risks. However, Danaher has a long track record of acquiring and successfully incorporating businesses, so I expect them to continue to do so.

Conclusion

Danaher has been a superb investment for long term investors. Their strong growth, solid profitability, and remarkable cash generating ability has been serving shareholders very well for a couple of decades at this point. Given their solid 2021 result and acquisitions, I expect this will be the case for the next couple of decades. The investor should watch out for their balance sheet strength and monitor the progress of the recent acquisitions. Given their historical track record, I expect 15-25% upside from here.

This article was written by

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Visit me at Cappuccino Finance, Each Sunday I provide Top Picks for Growth Stock (1st), Dividend Growth Stock (2nd), Value Stock (3rd), and Model Portfolio (4th). No registration or subscription needed. Also, you can find my Cappuccino Stock-Chat or Bull Bear on YouTube!On other days, I share my screener results (Value, Growth, Dividend Growth), market outlook, and interesting ideas from super investors, based on my 12 years of experience and knowledge in stock investment and in real estate. On Twitter (@CappuccinoFin), I share my thoughts and interesting market news daily! I, Justin J. Lee, believe in fundamental analysis and disciplined market research. I have strong quant background with a Ph.D. in model predictive control and an MBA. My primary focus is to identify 1) small cap companies with strong fundamentals and growth potential, 2) large cap companies going through temporary set-backs, and 3) stable companies with solid dividend yields and growth potential.

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Disclosure: I/we have a beneficial long position in the shares of DHR either through stock ownership, options, or other derivatives. 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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