A Good Buy Despite Strong Macro Headwinds

By Ankit Agrawal - September 13, 2012 | Tickers: MMM, DHR, GE, UTX | 0 Comments

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Danaher (NYSE: DHR) has a history of delivering consistent core results while simultaneously successfully integrating and realizing synergies with new acquisitions. Importantly, I believe, Danaher has been able to roll up businesses without significantly increasing its leverage or diluting its ROIC. The mixture of both organic and inorganic growth has helped Danaher deliver solid returns across business cycles. Therefore, despite current strong macro headwinds, I believe this mixture will continue to deliver good results in the future. Below mentioned catalysts could further provide potential upside to the earnings in the near term.

Potential for Acquisition in Near Term

Making significant strides with its life science and instrument products, Danaher’s successful integration of Beckman Coulter and X-rite acquisitions are a positive sign for more to come. The capacity for M&A over the next 18 months is in the $4bn range. I believe Danaher should be acquisitive for the following reasons:

• As shown by its 2Q12 earnings, emerging market healthcare and instrumentation can drive double-digit growth.
• Lower tax rates, higher operating margins, and greater free cash flow are possible in the life science markets
• Danaher’s balance sheet with 7.1% free cash, making the company net cash positive next year.

I believe Danaher executes best on the M&A front when buying foundational assets, rather than concoct businesses of similar size. 'Turn up' rather than 'turn around' stories also appear to have been more value accretive.

Strong Free Cash Flow

In my view, Danaher’s 20-plus year track record of deploying its free cash flow in high-return acquisitions is perhaps one of the more remarkable achievements across the U.S. Industrials landscape. Going forward, I believe the key challenges will be to deploy the larger pools of free cash flow into still-larger deals that may increase the risk over time of reverting to peers group type returns.

Robust Growth in China

I believe that the growth within China remains robust and will be recession resistant as the government maintains its focus on increasing national research and healthcare expenditures. While R&D investment in China has grown around 23% YoY for the last seven years, total spend as a share of GDP is only 1.8% vs. western peers of 3.0%. Thus, I am optimistic that the Chinese government will increase the health care expenditures in coming years.​

Company Deserves Premium Valuation

The following table summarizes the expected annual growth and forward PE of conglomerates like 3M (NYSE: MMM), General Electric (NYSE: GE) and United Technologies (NYSE: UTX) and Danaher.

Clearly, the company is trading at a small premium among other conglomerates. I believe that premium valuation is justified as UTX, GE and 3M are trading with lower expected annual growth in next 5 years as compared to Danaher. Also, I believe Danaher has better long term growth prospects and potential near term catalysts than its peers.

Danaher arguably has the most defensive underlying business within the multi-industry sector which should limit downside if macro conditions deteriorate. However, I believe the most likely macro scenario is several years of materially below-trend global growth rather than another major recession. In my view, Danaher’s M&A strategy, combined with opportunities for margin improvement, are a perfect fit for that low-growth environment. Therefore, even with a lack of visibility over deteriorating macro conditions, I recommend it a buy.

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