Analysis: DHR

Tuesday before the opening bell, Danaher Corp. (DHR) reported a top and bottom-line beat with its fourth-quarter results. Revenues of $5.364 billion (up 5.4% year over year) topped the consensus of $5.32 billion, and adjusted earnings per share of $1.28 (up 7.5% year over year) exceeded the consensus by a penny.

In the release, Danaher CEO Thomas Joyce said, "We are very pleased with our fourth-quarter results which wrapped up a tremendous 2018. During the year, we delivered strong revenue growth and operating margin expansion, leading to double-digit adjusted earnings per share and free cash flow growth. We believe we gained share in many of our businesses, driven by a combination of new product innovation and enhanced commercial execution. In addition, we closed over $2 billion in strategic acquisitions, and we believe we are well positioned for significant capital deployment in our attractive end-markets.

"Over the past several years, through a combination of organic and inorganic initiatives," Joyce added, "we have transformed Danaher into a higher growth, higher margin, and higher recurring revenue company with strong footholds in attractive, fast-growing end-markets. Our portfolio today - combined with the power of the Danaher Business System - positions us well as we focus on delivering long-term shareholder value in 2019 and beyond."

Danaher closed out 2018 with another strong quarter, as core revenue rose 5.5%, representing the fifth consecutive quarter where core sales increased by 5.5% or more. Altogether for 2018, Danaher achieved a robust core sales growth rate of 6.0%, well ahead of the 3.5% to 4.0% range management laid out at the beginning of the year. This outperformance exemplifies the strength of the company's fast-growing end markets and the quality of this management team.

Although fourth-quarter operating profit margin was a bit noisy, declining 50 basis points year over year due to a 15-basis-point decline in core, a 25-basis-point drop from acquisitions, and a 10-basis-point fall in Other, full-year operating profit improved 80 basis points (with 70 basis points in core). When management broke down the cause of the fourth-quarter operating margin compression, the root of the cause was pretty interesting. On the conference call, Joyce mentioned how they "saw a pretty strong quarter evolving, particularly in the latter month of December." To take advantage of this, management accelerated its investment in a few areas, and this impacted cost of goods and SG&A. Our takeaway from this is that during the pause, so to speak, in economic activity in December, Danaher came out with good growth and looked to capitalize on it further. That's a testament to the strength of Danaher's end markets and management's ability to recognize opportunities. Looking ahead, margins should improve through the course of 2019.

On the cash flow side, Danaher saw year-over-year gains as well. In the fourth quarter, free cash flow was $1.028 billion, up 55.5% from a year ago. For the full year 2018, free cash flow of $3.373 billion represented an increase of 16.5% year over year. This is all representative of the power of the Danaher Business System. Despite the strong results, the share are roughly flat in reaction to the print as upside was priced in when the company preannounced earnings on Jan. 8, which we wrote about here.

Life Sciences

Digging deeper, Danaher's Life Sciences business once again flexed its strength. Sales of $1.794 billion (consensus $1.794 billion) increased 10.5% on a reported basis and 7.5% in core. By individual operating companies, Beckman Life Sciences delivered high-single-digit core revenue growth, Leica Microsystem's core revenue growth increased in the mid-single-digits, SCIEX's core revenue growth was up high-single-digits, Pall had high-single-digit revenue growth, Biotech was up double-digits, Phenomenex had high-single-digit core growth, and IDT, which Danaher acquired in March 2018, delivered mid-teens revenue growth . As a negative, operating profit margin narrowed 30 basis points year over year to 19.7%. This contraction was mainly due to the effects of acquisitions, which contributed 50 basis points to the decline as core was flat and other improved 20 basis points.


At Diagnostics, revenue $1.684 billion (consensus $1.684 billion), represented an increase of 3.5% on a reported basis and 6.0% in core. By business, Beckman Diagnostics saw core revenue increase in the mid-single-digit range, Radiometer saw core revenue grow in the high-single-digits, Leica Biosystems core revenue increased in the mid-single-digits, and Cepheid had double-digit core revenue growth. Operating profit margin declined 40 basis points year over year to 22.7%, as core improved 5 basis points, acquisitions resulted in a 45-basis decline, and other was flat.


In Dental, sales of $759 million beat the $751 consensus. Although revenue was flat year over year, we think the important metric to look at was core sales growth, which increased 2.5% year over year. This rate was the best result in quite some time and represents an improvement from the third quarter's negative 0.5% figure. This is a positive sign that the business has stabilized, and it comes at a key time due to the upcoming spinoff this year. We need to see Dental improve to a position of strength, not weakness, so that Danaher makes the most off this transaction.

Breaking Dental down further, Specialty Consumables revenue increased in the low-single-digit range, driven by solid performance in orthodontics and implants. Importantly, growth was led by performance in high-growth markets, including China, where revenue is now over $200 million on an annual rate. Management also improved Dental's operating profit margin by 70 basis points year over year to 13.8% as the 260-basis-point improvement in Other more than offset the 185-basis-point decline in Core and the 5-basis-point drop from acquisitions. The steep decline in Core was primarily related to management's ongoing investment spend focused on new product development. This is just the cost of getting this business back on track for the spinoff. We continue to view the spinoff as a move that unlocks value through subtraction. The timing of the spinoff is expected to be in the second half of the year, and we continue to track the timeline for any potential delays related to the result government shutdown.

Environmental & Applied Solutions

Rounding out the company, Environmental & Applied Solutions revenue was $1.127 billion (consensus $1.124 billion), as sales grew 4.5% on a reported basis and 5.0% core. By business, Product identification core revenue increased at a mid-single-digit rate, Videojet core revenue rose in the high-single-digits, Water Quality saw core revenue up mid-single-digits, but packaging saw core revenue down low-single-digits. The operating profit margin in the segment narrowed 40 basis points year over year to 22.7% as the 45-basis-point decline from acquisitions more than offset the 5-basis-point improvement from core.


As for guidance, management expects first-quarter 2019 adjusted earnings per share to be in the range of $1.00 to $1.03, in line with the consensus of $1.03. There will be about a $0.05 to $0.06 hit to EPS related to FX. Management also backed its full-year 2019 guidance, which calls for adjusted EPS in the range of $4.75 to $4.85, in line with the consensus of $4.81, on core sales growth of approximately 4%.

Overall, the company's strong results were well expected by the market due to the previous positive preannouncement, but that does not take away from the fact that it was another great year for the company. Unlike machinery-related industrials, China does not appear to be an issue for the Healthcare/Life Sciences focused Danaher as the company saw double-digit gains in the region during the fourth quarter, marking the eighth consecutive quarter (or second straight year) of double-digit growth. Based on its core sales growth strength, we think Danaher is well positioned to build off this result and deliver a positive 2019 year, but we'll keep our Two rating on the name as we prefer to step in and buy off a broader pullback.