Danaher: Better Positioned for the Future (NYSE:DHR)

It's been 5 months since I published my first article about Danaher (New York Stock Exchange: DHR). A lot of things have happened since then, like the annual results show or the spin-off of Veralto. This article will aim to summarize All this updates the thesis, as well as outlines the new sectors that make up Danaher.

Annual results

On January 30, Danaher presented its 2023 annual results, rising 4.75% in the session. This year has been a transitional year for the company, thanks to the spin-off of Veralto and its plunge into a downward cycle of spending by its end customers. Therefore, fiscal year sales decreased by 10% if we exclude the Feralto effect. EBIT fell by 30%, and margin fell from 29% EBIT margin to 23%, although adjusted EBIT margin remains intact. 28%. Most of these adjustments are due to impairments and non-cash expenses that do not impact the company's cash generation. Free cash flow margin decreased by 21%, free cash flow margin decreased from 24% to 21%, and free cash flow/net income conversion increased to 121%, all excluding the Veralto effect.

Below, I'll list some of the comments made during the conference call. In December, they completed the acquisition of Avcamp, which will help the life sciences sector. The 10% sales decline includes a 9.5% impact from the coronavirus-related sales decline (as expected). They state that the portfolio's turnaround and overall position will continue in the first half of the year, but that they are better positioned to ride long-term trends and achieve higher sales growth rates in the long term. Demand in developing countries has been less affected, and the situation in China remains somewhat challenging. In the long term, China should be a strong growth engine as the country tries to build its own pharmaceutical industry. However, it should be noted that comparison with China (12% of Danaher's sales) was difficult due to the unique support program, especially in academic markets, which accelerated the acquisition of many life sciences research instruments.

In recent years, the company has improved with spin-offs Veralto and Envista, as well as the acquisitions of Cytiva, Aldebron and Abcam. Additionally, Cepheid is now 6 times larger than it was before the pandemic, and will likely enjoy repeat demand every flu season, thanks to 4-in-1 testing. They don't expect their book-to-bill ratio to exceed 1 at any time of the year, But they expect a slight improvement from the current ratio of 0.8 to 0.85. Danaher operates without cancellation invoices, which is better for customer satisfaction, although it may hurt the company in some cases. I believe this is the right way of business to endure and maintain long-term customer relationships.

JP Morgan 42nd Annual Healthcare Conference 2024

On January 2, Danaher participated in an interesting conference organized by JPMorgan. During this event, they discussed the future of the company and exchanged valuable information, which I will explain below.

They already have 80% repeat order, compared to 68% in 2018. Because they are a repeat business, they are in close contact with their end customers, who inform them of changes in trends and new innovations. The DBS system has been improving for 40 years. Long-term growth estimates almost never take into account potential drug launches for Alzheimer's or GLP-1, so there are upside opportunities, and long-term guidance may be conservative.

They also presented an interesting picture depicting the transformation that Danaher has undergone, thanks to the spin-off of two of its businesses, Envista and Veralto, the acquisitions of Cytiva, Aldevron, and Abcam, and the positive impact on Cepheid due to Covid-19. . 4-in-1 tests have become a recurring source of revenue, estimated at $1.5 billion per flu season. With this improvement in the business and its prospects, we can consider Danaher to deserve an upward rerating from the average 23x FCF it has traded at over the past 10 years.

Next, I will share with you some statements made by Reiner Blair – President and CEO.

He explained the steps they take when making an acquisition:

“And you see here we always use the three dimensions of the market where we develop a proprietary perspective on the end market that is looking for long-term, sustainable growth drivers. We of course look at the companies in that market and again, develop a proprietary perspective on defensibility – the potential to defend their competitive advantage.” Or our ability to create one. Then, of course, we look at the financial model and evaluate it. When all three of these dimensions intersect, not one, not two, but all three, then we execute a trade and enhance the power of compound returns over the long term.

As I mentioned in my first article, all the money they received during the pandemic was used for good acquisitions:

“So, again, we're positioning ourselves in a very attractive end market, Aldevron, the gold standard for DNA delivery in a very attractive genomic drug end market. And Abcam, as we just talked about, is the gold standard for proteomic research and analysis in the world. So, again, it's been Improving the final market position and at the same time improving the company's financial position.

They also provide views on the long-term tailwinds of the business:

“If we simply think about the size of the drug development pipeline, it continues to grow. We had 34 approvals in the US last year by the FDA, which is very high from a historical perspective. There is still a tremendous amount of development going on.” When we look at the relatively low penetration of biologics in the market, less than 10% worldwide, patients who could use these biologics for various reasons don't have access to them. If we think through it from a diagnostic point of view, the diagnosis, from our point of view. , a catalyst for ultimately driving value-based healthcare, identifying the right patient at the right time to get the right treatment, and the right treatment means knowing that a particular patient will respond to the therapeutic treatment. The treatment is ultimately prescribed. And so we see that chronic growth drivers Not only here in the United States, but also in Europe and China, it remains strongly intact.

Some numbers and conclusions

They expect the first half of 2024 to be weak, with a negative impact on sales, and to bottom out in the cycle and see positive growth in the second half of the year, although low single-digit declines in sales are expected for 2024 overall. I think the stock was up about 5% on results day, but if the second half of 2024 doesn't play out as they expected, it's very likely the market will punish it.

In the image below, I show the FCF for Veralto and Danaher excluding Veralto. The numbers in black are provided by the company, with Danaher providing a significant amount of information through 2020. The numbers in blue, all between 2017 and 2019, are estimates I made. What we can see is that Danaher's free cash flow margin excluding Veralto rose from 18% to 25% thanks to the pandemic. This year, it is 21%, but if we consider that capital expenditures will return to normal somewhat because there will be no need for huge production to meet demand (we have normalized it to 4% of sales) and order volumes will return to normal, therefore, not affected Margins At Danaher's fixed costs, we could see the company's free cash flow margins at around 25%-28%, which translates to free cash flow growth of 11%-14%. It is worth noting that management does not take into account the potential positive effects on sales from treatment for new diseases, and I am not sure to what extent they consider the expiration of the patents mentioned in the first article.

But, if we want to dispel any doubts, we can always build a 10-year DCF model and see what different DCF growth rates and fair values ​​we would obtain. In this case, I used a discount rate of 10% and a long-term growth rate of 3.5%. Based on all of this, I rate Danaher as a Buy.

In conclusion, here we have the difference in the performance of Danaher stock and Veralto stock since the day of the offering. As has been the case with other spin-offs, this divergence in performance is expected to continue over the long term, as Danaher divests itself of less profitable, slower-growing, and more capital-intensive businesses.

Conclusion

Danaher has undergone a transformation this year. Undoubtedly, all the events that occurred have made short-term analysis of the company more difficult. The good news is that the long-term outlook remains healthy, and even improved slightly, so my confidence in the business model and management team remains very high.