Description

For a $180bn mkt cap stock, Danaher is easy to miss.

For value investors it has been easy to miss decades of outperformance of the S&P 500 because in the past 25 years it has only traded obviously cheap once - during the 2008/09 crash.    

For generalists it is easy to miss Danaher’s transformation from a diversified conglomerate into what this year will become a life sciences pure play.  The Environmental & Applied Solutions segment will separate from the company in Q4 2023 as standalone public company Veralto, just like Fortive (Industrials) was spun off in 2016 and Envista (Dental) in 2019.  These major portfolio changes mean that Danaher’s current products, customers and even economics look very different from the Danaher of 2015-19.  Free cash flow per share has jumped from below $5 in 2019 to almost $12 in 2022.  Operating margins from high teens to now 25%.

For specialists it has been hard to disentangle temporary COVID demand from durable increases.  COVID related therapeutics and vaccines contributed $2bn in 2021 sales, $1bn in 2022 and are now guided only $150m in 2023 - a faster drop-off than management had expected.  Might other recent earnings also evaporate?  Consensus $10 eps for 2023 is down almost 10% on last year: not a sensible time to buy a growth stock.  But over the longer term, just like COVID has left some indelible impacts on us all, I posit that Biotechnology, Life Sciences and Diagnostics (the three segments excluding Veralto) might never look the same again in future, as innovative technologies like mRNA were proven both effective and vital, justifying future efforts and widening the company’s installed base.  Even ignoring COVID, plenty of secular drivers such as the efficacy of biologics but just single digit global penetration, or the manufacturing challenges of affordable personalized medicine, remain robust.  The timing of the Q1 2020 closing of the company’s largest ever acquisition of GE’s biopharma division, right at the start of the pandemic, made predictability even harder.  Sell-side analysts have spent much of the past dozen earnings calls basically asking: “What is normal demand?”  To which the company has replied (most recently at JPM in January):

HSD across all 3 segments, DD+ eps growth, for the next 7-10 years. 

Still, Peloton…

For members of this site who love to fret about macro and geopolitical risks it is easy to miss Joel Greenblatt’s and Robert Goldstein’s data-driven conclusion that this is a good time to be buying a “highly diversified research portfolio consisting of 700–800 positions selected from a universe of the largest 1,400 US securities, weighted towards those stocks priced at the largest discount to our assessment of value.” 

Source: https://gotham.com

The blue squares to the right of the current intersection of green and red lines above only occurred in 2008-11, a great time in hindsight to buy quality growth. 

As final proof that this is a stock that is easy to miss, Danaher has never been written up as a long on this site.  And yet:

I do not attempt to present an exhaustive Danaher write-up here.  Rather than building a valuation model which attempts to forecast unknowables for decades ahead, my valuation work here simply counts recent profits, listens to credible management forecasts, considers insider alignment and alternatives.  For anyone seeking more, there are plenty of good sources.  My investment thesis is straight forward but probably too boring for many:

The probability that Danaher can continue its long history as a serial outperformer of the S&P 500 is under-priced at its current merely average valuation.   

If management is correct and the company delivers long-term HSD sales growth and DD eps growth, its current 21x P/FCF TTM multiple will prove to have been an attractive entry point.  The two very smart Rales brothers, insiders, continue to bet their $20bn this way.

What is Danaher?

The company should be familiar to most VIC members but to quickly summarize it was founded in 1984 by brothers Steven and Mitchell Rales, whose father made his business fortune after growing up in an orphanage. 

The brothers named the company after a Montana river where they enjoyed good fishing, and through a series of acquisitions built a group of manufacturing companies that they set about continually improving using the Japanese kaizen philosophy, articulated through the Danaher Business System (DBS).

The brothers got rich through decent capital allocation and continual improvement: eliminating waste and reducing G&A, reinvesting the proceeds in R&D and Sales and Marketing. 

They have applied the concept of continual improvement to every level of their business decision making: manufacturing processes; talent; capital allocation; and - what I find most interesting of all – the choice of markets they play in.  They have seen many different industries up close, and yet over the past two decades have steered the company to focus on life sciences, spinning off (and personally selling out of) all the other business interests they had: dental, manufacturing, industrial, environmental. 

(I use the term “life sciences” – lower case - to refer to the scientific discipline which underpins the whole business.  And “Life Sciences” for the segment of that name.)

Danaher’s journey into what appears like an ultimate destination of life sciences began in 2005 with the acquisition of Leica Microsystems (German-based high precision optical instrumentation) for $550 million.  This was but the first of 30 life sciences acquisitions notably including Beckman Coulter (Diagnostics) for $7bn in 2011, Pall (filtration for biotechnology) for $14bn in 2015, Cepheid (Diagnostics) for $4bn in 2016 and Cytiva (biopharma carve-out from GE) for $21bn in 2020.  Current CEO Rainer Blair was EVP of the Life Sciences platform since 2014 and responsible for many of these acquisitions. 

Both brothers gradually sold down their stake each year, from 43% of shares outstanding each in 1995 to around 6% each in 2013.  Since then, Chairman Steven Rales has stopped selling completely, and his younger brother Mitchell virtually stopped selling 5 years ago.  This coincided with the acceleration into a life sciences pure play.

CEO Rainer is clear about the attractiveness of the long-term growth drivers of this market, for a company which as #34 biggest US public companies has been remarkably agile at choosing where they want to play.

“There are not many industries that have those growth rates at this kind of scale.”[1] 

“As we think about the long term, we think it's prudent to think about a business at that scale in a high single-digit. And we think that will compare very favorably with any other business out there in the short, medium, and long term.”[2]

Post the 2023 spin-out, the company will look as follows:

Source: 2023 Danaher at JPM Healthcare

Customers and products of Danaher 2024+ will be completely different from those of previous decades.  But certain aspects rhyme, such as building a recurring consumable revenue stream on an installed base, and constantly seeking mission critical applications.  For example:

“Diagnostics today represents about 2% of costs of healthcare broadly defined. And yet it informs well north of 60% of the decisions that are ultimately made in healthcare today. So we play a vital role in the overall market, but are relatively small portion of the overall cost structure.”                                                                     Former CEO Tom Joyce Q1 2019

Danaher aims to industrialize science.  This promises to be a picks and shovels play on the ongoing life sciences goldrush over the next decade or two, run by some of the best in the world at operational efficiency and creating shareholder value.

Investment Thesis

The probability that Danaher can continue its long history as a serial outperformer of the S&P 500 is under-priced at its current merely average valuation.   

Danaher stock has serially outperformed the S&P 500:

The positive vertical gap on a logarithmic scale is evident even if we reverse cherry pick to start with their weakest period:

Although log scales are appropriate for performance measurement, wealth creation feels linear.  So the Rales brothers would have perceived Danaher’s outperformance more like this:

This nuance matters when assessing if historic outperformance is likely to be sustained into the future.  Compounding wealth (when done right) means the biggest $ gains come at the end.  This is not a deep point arithmetically, but it can be profound for personal motivation.  Why does Buffett still tap dance to work at his age?  Why does he even work?  Sure, he likes the people, and finds it all quite stimulating.  But like most people accustomed to keeping score with money, the fact that his wealth has increased the most in the last decade of his life is probably a powerful motivation to want to stick around to see how it all works out. 

For several great investors, most famously Buffett and Munger, it has been mighty easy to underestimate their longevity.  Not just from a health perspective.  But in terms of their personal drive to keep investing well.  Incentives matter.  For the Rales, the opportunity to make billions now if they make the right decisions, rather than the millions of decades ago, could well keep Steven at 72 and Mitchell at 67 focused on applying all their experience and wisdom to extend their historical outperformance for many years to come.

Risks

1. Acquisitions
2. Unforeseen technological obsolescence
3. Company becomes a vanity project rather than wealth-generating machine

Appendix 1

When did you know that Charlie Munger was an investing genius? 

When did you buy COST / BYD? 

I love Munger as much as the next guy on this board.  Every time I read about his actions or listen to him speak I feel a little bit wiser, even if nobody else confirms this feeling when I parrot his proverbs.  But his investments can be as golden as his sayings.  To my cost, I have paid insufficient attention to this great investor’s concentrated investments: COST and BYD.  I have no excuse.  These were liquid stocks.  He explained what he saw in them many years ago.  In 2009 he pitched the Berkshire crowd on BYD, concluding:

“I will be amazed, if great things don’t happen here.”[3]

And for the knuckleheads in the back like me that didn’t appreciate how much he liked it, he ended:

“I have never, in my life, been more — felt more privileged to be associated with something than I feel about BYD.” 

Money made from this opportunity?  Zero for me.  He has made plenty.

The only explanation for my lethargy was that both stocks seemed expensive and the best seemed to be over – especially for Munger given his age.

Probably only a handful of business people are widely respected on this board as possessing superior capital allocation talent + a concentrated portfolio of only a few business investments + their current investments are actionable for us.  I suggest that the Rales brothers should make that list.  They have concentrated their holdings almost exclusively into Danaher, divesting from the spin-offs and other companies they founded like Enovis (formerly Colfax).  Is their best wealth creation in the past, or is there still plenty to come?

Appendix 2

Typical earnings call interactions on durability of demand

Jack Meehan

So on Life Sciences, I wanted to turn to some of the capital heavy businesses, SCIEX, Leica Micro, Pall Industrial. Can you just talk about the durability of the growth you are seeing there? How are order trends – and any change to the growth expectations for the year?

Rainer Blair

So, in Life Sciences, if we now pivot from bioprocessing and more to the life science analytical businesses, as you suggest, Jack, we are seeing very strong underlying activity in the various sectors of the business. If you think about the Pharmaceutical segment, CROs, academic research customers, our funnels are strong and continue to outpace quarter-over-quarter what we have seen in 2021. I think that buttressed for us, particularly because of the strong innovation track record and the recent launches that we have had. I have talked to those at SCIEX, the ZenoTOF, the accurate mAb instrument as well as the 7500 Triple Quad, those are class-leading innovations that are growing exceptionally well and driving market share gains.

Beckman Life Sciences, with their CytoFLEX Benchtop sales order the most recent launch. And then of course, we talked about Mica, which is that combination of wide field and confocal leveraging machine learning. So, we are firing on all cylinders here in a strong investment environment.

And we think that, that’s sustainable here for the foreseeable future as we continue to see investments from both the biotech sector, but also academic sectors, as well as institutions that are very, very bullish on the innovation and the science that they want to drive forward.

Q1 2022 earnings

Appendix 3

Scott Davis has covered Danaher for years, and wrote a good chapter on Danaher in his co-authored 2020 book “Lessons from the Titans”

Your next question comes from the line of Scott Davis with Melius Research.

Thomas Joyce

Hi, Scott. How you're doing?

Scott Davis

Great. It's easy covering your company. Every quarter, you put up decent numbers and not exactly sure what you make and what you sell, but it's working.

Thomas Joyce

Scott, you know we love to make life easy for all of the visitors on this call. One of our goals, among many.

Scott Davis

I don't know if I might be the last industrial guy left, but you're not going to get rid of me that easily.

Thomas Joyce

That's okay. Welcome back. What's up today?

Q3 2019 earnings call

NB header valuation figures are consensus.

Catalyst