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Danaher: Is it Worth Paying a Premium?

Posted on: October 1, 2008 - Email Article - Printable Version

Mahir Desai

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In today’s catastrophic market everyone is looking for that one play that looks attractive with potential to outperform the market, yet will give them stability in this turbulence. But in this world, most of the greatest investments are worth paying a little more in order to obtain. Whether you are contemplating paying more for that luxury car or debating whether to buy a more expensive company in relation to its peers, it all comes down to one question: Is it worth paying a premium?

I feel that I have found a company, that surprisingly enough in the current market conditions is worth paying that premium. That company is Danaher Corporation [DHR: 56.91, 0.00 (0.00%)]. Danaher is an industrial conglomerate that designs, manufactures, and markets a wide variety of products. They operate through four business segments:

Professional Instrumentation: Within this segment Danaher produces and sells electronic test tools and calibration equipment as well as water quality instrumentation, water treatment solutions and both retail and commercial petroleum products including goods such as: storage tank leak detection, vapor recovery systems and other related goods.
Medical Technologies: Danaher offers acute care diagnostic equipment, optical systems, automated specimen preparation instruments along with some cancer diagnostic products and a wide range of products for dental professionals.
Industrial Technologies: manufactures sub-systems and products used by customers into production and packaging lines, as well as by equipment manufacturers into many end-product systems. They also offer a wide range of identification equipment from motion and speed detection all the way to liquid flow and aerospace devices.
Tools and Components: They make a wide range of general purpose tools and specialty equipment as well as drill chucks.

So why are they trading at a premium?

In my opinion the simple answer is that they are just that much better than most companies; therefore, you need to pay more for that level of quality. They have outperformed the industrials select spider [XLI: 24.09, 0.00 (0.00%)] as well as their competitors. Two reasons why I feel that they have traded at a premium relative to their peers is that they have a faster long term growth rate as well as wider net margins. To justify my rationing lets dive deeper into the core business of Danaher.

Danaher Business Systems (DBS)

DBS is the company’s way of improving their internal operating performance and efficiency as well as sticking to the company’s core values and processes including strategically implementing their acquisition and divestiture strategy through the six sigma system. The six sigma system is a data-driven approach targeted to eliminate defects in any of the company’s processes. This can range from manufacturing to transactional.

Danaher really spells out how they want the company to succeed and thrive and its more than just the average company strategy. I truly believe one of the reasons that Danaher has stayed so strong in a weak market is that they religiously follow this strict and deliberate system.

Sound Acquisition Strategy

In essence their strategy is to expand their core businesses without deviating from their comfort zone. To finance these acquisitions Danaher uses internally generated cash and cash equivalents. Danaher only looks to acquire businesses that fit their strategic model and divest businesses that do not achieve the company’s target return on investment. I strongly feel that by sticking to this and not varying from their target markets Danaher can keep the risk of making a poor acquisition to a minimum.

Acquisition Statistics

In 2Q08 14% of Danaher’s total sales were from acquisitions
For the six months ended July 27, 2008, Danaher had recorded EPS growth of 14% strictly from acquisitions
In 2007 Danaher acquired 12 businesses for an aggregate purchase price of $3.6 billion
In the first six months for 2008 they have acquired 7 companies for a total consideration of $102 million. These companies have complimented their industrial and medical segments
In November of 2007 they acquired Tektronix, Inc. which is a supplier of test and monitoring equipment that creates $1.1 billion in annual sales

I feel that margins should expand for Danaher as they consolidate their acquisitions and cut costs through DBS and six sigma.

Strong Balance Sheet along with Superior Free Cash Flow

To back up their strong acquisition strategy and to prove that Danaher can really finance these with cash, just take a look at their balance sheet. Currently, they have the capacity to invest just over $2 billion while putting no strain on the balance sheet. For an industrial company this is unheard of in these market conditions. On top of that, Danaher is on track to complete the 17th consecutive year of generating free cash flow in excess of net income, a great measure of earnings power and the translation of cash flow from the top to bottom line.

Summary

I feel that between the down economy, Danaher’s supreme business model, and the sheer diversification of their business segments, Danaher is the perfect play in a less than perfect marketplace. The rational behind their premium is very apparent and easy to justify for investors.

-Mahir Desai

Disclosure: The mutual fund that the author manages is long DHR.

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