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Morningstar | Danaher’s Life Science and Environmental Units More Than Offset Diagnostic and Dental Weakness

Danaher reported another fairly stable quarter across most of its business segments, especially with negative currency effects on the top and bottom lines. Internal revenue growth of 6.5% and an operating margin improvement of about 30 basis points from last year to 17.1% both put the company on track to slightly outperform our previous forecast. Management raised its year-end adjusted EPS outlook from $4.49 to $4.52 (up from $4.43 to $4.50), which looks achievable to us given performance over the first three quarters of the year. Although we’re raising our fair value estimate to $93 per share as we slightly increase our near-term organic growth expectations combined with the time value of money since our last update, we still think Danaher’s shares look modestly overvalued. Aside from the dental segment, we think Danaher’s narrow moat remains in good shape, especially in its life science and diagnostic divisions.

Summarizing our thoughts from the quarter, life sciences as well as the environmental and applied segments exceeded our expectations offset by weaker results in the diagnostic and dental divisions. The life sciences segment--with 9.5% organic growth and 190 basis points in segment margin expansion--posted particularly strong results, in our view, thanks in large part to double-digit growth in bioprocessing and single-use technology among biopharma customers from the legacy Pall business. Other life science units also posted high-single digit growth, which suggests potential market share gains. Meanwhile, double digit growth in the water quality operations within the environmental and applied segment, especially from demand in China, led the performance in this division.

Meanwhile, the diagnostics division was negatively affected by currency movements and some weakness in developed markets within the Beckman Coulter business. This quarter’s organic growth of 5.5% and a nearly 120-basis-point operating margin decline is weaker than we anticipated. Management noted healthier performance in the other diagnostic units, with Cepheid sustaining double-digit growth. It’s hard to know if changes to the Medicare clinical lab fee schedule in the U.S. might be sapping demand for diagnostic products, especially in the more mature clinical chemistry and hematology portions of the market where management highlighted weakness, but we still think this segment overall has noteworthy growth and margin expansion opportunities ahead. Following the Cepheid acquisition, we still think management will eventually look to deploy capital into the genomic testing portion of the market to gain access to higher growth opportunities.

Conditions remain weak in Danaher’s dental segment, but management continues to suggest the outlook is improving. Organic revenue fell 0.5% for the quarter with a nearly 195-basis-point decline in operating margin, thanks in part to currency effect and investments to prepare this division for its expected spin-off in the second half of 2019. We’re still surprised by the weak performance in this segment, and we support the decision to separate the business due to the likelihood of increasing competition in this market over time, including greater buying power from corporate accounts and buying groups as well as the rise of low-priced competition. While traditional consumables and equipment remain the sore spot for Danaher, the company posted stable growth in its specialty orthodontic and implant product categories. Management’s increased investment in the dental business will target these specialty segments as well as ramping up the clear aligner business, which will specifically target Align Technology’s stronghold in this area.