Danaher Corporation Stock Boosted After Earnings: What You Need to Know

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The market gave Danaher's  third-quarter earnings results the thumbs-up and sent the stock up more than 3% on the day of their release, last Thursday. The numbers weren't fantastic, but they reassured Danaher investors that management is dealing well with an uncertain macroenvironment. But did we learn anything new about Danaher's prospects?

Danaher's earnings beat cautious guidance

Danaher declared that third-quarter earnings per share of $0.95 were above expectations, but management arguably had given cautious guidance the last time around. At the time of its second-quarter earnings, management had forecast that core revenue growth would be 2%-4% for the full year, and discussed ongoing weakness in two of its higher-margin businesses: communications testing (test and measurement segment) and U.S. dental consumables (dental).

In truth, nothing really changed from an end-market perspective in the third quarter. Core revenue growth came in at 3%, and the two specific product lines remained weak. However, there was some positive news on the weak product areas. Earlier in the week, Danaher announced the merger of its communications unit with NetScout Systems. Plus, strong growth in other parts of the dental segment more than offset ongoing sluggishness with U.S. dental consumables.

The end result was core operating margin growth in four of its five segments -- note the return to form in dental -- and action has been taken on its ailing communications (test and measurement) product line. The following chart is measured in basis points, in which 100 basis points is equivalent to 1%:

Source: Danaher Presentations.

Danaher confirms its core values

However, these results weren't just about comforting investors regarding the performance in two product lines; the earnings presentation also helped assuage fears that Danaher had lost its way. I've described previously why Danaher has underperformed in 2014. Two of the three reasons were that longtime CEO Larry Culp was leaving the company and, relatedly, that there were questions about Danaher's future business strategy.

Danaher followers know the company has traditionally acquired businesses and then applied to them what management calls the Danaher Business System, or DBS. Simply put, the DBS is a lean-management system designed to be incorporated across all of its businesses.

Indeed, observant readers will note that the chart above highlights core operating margin increases -- the impact of acquisitions is excluded from the figures. The idea is to reflect a key part of Danaher's business strategy: buying businesses, integrating them, and then raising margins over time. The question is whether the strategy is relevant in an environment in which acquisitions are increasingly harder to make.

This an important question, given the valuation premium that Danaher used to command over rival Agilent Technologies and its peers in the diversified industrial sector, such as 3M, Dover, and Illinois Tool Works. Enterprise value (market cap plus debt) over free cash flow is used as a valuation metric, because it factors in debt -- always a concern with acquisition-hungry companies -- and what a company actually has (free cash flow) to reinvest and/or distribute to shareholders.

DHR EV to Free Cash Flow (TTM) Chart

DHR EV to Free Cash Flow (TTM) data by YCharts.

This was Tom Joyce's first conference call as CEO, so there was a need to make a clear statement on the issue of strategic direction, and he didn't disappoint: "[W]e're always in the process of evaluating [our] portfolio and our focus will be on acquiring smartly, partnering smartly, and managing smartly. Lastly, our team's culture of continuous improvement using Danaher Business System will remain our primary focus."

Danaher's investment proposition

Joyce's comments help define exactly what the investment proposition is with the stock. In other words, unlike Agilent Technologies, Danaher's management isn't about to break up the company into two parts. Moreover, there isn't going to be any change in its fundamental strategy, even if acquisitions are harder to make at the moment.

All told, investors have been clearly told what they are getting with Danaher. So, if you believe in management's goals, then with the company generating 5.2% of its enterprise value in free cash flow and analysts forecasting 9% EPS growth for 2015, the stock looks like a decent value.

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The article Danaher Corporation Stock Boosted After Earnings: What You Need to Know originally appeared on Fool.com.

Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends 3M and Illinois Tool Works. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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