Danaher Corporation (DHR)
Equity Research Analyst
Nathan F. Ritz, CFA
Equity Research Analyst
industry experience since 2008
joined Weitz Investment Management in 2011. Prior to joining the firm, Nathan interned
at Moody Aldrich Partners and was a credit analyst at West Gate Bank.
Nathan has a bachelor's in finance, economics and mathematics from the
University of Nebraska-Lincoln.
Danaher Corporation (DHR) is a diversified science and
technology company that designs, manufactures, and distributes professional,
medical, industrial, and commercial products and services around the world. The
company is a global leader in each of the following four businesses with
operations in over 60 countries.
- Life Sciences — provides instruments and consumables (products that regularly used up or depleted, thereby needing regular replacement and/or replenishment) used by scientists to study diseases and develop drugs & therapies and by researchers and engineers to test and manufacture a wide range of biopharmaceuticals, cell and gene therapies.
- Diagnostics — provides clinical instruments and consumables to hospitals, clinics, and physicians' offices to aid in the detection, diagnosis, and treatment of diseases.
- Water Quality — provides water quality testing & analytics and water treatment for municipal, environmental, and industrial applications.
- Product Identification — provides high-speed coding used for consumer-packaged goods (CPG) and pharmaceutical packaging and product traceability.
Weitz has a long history with Danaher, spanning more than
a decade. One of the key pillars of the Danaher story is portfolio
transformation through mergers and acquisitions (M&A). Over time, we have
seen Danaher shift away from manufacturing and industrial end-markets, and move
toward businesses in healthcare, life sciences, and environmental and applied sciences.
Important strategic moves include the divestment of Danaher's Industrial
businesses, which were spun-out as Fortive in 2016, and its Dental segment,
which was spun-out as Envista in 2019. Additional moves include strategic
acquisitions within Diagnostics with the purchases of Beckman Coulter in 2011
and Cepheid in 2016, and in Life Sciences with the acquisitions of Pall in 2015
and Cytiva (GE Life Sciences) in 2020.
These portfolio shifts have enhanced Danaher's organic
growth rate, cash flow profile, and economic resiliency by mixing into less
cyclical end-markets (healthcare, biopharma, water quality) and by emphasizing a
greater mix of recurring revenue with consumables, which are contractual and
specified into their customers' workflows, now representing over 75% of
Danaher's revenue. We believe the Danaher of today offers a higher-quality mix
of businesses with more avenues for reinvestment and growth compared with the Danaher
of years past.
A critical eye is warranted for acquisitive companies. Looking
at the broader market, acquisitions have — on average — destroyed shareholder
value over time. Few companies have passed our vetting process, and fewer still
are companies where we consider M&A a strategic asset. The bar is high, and
Danaher is one of a select few that fall into this category. Danaher has a long
history of surpassing our high hurdles for return on invested capital (ROIC)
and, more importantly, has business processes in place for creating shareholder
value from acquired assets.
At the center of all of this is the Danaher Business
System (DBS) — Danaher's system for continuous improvement, commercial
excellence, talent development, and strategic planning. Danaher has a highly
decentralized organizational structure with 25 operating companies, where
business leaders have the autonomy and accountability to drive results through
the Danaher Business System. Mapping out business processes and value streams uncovers
the data needed by business managers to identify customer demands and pain
points; target commercial opportunities and R&D; improve operations to
drive lower costs, improve quality, and become more agile; and identify the
best uses of capital for organic investment and M&A. DBS is the foundation
of Danaher's culture and a core driver of shareholder returns.
The typical DBS playbook for acquisitions is to first enhance
operations through continuous improvement and move closer to the customer
through voice of customer (VOC) work. Cost savings are then recycled into
targeted, high return on investment (ROI) innovation and R&D. This drives
value for customers who then increase partnership with Danaher, which further
ingrains Danaher's solutions into customers' workflows. This increases
stickiness, switching costs, and pricing power. The value created is then recycled
into additional M&A and the cycle repeats.
Nearly without exception, we have seen organic growth
accelerate and margins expand meaningfully for acquired assets. This has driven
average return on invested capital for M&A well above their cost of capital.
We believe that DBS is a sustainable moat for Danaher given institutional
hurdles to implementation, lengthy time horizon before results manifest, and
decades of process iteration it took for Danaher to get DBS where it is today.
Moreover, Danaher has the focus within their executive management team, depth
of talent throughout the organization, and buy-in from the board to sustain DBS
In addition to best-in-class management, culture, and
capital allocation, we believe Danaher is exposed to industries with attractive
secular growth prospects and that Danaher plays within the most attractive
pieces of the value chain within these industries.
Looking first at their largest business, Life Sciences, Danaher
is well positioned within bioprocessing and increasingly within gene and cell
therapies. Danaher's largest exposure is to biopharma which, as a category, is
taking market share from small molecule (traditional pharma). We expect this
shift to continue. There is strong growth in the number of biopharmaceuticals
across clinical stages (pre-clinical, Phase I, Phase II, and Phase III) and high
R&D budgets across Danaher's customer base. Danaher benefits from
diversification as they are a broad “pick and shovels” provider across the
biopharma industry. An additional growth driver is the still nascent biosimilars
(“generics”), which is likely to see strong growth from drugs coming off patent
in years ahead. Danaher has high upfront customer intimacy within customers' R&D
processes, and the company also benefits as its solutions are critical for
customers to scale up to commercial production. At this
stage Danaher enjoys a long stream of high-margin consumables as they have
regulatory lock-ins (FDA), where the costs and approval time to switch to a
competitor are prohibitively high. Within bioprocessing, Danaher plays in
some of the most attractive pieces of the value chain: purification,
filtration, and chromatography. Danaher is also a market leader in high margin single-use
technologies (SUT), which continues to take market share within bioprocessing
Through their Integrated DNA Technologies (IDT) business,
organic investments, and their recent acquisition of Aldevron, Danaher has
established a foothold into the rapidly growing gene and cell therapy industry.
To the extent that the market scales, we expect Danaher to benefit given the
complexity of the gene and cell therapy manufacturing process, growth in automation
and continuous bioprocessing, and higher customization of solutions as
therapies have tighter tolerances and smaller sub-populations. We also believe
this is an industry with ample opportunity for M&A, creating an additional growth
avenue for Danaher.
Diagnostics is Danaher's second-largest business line. The
diagnostics industry is attractive because diagnostic testing represents a
small percentage of healthcare system costs but has a meaningful impact on
treatment and patient outcomes. There is also a high recurring revenue mix in
diagnostics with reagents and test cartridge consumables and services
representing 83% of diagnostic revenue for Danaher. We see industry-wide
secular growth benefits from aging populations, growth in preventative medicine,
increased companion diagnostics and testing alongside drug treatments, growth
in genetic testing, and scientific and technology advancements expanding the
diagnostics testing menu.
Within diagnostic testing, Danaher is exposed to the most
attractive modalities with point-of-care (POC) and molecular diagnostics
through their Cepheid business. Danaher should also benefit as they have
invested behind diagnostics integration and workflow automation, which is
becoming increasingly important. Despite some near-term headwinds on the
equipment side of their business, we see a long runway for molecular
diagnostics penetration. In addition, Danaher's consumables business will
benefit over time from the more than 75% increase in their install base since
the onset of the COVID pandemic.
Danaher's final two businesses are Water Quality and Product
Identification (PID), which are reported within Danaher's Environmental &
Applied Solutions (EAS) segment. Within Water Quality, Danaher provides water
quality analytics, testing, and measurement through Hach, chemical metering and
pretreatment through ChemTreat, and UV disinfection through Trojan. We believe
these are some of the most attractive niches within the water industry given
low capital intensity, low cyclicality, high touch/service model, and barriers
to displacement. Within Product Identification, Danaher provides high speed
labeling & coding for consumer-packaged goods (CPGs) with VideoJet and
color formulation & packaging design with X-Rite and ESKO.
Similar to Life Sciences and Diagnostics, both Water
Quality and PID have large consumable revenue streams, represent a small
percent of their customers' cost base, and have regulatory and/or process
lock-ins. Growth tailwinds within Water Quality include regulatory requirements
and a growing number of contaminants. Within PID, tailwinds include growth in
traceability and product tracking. While both Water Quality and PID are good
businesses in their own right and Danaher has strong positioning within both,
we expect EAS to be less meaningful to Danaher's results over time, and we
wouldn't be surprised if that part of the business were eventually spun-out to focus on more profitable businesses, like their Life Sciences
and Diagnostics platforms.
We expect Danaher to benefit from strong secular growth
trends within the industries they participate and for internal execution
through DBS to drive market share gains over time. Additionally, withing Life
Sciences and Diagnostics, we see long runways for M&A. We believe a
combination of secular growth, high competitive moats, strong management, differentiated
culture, and value-creating capital allocation makes Danaher a high-quality
long-term compounder. With the market decline in 2022, we were able to initiate
positions in Partners III Opportunity Fund and Partners Value Fund and add to
our positions in Value Fund and Balanced Fund at what we believe are attractive
/sitefiles/live/documents/AnalystCorner/Analyst Corner Danaher.pdf
As of 06/30/2022, the following portfolio company constituted a portion of the net assets of Balanced Fund, Hickory Fund, Partners III Opportunity Fund, Partners Value Fund, and Value Fund as follows: Danaher Corporation: 2.1%, 0.0%, 2.0%, 2.6%, and 4.7%; Envista Holdings Corporation: 0.0%, 0.0%, 0.0%, 0.0%, and 0.0%; Fortive Corp.: 1.0%, 0.0%, 0.0%, 0.0%, and 0.0%.
Holdings are subject to change and may not be representative of the Fund's current or future investments.
The opinions expressed are those of Weitz Investment Management and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through 07/22/2022, they are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor's specific objectives, financial needs, risk tolerance and time horizon.