Danaher Shares Look Like Bargains

By Sandra Ward 

One of the best-run and top-performing U.S. companies can be bought for less than its usual lofty premium as investors fret about the slow pace of its merger activity and whether it is making the best use of its capital.

In the past six months, shares of Danaher (DHR)--a Washington, D.C.-based conglomerate whose interests span a wide swath of industries including electronic measuring equipment, medical diagnostic instruments, and water-treatment systems, among others--have shown uncharacteristic weakness amid a slowdown in its deal making, on which it depends heavily for growth.

High valuations for firms that Danaher might otherwise pursue are preventing it from making deals at its customary pace as it sticks to a strict price discipline.

The company, with $19 billion in annual revenue and a stock-market value of $55 billion, is renowned across corporate America for its Danaher Business System, a set of organizational processes based on the Japanese principle of kaizen, or continuous improvement.

Adding to concerns, longtime Chief Executive Lawrence "Larry" Culp, 51 years old, surprised investors in mid-April by announcing his retirement. The lengthy period before Mr. Culp's successor, Thomas Joyce, 53 and a 25-year veteran of Danaher, takes the helm in March 2015, prompted fresh worries that the company's M&A strategy might be on an extended hiatus.

The shares, swept up in the broad market rally that has pushed the S&P 500 to a record high, trade just below the 52-week intraday high of $81.14 they hit June 9. Despite the run-up, the stock represents good relative value.

Danaher trades at 21 times estimated 2014 earnings of $3.75 a share and, on a price-to-earnings basis, commands half the 20% premium it has been typically afforded versus its peers in the past 10 years. The shares trade at 19.5 times projected 2015 earnings of $4.17, below the 20 times that has been more typical historically.

On the basis of enterprise value to Ebitda (earnings before interest, taxes, depreciation and amortization) as well as a price to free cash flow, Danaher shares also trade at about half their historical premium to a peer group that includes 3M, Dover and Illinois Toolworks, among others.

"There is a lot of upside potential in Danaher," says James Tarkenton, portfolio manager at Lateef Investment Management, a money-management outfit overseeing $5.7 billion in assets based in Greenbrae, Calif.

Danaher's potential lies in the more than $8 billion in surplus cash it has available for deals that will drive earnings and free cash flow higher. In weighing the best use of its capital, Danaher typically favors mergers and acquisitions over stock buybacks or dividends as a way to create value and achieve higher returns.

Stephen Tusa, an analyst at J.P. Morgan, says the stock could climb to $95 a share based on improving fundamental growth and a pickup in acquisition activity.

Subscribe to WSJ: http://online.wsj.com?mod=djnwires