Why we bought more Danaher even after it lowered the forecast for a key business

Published Tue, Oct 24 20233:14 PM EDT

Danaher (DHR) delivered beats on the top and bottom lines for the third quarter on Thursday. But shares of the life sciences and medical diagnostics company remain under pressure after management was forced to lower expectations for one of its key businesses. Revenue for the period ended Sept. 30 declined 11.5% organically year over year to $6.87 billion, outpacing analyst estimates of $6.63 billion, according to Refinitiv. When excluding the 8.5% headwind relating to Covid-related tests and products, Danaher's base business sales were down 3% versus the year ago period. Adjusted earnings-per-share (EPS) decreased 21% annually to $2.02, ahead of the consensus estimate of $1.87 per share, Refinitiv data showed. Bottom line The biggest drag on the Danaher's outlook remains its bioprocessing unit, a large part of the biotechnology segment, and hasn't seen an inflection in orders and is "sort of at the bottom here bouncing along," according to CEO Rainer M. Blair. It doesn't help that German competitor Sartorius said last week that its bioprocessing orders jumped 15% sequentially in the third quarter. Bioprocessing is the process of creating products through the use of a living thing like a cell or a virus. (Think mold to create antibiotics.) Danaher does expect to see orders in this embattled business rebound in 2024. We used Tuesday's sell-off in Danaher shares to add to our position . Our thinking: Stocks tend to bottom before their industry cycle does, and Danaher is almost there in working through the excess supply that is limiting new order demand. We believe it's more prudent to buy now and be patient than to attempt to time the exact moment when investors will start to buy shares again. The long-term positive trend for biologics remains intact. Results were mixed across the rest of the company's businesses. Sales for the diagnostics unit outpaced expectations, while life sciences came up short. Environmental and applied solutions results were also a bit better than expected, a positive sign for Veralto (VLTO), which was recently separated from Danaher, but does little for DHR shares. We continue to view this as a transitional year for the company as it works excess inventory from the pandemic. We still believe in the strength of this management team. Once the bioprocessing glut is worked through, Danaher will be in a much stronger position. In line with our purchase of 30 DHR shares on Tuesday, we reiterate our 1 rating and $250 price target. Guidance Management expects overall core revenue growth for the fourth quarter to fall by percentage points in the high teens. That looks a bit light versus what the Street's estimates. Driving this forecast is an expectation for biotechnology sales drop in the mid-20% range, life sciences sales to decline by mid-single digit percentage points, and for diagnostics to be down about 20%. The adjusted operating profit margin is expected to be 28% — lower than the roughly 30% estimated on the Street. For the full year, excluding Veralto, management continues to expect overall core revenues to be down by low-double-digit percentage points. This also appears to be a slight miss versus expectations. Driving this forecast is an expectation for biotechnology sales to be down in the high-teens percentage range, life sciences sales to be about flat (lower than the low-single digit increase previously expected), and for diagnostics to be down in the mid-teens percentage point range. The adjusted operating profit margin is expected to be 29% — slightly better than the Street's 28%. On the conference call with analysts and investors, management noted that core revenues were down in developed markets driven by a decline in COVID related revenues, while revenues in high-growth markets were down high single digits. China in particular saw mid-teens decline with the team referring to the economic landscape as "challenging". The sharp decline we saw in the operating margin is attributable to lower biotechnology and diagnostics volumes along with costs associated with the spin out of Veralto, completed Sept. 30. Though free cash flow came up a bit short versus expectations, Danaher has achieved a year-to-date free cash flow to net income conversion ratio of more than 120%. Earnings backed by cash are considered to be of higher quality, so we certainly like this dynamic, even if slightly elevated capital expenditures weighed on the third quarter result. Bioprocessing remains a headwind. China was down 45% in the quarter. Assuming no additional headwinds in the fourth quarter, management reiterated their full year outlook for the bioprocessing base business to be down 10% on a full-year basis. Longer term, managements remains confident that global demand for biologic medicine will continue to grow, saying "more patients [are] using biologic medicines, [and] this year is on pace to be a record year for FDA approvals of biologics, including approvals for meaningful indications such as Alzheimer's disease and several cancer immunotherapies." The life sciences unit was hampered by pressure in the instruments business. Management said "an already challenging funding environment [in China] further deteriorated as the quarter progressed." The team also send it expects the pending $5.7 billion acquisition of Abcam, a leading producer of protein consumables, will be accretive on multiple levels, including earnings. (Jim Cramer's Charitable Trust is long DHR. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Jim Cramer at the NYSE, June 30, 2022.

Virginia Sherwood | CNBC

Revenue for the period ended Sept. 30 declined 11.5% organically year over year to $6.87 billion, outpacing analyst estimates of $6.63 billion, according to Refinitiv. When excluding the 8.5% headwind relating to Covid-related tests and products, Danaher's base business sales were down 3% versus the year ago period.