We’re on the cusp of being shareholders in Danaher’s water business
Danaher (DHR) is a day away from shedding its environmental-and-applied solutions segment, and the Club holding’s ability to deliver returns for shareholders appears stronger than ever. Those potential returns can come from two places: Danaher stock and shares of Veralto (VLTO), the soon-to-be-standalone company that’s in the business of water quality. We see underappreciated value in Danaher, and a favorable setup for Veralto after it’s spun off into a separate, publicly traded entity on Saturday. When we receive Veralto shares on Monday, as all Danaher shareholders will, we intend to keep them, based on their current expected value. Danaher has looked attractive in recent weeks – Jim Cramer called its stock a buy during the Club’s September Monthly Meeting – and that appeal increased this week following a key step in the spin-off process. A “when-issued” market was established Wednesday for both Danaher and Veralto stock, providing a first look at how investors are valuing the companies on their own. And what we saw indicates that Danaher is currently being underpriced ahead of the spin, adding to its upside potential once the market recognizes the remaining company should be a faster-growing, higher-margin firm. Danaher is following a traditional spin-off playbook with the transaction. Investors will receive one share in Veralto for every three shares of Danaher they own. It’s a tax-free maneuver that sharpens Danaher’s focus on the life-sciences industry, while giving Veralto management the autonomy and flexibility to run and invest in the company. In our case, after the spin is completed, Jim Cramer’s Charitable Trust will continue to own 520 shares of DHR and will then also own 173 shares of Veralto. Fractional shares will be sold for cash. At present, the “when-issued” market points to Danaher trading slightly over $220 per share on Monday and Veralto opening at $84.65 per share, its first day of trading post-spin. Danaher closed at $247.19 per share Thursday. The “when-issued” prices suggest Danaher is being undervalued, according to a Wells Fargo analysis earlier this month, when Danaher traded at $252 per share. In a note to clients, the firm said if Veralto were to trade at $85 per share it should lead to a $224 stock price for the remaining Danaher. That implies an enterprise-value-to-EBITDA multiple below the company’s historical valuation. EBITDA — short for earnings before interest, taxes, depreciation and amortization — is a measure of operating profitability. The discount is more noteworthy, the firm argued, because Danaher without its environmental-and-applied solutions segment should actually trade at a premium to its historical average, a result of its improved growth-and-margin profile. That’s an argument we’ve been making since last year , when Danaher first announced plans to spin off the slower-growing, lower-margin water business. Our belief is that a faster-growing, stronger-margin company relative to its own history is deserving of a higher multiple. Additionally, Danaher’s pending acquisition of antibody-and-reagent supplier Abcam (ABCM) should further improve the company’s growth-and-margin profile. Mergers and acquisitions are hallmarks of Danaher’s value-creation strategy, and we see the current portfolio transformation as no different to what has worked for investors in the past. While value won’t be created overnight — a confirmed bottoming in the bioprocessing market remains the last piece to the Danaher puzzle – we remain committed long-term investors in the life sciences firm. DHR YTD mountain Danaher’s stock performance so far in 2023. Veralto If Veralto remains around the nearly $85-per-share level on Monday, we’ll stay invested – at least in the near term. The caveat is that spin-off debuts can see substantial volatility, and if Veralto shares were to receive a big pop, our discipline may require us to capitalize on that and take profits. But zooming in on the fundamentals of Veralto alone, we see plenty to like. Under Danaher ownership, Veralto’s two units – water quality and product quality & innovation – both demonstrated mid-single-digit organic revenue growth over the long term, management has said . And its products and services touch many facets of everyday life – from UV light systems that help disinfect New York City’s municipal water supply to commercial printers that are responsible for the expiration dates on food packaging. The water quality unit contributed about 60% to the combined $5 billion in revenue that Veralto’s collection of businesses generated in 2022 while part of Danaher. And over the past three years, Veralto, on average, has had free cash flow conversion north of 100% — an indication that its accounting profits are being turned into cash. That’s money that can be invested internally in the business and used to later acquire other companies, while also returning some of it to shareholders via dividends and buybacks. Once Veralto is out from under the Danaher roof, management will have more flexibility to execute mergers and acquisitions – employing a modified version of Danaher’s well-regarded value-creation strategy. Against this backdrop, some Wall Street analysts are upbeat on Veralto’s prospects and see upside from the $84.65 stock price implied in the “when-issued” market. In a September note to clients, Deutsche Bank pointed out that Veralto’s margins and cash generation are superior to peer companies, which should enable its stock to command a premium multiple. The firm projected a standalone equity value for Veralto between $95 and $105 per share. We lean toward the $90-per-share camp for Veralto, which will be added to the S & P 500. And that will be our initial price target when Veralto starts trading Monday. We arrived at that target by analyzing the financials and valuations of key competitors in the water-and-product quality industries: Xylem (XYL) and Zebra Technologies (ZBRA). Veralto, though, has superior operating margins compared with both rivals. And stronger margins mean a higher multiple. Analysts currently expect Veralto’s 2024 revenues to be $5.16 billion, with operating income of $1.3 billion, reflecting a margin of 25%, according to FactSet. That’s nearly double Xylem’s margin and about one third more than that of Zebra. So, if we assign a premium to Veralto’s water business by giving it an 18 times multiple, and a premium to the product division by giving it a 20 times multiple, the blended average for Veralto comes out at about 19 times 2024 estimates — and that translates to a stock price of around $90 a share. Xylem and Zebra trade at roughly 12 and 15 times EV-to-EBITDA, respectively. Bottom line After roughly a year of anticipation, Danaher will soon become the pure-play life sciences firm we’ve been waiting for. And it comes at a good time for the company – somewhere near the bottom of this business cycle, after suffering through a multi-quarter period of post-pandemic inventory overhangs and weakness from Chinese biopharmaceutical customers. But longer term, we think the stock should command a premium — and it’s attractively valued right now. We don’t feel compelled to choose one or the other – Danaher or Veralto. We’re pleased to receive shares in a high-quality company that sells into important end markets like Veralto and intend to keep them, as long as we feel the valuation doesn’t get stretched. At the same time, if we see a big run in the stock out of the gate, we won’t hesitate to lock in profits. (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.
In this photo illustration, Danaher Corporation logo is seen displayed on a smartphone and PC screen.
Pavlo Gonchar | SOPA Images | LightRocket | Getty Images
Danaher (DHR) is a day away from shedding its environmental-and-applied solutions segment, and the Club holding’s ability to deliver returns for shareholders appears stronger than ever.
