Diversified industrial firm Danaher (NYSE:DHR) reported better than expected second quarter earnings. Revenue advanced 4% to $4.7 billion (organic revenue growth was 2.5%), which led to nearly a 4% increase in operating income. The firm's gross margin improved 100 basis points, and core operating margin grew 95 basis points. Adjusted diluted earnings per share increased 7.5% to $0.87 (which beat consensus estimates of $0.85). Year-to-date, free cash flow has fallen nearly 10%, though it still represents 13.9% of revenue, which is a very healthy number.
Revenue growth across Danaher's segments was modest, with the exception of its 'Test & Measurement' segment, which was roughly flat during the period. The company experienced sequential improvement in Brazil and the Middle East, as each region was up more than 15% year-over-year. Danaher also saw low double-digit growth in China during the second quarter, led by the firm's largest segment, 'Life Sciences & Diagnostics', as well as its 'Dental' division, which grew in excess of 20% in the country. Danaher's developed markets were up slightly, though revenue from Western Europe fell at a low-single-digit pace due to austerity measures.
The company's 'Life Sciences & Diagnostics' segment led the charge in operating-income expansion, jumping 15% on a year-over-year basis in the quarter. Profit margin expansion in the segment was driven by higher volume throughput, productivity initiatives, and restructuring efforts during the latter part of 2012. The 'Environmental' and 'Dental' segments also performed well, expanding 8% and 10%, respectively. Overall, operating-profit performance was decent, and we credit this to the Danaher Business System, which also helped drive solid free cash flow conversion in the quarter (124% of net income).
Looking to the second half of the year, Danaher intends to make additional investments aimed at share gains and margin expansion. Notably, Danaher continues to deploy significant research and development efforts in Beckman Coulter Diagnostics, which it acquired a couple years ago. The firm also noted it remains focused on bolt-on acquisitions-particularly in its 'Environmental' and 'Life Sciences & Diagnostics' segments-and identified $8 billion in available M&A capacity through 2014. Though we're not expecting a multi-billion dollar transaction, we'll be looking for the firm to hit headlines in the coming months with another deal. Danaher narrowed its full-year 2013 adjusted earnings outlook to the range of $3.37-$3.42 per share (was $3.32-$3.47).
Danaher is one of our favorite industrial firms. Though cyclical to a degree, the firm continues to drive gross margins higher (today: 50%+; 2001: ~38%) as it enhances its recurring revenue base (today: 40% of sales; 2007: ~20%). And while it wouldn't be the only reason why we'd like the firm, the Danaher Business System ensures the firm will stay competitive across the variety of market segments it serves. Still, at the time of this writing, we're only watching Danaher as its shares have advanced significantly above our estimate of their intrinsic value (on the strong quarterly performance).
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