Wall Street Eyes Value Creation For Agilent, Danaher

Includes: A, DHR, TMO
by: Takeover Analyst

While the Street generally maintains a bullish sentiment on companies right now, two stocks that have particularly caught on are Agilent (NYSE:A) and Danaher (NYSE:DHR). These technology instrument producers have solid free cash flow momentum and are focused on driving ROIC. But with multiples trading at high levels and macro challenges, I am considerably more reserved. Based on my multiples analysis and DCF model, I find that these companies have lower upside that what some investors were hoping for.

From a multiples perspective, Agilent is the cheaper of the two. It trades at a respective 14.8x and 11.8x past and forward earnings while Danaher trades at a respective 19x and 15.7x past and forward earnings. In addition, Agilent's board recently approved a dividend distribution, which will begin in April 25. With this pushing the dividend yield up to 1% - 80 bps higher than Danaher's - management took a step in the right direction to attract investors. With that said, the stock is fairly volatile with a beta of 1.5, which is nearly double that of Thermo Fisher Scientific (NYSE:TMO). Thermo Fisher trades at a respective 19.5x and 10.8x past and forward earnings.

At the fourth quarter earnings, Agilent's CEO, Bill Sullivan, noted overall strong performance, but provided a conservative guidance:

"Agilent had Q4 orders of $1.75 billion, up 4% year-over-year. Q4 revenues of $1.73 billion were up 9% year-over-year. The revenues were slightly below our guidance due to currency.

Non-GAAP EPS was $0.84 per share, above our guidance, and operating margin was 21.6%. Agilent's operational performance was the best in its history.

Our outlook for FY '12 is for the revenue to be $6.85 billion to $7.15 billion. FY '12 EPS is expected to be in the range of $3 to $3.35 per share. The basis for our forecast is as follows. Today, the outlook for the worldwide gross domestic product growth is about 3.5%. We are going to take a conservative position in the measurement market and assume that, that market will also grow 3.5%. Based on our geographic and product mix of our 8 market segments, we will believe we'll have an additional 1.5% growth. And finally, the Electronic Measurement Group's backlog flush will contribute 0.7%. Therefore, we'll end up in the midrange of our guidance of roughly 5.7% growth for next year".

The company has solid FCF yield and its life science-related business had solid momentum in the fourth quarter. Agilent has outperformed in terms of organic growth, margins expansion, and R&D. I am further attracted to how the company's conservative guidance is nicely balanced with the focus on ROIC. Furthermore, Agilent has a strong flexible cost structure that can be optimally tuned to the upswings and downswings of the macro economy. The $1.4B worth of net cash is nearly all overseas and repatriation could happen sooner than expected so long as tax rates drop.

Consensus estimates for Agilent's EPS forecast that it will accelerate - growing 7.8% to $3.18 in 2012 and then by 9.1% and 10.1% more in the following two years. Assuming a multiple of 15x and a conservative 2013 EPS of $3.38, the rough intrinsic value of the stock is $50.70, implying 23.3% upside. Modeling a CAGR of 9% for EPS over the next three years and then discounting backwards at a WACC of 9% yields an even smaller figure of $48.77. While meaningfully high, more attractive risk/reward opportunities exist elsewhere.

Danaher is also rated a "strong buy" on the Street, but I do not see how this bullish sentiment accords with earnings expectations. The company has had solid international momentum and its BEC integration is proceeding much more smoothly than expected. In fact, management recently rose its 2014 cost synergy estimate up 40% to $350M. With that said, BEC's troponin was recalled and a resubmission is expected some time in the first quarter of 2012. Growth trends have struggled in BEC, so this level of uncertainty should result in unusually high volatility. Furthermore, even though BEC outperformed peers in 2008, its profitability is well below peer levels.

Consensus estimates for Danaher's EPS forecast that it will grow by 22.1% to $2.82 in 2011 and then by 16.7% and 10.9% more in the following two years. Assuming a multiple of 17.5x and a conservative 2012 EPS of $3.21, the rough intrinsic value of the stock is $56.18, implying just 9.4% upside. Modeling a CAGR of 16.5% for EPS over the next three years and then discounting backwards at a WACC of 9% yields a fair value figure even smaller at $46.06. Accordingly, I do not believe that the Street's earnings projections sync well with its bullish price targets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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