Danaher (DHR) reported solid first-quarter results before the opening bell Thursday 21 Apr 2022. And while the company is seeing a solid boost from Covid testing, its core business continues to grow at a healthy clip.

The medical diagnostics and health technology company posted revenue of $7.69 billion, outpacing the $7.54 billion consensus. That represents 12% annual core growth, above the 10.4% expected by the Street. On the bottom line, earnings of $2.76 per share, an increase of 9.5% year-over-year, exceeded the $2.68 per share expected. In addition to the headline results, though not quite as positive, the operating margin came in a bit light at 28.3% versus a 29% consensus, representing a core contraction of 65bps, while free cash flow of $1.72 billion (+5.5% YoY) fell short of expectations of $1.978 billion.

Guidance

Looking to the second quarter, management expects core revenue growth to be in the mid-single-digit percent range, in line with the 2.7% the Street was looking for coming into the print.

• Included in this guidance is a 200-300 basis-point headwind from the shutdowns in China, which are expected to have the greatest impact on the company’s diagnostics business. On the call, management noted that this is largely a supply issue — a plant shutdown as well as issues relating to customer accessibility in hospitals and labs — as demand in China “continues to be very robust.”

For the full year 2022, management forecasts core revenue growth, which excludes the impact of Covid-19 testing in the high single-digit percent range. When factoring in the Covid testing headwind, overall core revenue growth is expected to be in the mid-single-digit range. This compares with an expectation for 4.85% full-year core growth coming into the print.

• This is unchanged from the previously provided guidance, with management commenting that they expect shutdowns in China to normalize as we work through the rest of the year.

• Included in this guidance are expectations for a low single-digit core growth headwind from Covid-19 testing and overall mid-single-digit core revenue growth.

Segment results

Life sciences revenue of $3.88 billion outpaced expectations of $3.82 billion, representing 7.5% core growth after factoring for a 4% benefit from acquisitions and a 2% headwind from foreign exchange rates. Additionally, adjusted operating profit came in at $1.48 billion, largely unchanged from the prior year’s period as the profit margin contracted to 28.8%.

• On the call, management called out robust growth in bioprocessing at Cytiva and Pall noting the backlog continued to grow across both businesses.

• Regarding the impact of Covid testing-related sales, management commented that “over the last two years our customers prioritized the development of Covid-19 vaccines and therapy to rapidly accelerate their time to market. Today these programs require less investment and manufacturing capacity as they mature and become a part of our customers’ core business. And as a result, our customers are starting to reallocate resources back to previously paused and new programs for other modalities, notably monoclonal based therapies or MABs cell and Gene therapy and mRNA-based technology.” According to the team, due to their importance in combatting Covid-19, monoclonal antibodies are the now largest investment their customers are making in bioprocessing as they look to add manufacturing capacity.

• The team also called out “strong levels of activity in all major end markets” for the instrument business noting particularly strong demand from pharmaceutical, contract research organization, and academic research customers thanks to a “healthy funding environment.”

Diagnostics revenue of $2.64 billion outpaced the $2.57 billion consensus, representing an incredible 22.5% core growth, after accounting for a 1% benefit from acquisitions and a 2% headwind from foreign exchange rates. Additionally, adjusted operating profit came in at $940 million, up 36.8% year-over-year, as the profit margin expanded to 33.5%.

• Within the segment, management called out the seventh consecutive quarter of double-digit growth for Leica Biosystems and a greater than 50% annual growth rate for Cepheid as point-of-care testing remains “very strong” and it is their belief that the company is gaining market share on this front. This strength helped offset some global easing of respiratory testing volumes resulting from the subsiding of Omicron outbreaks in most regions. The team expects this widening of demand shift from respiratory to a broader test menu to continue and believes they have a significant opportunity to drive broader utilization and demand for Cepheid’s point-of-care molecular testing solutions.

• While Covid testing had an outsized impact on this segment, management called out that clinical diagnostic markets volumes remain at healthy levels in all geographies as patients are returning for wellness checks, routine screenings, and other elective procedures.

• Speaking on the lockdowns in China, Diagnostics is expected to see the greatest impact in the second quarter due to the impact on patient volumes.

Environmental and applied solutions revenue of $1.16 billion came in ahead of the $1.15 billion expected, representing 6.5% core growth after adjusting for a 2.5% headwind from divestitures and 1.5% negative impact from foreign exchange rates. Additionally, adjusted operating profit came in at $251 million, down 16.6%, as the profit margin contracted to 20.3%.

• On the call, management called out that in the water quality division, ChemTreat realized its fourth consecutive quarter of double-digit core growth with accelerating demand for analytical chemistries and consumables driven by municipal, chemical, food, and beverage end markets.

• In the product identification group, the marking and coding business saw high single-digit growth, though this was partially offset by a slight decline in packaging and color management.

Bottom line

The company may not be getting the full credit of that 12% core growth rate as Covid-19 testing contributed 4 percentage points (meaning base business growth was 8%), above guidance for a low single digit tailwind. While we think testing is here to stay to some extent, investors are not going to give as much credit to Covid-related upside do to the uncertainty of sustainability.

Though we expect some of the noise around Covid testing to continue as we work through China lockdowns, it’s a distraction from Danaher’s long-term growth story. Three-quarters of the company’s revenue is consumables based (meaning they must be replenished) and demand is broadening out as wellness checks, routine screenings, and other elective procedures bounce back post-pandemic. 

With the broad-market sell-off returning to fashion due to macro-economic, interest-rate concerns, the stock of Danaher has been beaten down more than 5% since it reported the earnings results. We view this as an incredible buying opportunity, either to start a new position or to add to a current position.