Danaher (DHR) reported second-quarter earnings that were much better than expected on Thursday.

The medical diagnostics and health technology company posted revenue of $7.75 billion, outpacing the $7.26 billion consensus. That represents 9.5% annual core growth, well above the 2.4% expected by the Street. Even when excluding the impact of Covid-related sales, Danaher’s base business realized organic growth of 8% versus the year ago period. On the bottom line, earnings of $2.76 per share, an increase of 12.0% year-over-year, exceeded the $2.34 per share expected.

These are the reasons why the stock popped ~9% on Thursday, a well-deserved reaction.

Segment results

Life sciences revenue of $3.97 billion outpaced expectations of $3.91 billion, representing 7% core growth after adjusting for a 4% benefit from acquisitions and a 5% headwind from foreign exchange rates. Additionally, adjusted operating profit came in at $1.17 billion, largely unchanged and up 2.6% from the prior year’s period as the profit margin contracted 100 basis points to 29.6%.

• On the call, management called “broad-based growth across the segment,” adding that high-single-digit or better base business core revenue growth was realized at all of the larger operating companies within the segment including Cytiva (formerly known as GE Life Sciences) and Pall Biotech.

Diagnostics revenue of $2.56 billion outpaced the $2.2 billion consensus, representing solid 12.5% core growth, after accounting for a 1% benefit from acquisitions and a 4% headwind from foreign exchange rates. Additionally, adjusted operating profit came in at $800 million, up 23.3% year over year, as the profit margin expanded 340 basis points to 31.2%.

• Leading the segment’s strong growth was nearly 30% growth at Cepheid, while other operating businesses such a Beckman Coulter Diagnostics, Radiometer and Leica Biosystems delivered mid-single-digit core revenue growth collectively.

Environmental and applied solutions revenue of $1.22 billion came in ahead of the $1.16 billion expected, representing 10% core growth after adjusting for a 3.5% negative impact from foreign exchange rates. Additionally, adjusted operating profit came in at $307 million, up 9.6%, as the profit margin expanded 70 basis points to 25.1%.

• On the call, management called out that double-digit core growth in the water quality division and mid-single-digit core growth in product identification.

Guidance

Looking to the third quarter, management expects base business core revenue growth (meaning organic growth after factoring Covid-related sales) to be in the high-single-digit percent range. After adjusting for a mid-single-digit growth headwind from Covid-related sales, management expects overall core revenue growth to be in the low-single-digit percent range. These forecasts compare with Wall Street expectations for 2% organic growth coming into the print.

For the full year 2022, management continues to forecast base business core revenue growth in the high single-digit percent range. When factoring in the Covid testing headwind, overall core revenue growth is still expected to be in the mid-single-digit range. This compares with an expectation for 5% full-year core growth coming into the print.

Bottom line

It was a great quarter for Danaher as those strong headline results were met with operating margin expansion. Moreover, free cash flow generation remains solid, the balance sheet is healthy and about 75% of sales are recurring in nature (think consumables that require replenishment) — a crucial factor supportive of a higher valuation multiple.

Additionally, while China lockdowns were a headwind, management effectively navigated the environment and impressively, managed to realize high-single digit growth in the region, “significantly exceeding” management’s expectations; management previously guided for China to be down mid-to-high single digits.

One reason why Danaher greatly outperformed its expectations in China was its proactive approach to the supply chain and a high degree of employee dedication and execution. Danaher pointed out that its manufacturing employees literally lived inside their plants, with showers, cots, and food and clothing brought in to support conditions.

The lapping of Covid-19 poses a growth headwind for Danaher — mainly at Cepheid, in the diagnostics segment — due to the strong boosts the company realized on the back of increased testing demand. But the team said this decline is being offset by customers beginning to “consolidate their point of care PCR testing platforms onto the Cepheid Gene expert.” In other words, overall growth is expected to continue with non-Covid sales seeing an acceleration in the quarter as customers look to Danaher for it’s other best-in-class diagnostics offerings. This reaffirms our view that while the company certainly did benefit from the pandemic, the stock is much more than a Covid play.

Our price target for DHR is $330, representing 30 times 2023 estimates and implying nearly 20% upside to achieve what we think is fair value. That’s a slight premium to the historic valuation, but one we think is warranted given the recurring revenue profile and resiliency of the business model. These are also the two factors we believe investors will place greater emphasis on should economic growth slow.