Is it Time to Buy Danaher Corp?

Unfortunately, Danaher Corp unveiled a second-quarter set of results that only sought to prove how choppy the global economic recovery has been. Its earnings were mixed, with its life science operations notably outperforming other industrial areas -- in common with what Pall Corporation  has been reporting. Moreover, the two principal areas of weakness should sound a note of caution to other investors.


Danaher Corp. saw weakness in its communications results -- test and measurement segment. This doesn't bode well for Agilent Technologies. Also, dental consumables sales disappointed; they looked more promising in the previous quarter. This isn't a good sign for dental distributor Patterson Companies, Inc..


Danaher Corp. disappointsGoing into the second quarter, investors had some cause for optimism. After all, in the first quarter, the company had recorded core revenue growth of 3.5% -- at the high end of its full-year forecast of 2%-4% core revenue growth. However, the second quarter saw core revenue growth slow to 3%.
In addition, Danaher Corp. saw margin growth held back by some setbacks in its communications and dental consumables businesses. Readers can see how this affected profit growth in the following chart.

Source: Danaher Corp. Presentations

In fact, the issues spoiled Danaher's otherwise excellent record of segmental operating margin expansion.


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Danaher Corporation Equity Research

Industrial conglomerate Danaher Corporation's  recent results were better than they superficially looked. Even though its second quarter guidance was lower than the market had hoped for, there is good reason to believe that Danaher has upside potential in 2014. Moreover, the earnings report suggested good things for other companies such as dental distributor Patterson Companies   in 2014, but less so for testing and measurement company Agilent Technologies . On balance, the positives outweighed the negatives, but is the company's stock still a good value?

3 reasons why Danaher's results were good
Danaher is the sort of company that often disappears under the radar of investors due to its low dividend yield and its P/E ratio of over 20 times current earnings. Moreover, its less than double-digit forecast EPS growth rate doesn't excite many. On the other hand, it's one of the best run companies in the industrial sector, and has relatively defensive end markets.

Focusing on the recent results, there are three key reasons why investors should like the company's stock.

 

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Sirona Dental Systems Equity Research

One of the hardest puzzles in investing is to know what to do when a long-term growth story experiences a slower year. This is exactly the issue facing investors in dental CAD/CAM equipment maker Sirona Dental Systems. After three years of reporting constant currency growth of 16.4%, 12.6% and 11.7% respectively, Sirona's forecast of 4%-6% constant currency growth to Oct. 2014 looks disappointing. It's time to look more closely at the factors influencing its growth.

Four key questions for Sirona Dental
A quick look at its segmental gross profits illustrates that its CAD/CAM systems and imaging instruments are its core profit centers.

Source: Company presentations.

In particular, its CEREC CAD/CAM systems are the key to growth. The systems are distributed exclusively by Patterson Companies  in the U.S., and by Henry Schein  in Europe. Essentially, the systems gives dentists the opportunity to offer same day teeth restorations. Focusing on CEREC, there are three key questions that investors need to ask themselves.

Sirona Dental's gross margin
The first question is what will happen to Sirona's gross margins in 2014?

Sirona faces some challenges and opportunities with margins. Management indicated that next year's gross margins would be flat, but its CAD/CAM segment gross margins could decline by 50 to 100 basis points. One key issue is that its customers continue to trade up to Omnicam CEREC from its older CEREC Bluecam system. The main differences in performance are outlined in this video. Omnicam has a higher ticket price so it generates higher revenue, but its gross margin is lower. Ultimately, both products generate similar gross profits, so investors should expect lower margins as trade up occurs. Indeed, in the fourth quarter CAD/CAM gross margins fell to 64.5% from 68.9% last year, even as revenue grew 35.2%.

The other margin issue to look out for is that, Sirona's management nudged the market toward expecting emerging markets to contribute more growth next year.

Our geographic diversification continues to be an asset for Sirona. Our non-European international markets accounts for 35% of sales. We expect them to be a key driver of growth in fiscal 2014.

If you assume that emerging markets will tend to want to buy lower-priced products than this could imply a lowering of margins in 2014.

Sirona's CEREC penetration rates
The second question is can Sirona increase its penetration rates with its CEREC system?

This is the key to its long-term growth. The CEREC chair-side milling system is now in 15% of dental offices in Germany and 14% in the U.S. Penetration rates are significantly lower outside of these markets. These figures imply that long-term growth can take place in these core markets, and help -- at least in the U.S. -- could come from an unlikely source. Henry Schein has recently agreed a deal to distribute E4D Technologies CAD CAM system in the U.S. Although this is a rival system, Henry Schein's distribution of this product in the U.S. will surely increase awareness of the need for CAD/CAM systems. In other words, it could spur "me too" purchases of Sirona's systems.

Sirona's geographical growth
What will Sirona's geographical growth look like?

Germany and the U.S. make up 50% of Sirona's sales, and they grew 20% in 2013. The U.S. benefited from some pull-forward in sales due to the medical device tax, and from Omnicam trade ups. Germany was described as being "very difficult to grow" in 2014. In other words, growth is going to be a lot tougher in its core markets.

One issue is that Bluecam was only launched in 2009 , and many dentists may feel reticent to upgrade a system only purchased a few years ago.

Another issue that could possibly impact Sirona was mentioned on its U.S. distributor, Patterson Companies, conference call.

one of the issues we did run into in the quarter was the process of installing... ...Omnicams to our Bluecam customers. That process took longer than we had anticipated... ...our salespeople ended up taking more time in terms of the change management process.

Obviously, this is more of an issue for Patterson Companies, but if it causes an inventory build up, then Patterson may decide to slow the growth of orders from Sirona.

And finally, the cost of a CEREC system to its non-core emerging markets may prove prohibitive.

Where next for Sirona?
All told, it's likely to be a year of slower growth for the company, but not all growth stories are linear. The stock may well sell off in response to some disappointing guidance, but Foolish investors should watch closely and look out for an entry point of it does so.

Time To Buy Patterson Companies

Sometimes investing is about buying go-go growth stocks that are lovingly discussed by the general public, and sometimes it's about buying boring medical supply stocks like Patterson Companies  . Patterson's end markets of dental, veterinary, and medical rehabilitation aren't growing very fast, but the company has taken a number of initiatives to generate growth. Moreover, the underlying business is highly cash generative. It's worth taking a Foolish look.

Patterson beefs up its veterinary supply business
The company reports in three segments, with dental being its largest revenue generator.

Source: Company presentations.

In each of these segments, Patterson has been taking measures in order to generate earnings long-term earnings growth.

Eagle-eyed readers will note that the veterinary division has seen a jump in revenue this year, which is largely due to the $117.7 million contribution from the acquisition of U.K.-based veterinary distributor NVS, from its former parent Dechra Pharmaceuticals. The deal is particularly interesting because unlike its rival Henry Schein    Patterson didn't have substantive international veterinary operations before the acquisition took place.

In recent years, NVS has tended to be a low-growth but highly cash generative business. Dechra's focus has been on expanding sales of its growing veterinary pharma business, and its 87.5 million pound sale of NVS looks like a good deal for both companies. Dechra reduced its debt with the cash while renewing its focus on pharma. Meanwhile, Patterson bought the leading player in the U.K. vet supply market for just 10.4 times its underlying profit. That's an attractive valuation considering that Patterson currently trades on a P/E of 19.3 times forward earnings.

NVS generated 333.2 million pounds (around $539 million) in revenue in its year to June 2013 with 5.5% revenue growth, but has wafer-thin operating margins of 3.3%. It's entirely possible that Patterson can use its distribution expertise and scale in order to generate some margin improvement in the future. Indeed, Patterson is expecting the acquisition to be earnings accretive by $0.03-$0.04 in 2014 alone. More to follow?

Patterson's mixed earnings from dental
In theory, the dental market should provide strong long-term growth for Patterson. An aging U.S. demographic and better dental care (which implies more teeth per mouth to service) should mean increased demand in the future. Unfortunately, dentists don't see it that way at the moment and are reluctant to spend on core equipment. According to Patterson's management on its conference call:

While dental consumable sales were up year-over-year, consumable growth remained sluggish... ...On a macro level, since the economic downturn, dentists have remained cautious about expanding and upgrading their basic practice infrastructure, which includes chairs, units and cabinetry. 

Patterson's dental supply sales were up just 2.5% in the third quarter, with consumables only up 1.7%.  Equipment and software sales were up a more impressive 4.3%, and this is where the immediate growth prospects lie.

Indeed, Patterson has taken measures to accelerate dental growth by expanding its relationship with dental dental CAD/CAM company Sirona Dental Systems . Sirona's CEREC system allows for same-day teeth restorations, and the technology looks set to benefit from strong growth in future years. Indeed, Sirona just gave its full-year results and reported 18% revenue growth with its CAD/CAM and imaging solutions. Its growth is always likely to be lumpy (it's somewhat contingent on the timing of new product releases), but Sirona (and Patterson) should receive a boost from an unlikely source.

Henry Schein recently signed a deal with Sirona's rival E4D Technologies in order to roll out E4D's CAD/CAM technology to various dental practices in the U.S. This could be good news for Patterson and Sirona, because Henry Schein's move (it already distributes Sirona's products in Europe) will help create awareness of the benefits of this class of technology. Ultimately, this could spur adoption of Sirona's CEREC system.

Medical disposals and IT investment
Patterson's medical rehabilitation business is in a tough market as austerity measures impinge on its growth opportunities. Its sales declined 5% in the third quarter, but this is partly due to measures taken to drive long-term earnings growth. In response, Patterson has been disposing of some of its non-core medical assets in a bid to cut costs. Management forecasts that savings equivalent to $0.01 in EPS will be generated by these measures starting in 2015.

And finally, Patterson is investing between $55 million and $65 million in IT over the next five years in order to ensure future productivity gains.

Where next for Patterson?
After excluding the $0.12 restructuring charge taken for its medical business, its internal guidance is for $2.13-$2.24 in EPS for the year to April 2014. This puts the stock on a P/E ratio of 19 times forward earnings. This may seem expensive but recall that Patterson has generated an average of $264 million in free-cash flow over the last three years. This equates to around 5.8% of its enterprise value as I write.

In conclusion, Patterson has been busy engaging in "blocking and tackling" initiatives to improve its productivity in medical. Veterinary has seen the acquisition of NVS, and its dental segment has expanded its relationship with Sirona. All three measures are set to increase its long-term potential, and Foolish investors should look favorably on the stock.

Sirona Dental Systems Looking Good

The market decided it didn’t initially like dental equipment maker Sirona Dental Systems’ (NASDAQ: SIRO) third-quarter results, and subsequently marked the company down by more than 5%. Investors may well have reacted negatively to the margin declines in each of Sirona’s business segments, but that shouldn’t detract you from its positive long-term prospects. In fact, here's why now looks like a good time to pick up the stock.

Sirona generates growth

I’ve described Sirona as a "dental equipment maker," but this shouldn’t make you think of it as a boring low-growth company. On the contrary, it’s actually a proprietary technology company set to generate long-term growth, primarily thanks to its revolutionary CEREC CAD/CAM system. The system allows for same-day teeth restorations, and generates significant cost savings for dentists. It also allows patients to be treated more quickly, and with less intrusive procedures.

While the benefits of the system are obvious, the CEREC system’s up-front costs can be prohibitive to emerging-market customers. Indeed, it is noticeable that much of the strong growth in the third quarter came from Sirona's U.S. and German operations. Constant currency revenue growth was up 15.7% overall with U.S. growth cited as being up a whopping 28.8%.

Furthermore, Sirona stated in its results presentation that international sales were up 10% in constant currency, “led by an exceptionally strong performance in Germany.” Going forward, it will be challenged to continue generating growth in the U.S. and Germany, while finding a way to increase penetration rates in other markets as well.

Sirona’s growth plans

Sirona’s plans to increase market penetration include its ‘CAD/CAM for Everyone’ initiative. The latter involves trying to segment the market by offering a range of products and solutions. In fact, Sirona has 25 new products in its portfolio to sell through to customers. Dentists can buy the solution best tailored to their needs, at a price point that they find comfortable.

A big part of the plan involves training Sirona’s distribution partners, principally Patterson Companies (NASDAQ: PDCO) and Henry Schein (NASDAQ: HSIC).

Patterson is Sirona’s exclusive distribution partner in the U.S., and it’s notably bullish on its prospects to generate growth by distributing high-tech products such as the CEREC system. Patterson needs to focus on these areas, because its core equipment sales to dentists have been slowing. Dentists remain cautious in their spending habits.

Sirona’s chief European distributor, Henry Schein, has similar plans. Low growth in its dental consumables sales is spurring it to focus on selling Sirona’s systems in Europe. In summary, both distributors are a large part of the ‘CAD\CAM for Everyone’ plan, and with their distribution expertise, they should be able to sell the new products on successfully.

Margins declining, product mix responsible

Unfortunately, gross margins declined in every one of Sirona’s segments.

Source: company accounts.

However, it’s not time to panic.

Firstly, CAD/CAM margins were down thanks to increased sales of the new Omnicam camera system. Incidentally, you can learn about the differences between Omnicam and Sirona’s older system, Bluecam, in a video linked here.

Omnicam’s ticket price is higher than Bluecam, but its costs are, too. In its conference call, Sirona outlined that while gross profits are similar for the two products, margins are lower on Omnicam because of those higher costs. In other words, the acceleration in Omnicam purchases is likely to create profit growth at margins' expense. That's not a big deal as long as profits are still growing strong.

Second, margins in imaging usually bounce around for Sirona, so the decline this past quarter shouldn't be worrying. It owed to changes in the product mix. Moreover, despite the decline in Sirona's treatment center margins, they remain above its targeted figure of 40%.

And finally, potential investors need not worry too much about small movements in margins with treatment centers and instruments sales, because they only make up around 20% of gross profits at Sirona.

Source: company accounts.

Where next for Sirona Dental?

In conclusion, the margin declines at Sirona are really not a big deal, and the company's long-term plans make good sense. Sirona’s distributors are keen to push its new products, and with CAD/CAM penetration rates in the low teens in the U.S. and low-single-digits internationally, its long-term growth prospects look favorable. Sirona’s technology presents a rare way to get exposure to a secular growth trend in a stable industry like dentistry.

Sirona now trades at a relatively cheap valuation compared to where it has been over the last few years.

SIRO Price to Cash Flow TTM data by YCharts

The market reaction looks overdone, and this could be a good time to take a position. Analysts have low-teens growth penciled in for the next few years, and the stock looks attractively priced for its long-term prospects. In fact, I found Sirona compelling enough to buy some shares for myself.

Patterson Companies Looks Like a Good Value Stock

Investors had a right to feel a bit cautious about what Patterson Companies (NASDAQ: PDCO) might say in its full year results, but in the end the results were quite good.

Its end market conditions are not ideal and its hard to see the stock recording rip roaring top line growth over the next few years. On the other hand, it offers investors a good value proposition coupled with decent earnings prospects and some upside from an improving economy. Moreover, its downside is somewhat protected by the core stability of its dental earnings.

In summary, Patterson is an attractive stock for cautious investors or those looking to balance the cyclical end of their portfolio.

Patterson Companies reassures investors

It might seem contradictory to refer to the need for Patterson to reassure investors while also mentioning its stability, but there were a few short term questions going into these results.  I’ve noted three of them below.

•  Its rival Henry Schein (NASDAQ: HSIC) had spoken of a pull forward effect in Q4 caused by speculation over the potential loss of a tax benefit. Although Patterson had said in February that this wouldn’t have an effect on its numbers, the issue was likely to still be on investor’s minds.

•  Its consumables and core equipment sales had been weak in the back half of the calendar year, and the fear was that this could extend into this year.

• The overall economy hasn’t grown strongly, so the macro pressures on dentists were still likely to constrain spending.

All of these fears were pretty much allayed in Patterson’s results. The pull forward effect didn’t really occur for Patterson, and I’m wondering whether Henry Schein saw this because its sales force emphasized this in Q4.  Moreover, Henry Schein has a couple of major trade shows that should help it report good Q2 numbers. Like Patterson it is not the most exciting stock, but if you are looking for solid cash generator with limited downside and moderate upside Henry Schein could fit the bill. Analysts have it on near 10% earnings growth rates for the next couple of years. Nothing wrong with that!

For Patterson, consumables sales were up 2.4% and basic equipment (chairs, cabinets, lighting etc) sales rose ‘double digits’ in the quarter. While the latter appears bullish, its management was not keen to ‘call that out as a trend.’

Essentially dentist spending decisions will still be guided by their feelings about the economy, so we should expect it to continue to correlate with that. The good news is that dentistry spending is stable, and even in a downturn there will still be decent core demand for basic dental equipment.

Growth prospects?

Going forward I suspect it is more of the same from Patterson. The expansion of its distribution deal with Sirona Dental Systems (NASDAQ: SIRO) in order to sell its entire product line is a clear sign that it wants to migrate sales towards higher growth technology based sales. I’ve discussed Sirona at some length in this article. The key drivers of its growth are its market defining CEREC CAD/CAM system and its imaging systems, both of which Patterson distributes.

The CEREC system’s penetration rate is still in the low teens in the US, and multi-year growth looks assured. It can also generate growth in less developed markets thanks to its CEREC connect system (which allows a group of dentists to utilize the system) sales. Analysts have Sirona on double digit revenue growth for the next few years, and trade shows like the IDS in March are also likely to spur market take-up. In the longer term, an aging demographic (with more teeth per mouth) will ensure long term demand for teeth restorations--all of which speaks to good potential for Patterson.

The technology side of its dental operations is doing well, and it needs to be, because elsewhere Sirona is seeing some weakening. For 2014 it forecast low single digit growth in dental consumables, and the overall equipment market is forecast to grow in mid-single digits.

Meanwhile, it gave a mixed outlook for its other divisions. Its veterinary operations were predicted to grow at 3%-5% amidst talk of ‘headwinds’ and tougher comparisons, while its medical business was forecast to operate within an underlying market that was ‘flat to slightly down.’

Sirona's outlook pretty much mirrored what Henry Schein had said earlier. It had also spoken of stability in North American dental conditions and an overall animal health market growing 4%-5%. In addition, its commentary on competition from local players (versus large national distributors like Patterson and Henry Schein) was very interesting. It argued that the increasing share of dentistry spend on technology would make things harder for the smaller players. This is obviously good news for Patterson too, and suggests that there are consolidation opportunities within the fragmented dental distribution sector.

Where next for Patterson Companies?

In conclusion I think Patterson's attractive features remain in place. It is not the sexiest stock out there, but it is highly cash generative, with $277 million in free cash flow brought in for 2013 and a similar amount forecast for 2014. This represents 6.5% of its enterprise value of $4.25 billion, and given the relative stability of its growth prospects I think it is a decent value.

The question will always be over its growth prospects. Investors will have to look for sales of Sirona’s products to generate top line sales growth and hope for an improvement in overall economic conditions. In addition Patterson announced a $55-$65 million investment in information systems which should generate operational efficiencies (and margin expansion) down the line but will reduce EPS by around $0.06 next year.

It is a nice mix of modest upside potential with limited downside and on a decent evaluation. Well worth a look for a value investor.