Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

The list of industrial companies on breakup watch is long and growing. Dover Corp. and Danaher Corp.'s earnings reports on Thursday should move them higher up the spectrum of probability, for very different reasons.

Let's start with Danaher. The maker of water-purification technology and dental implants is only kind of, sort of an industrial company at this point. It's spent close to $20 billion on life-science and diagnostic-equipment deals since the start of 2015 and spun off its more industrially inclined sensor and automation-equipment businesses last year. That shift, along with minimal exposure to the rout in oil and gas markets, has helped shield its revenue from the slumps that have plagued other companies (like Dover). And yet, ever since Danaher announced its breakup, there has been a feeling that its transformation missed a spot, namely its dental unit.

It's not a horrible business, but Danaher's reputation as a top-notch operator with a consistent track record of profitability and revenue gains has meant investors hold it to high standards and the dental unit's missteps have stood out. Excluding currency swings and M&A, dental sales dropped 1 percent in the second quarter.

Toothache
Danaher blames its dental disappointment on inventory cutbacks for its consumable products. Rival 3M hasn't seen the same weakness in demand and is actually taking market share, as RBC analyst Deane Dray points out.
Source: Bloomberg Intelligence

That unexpected decline was a big reason why Danaher's overall organic revenue growth for the period fell short of analysts' estimates. Dental had already dragged down results in the first quarter, raising doubts as to whether Danaher can accelerate sales enough in the back half of the year to meet its 2017 growth targets of 3 percent to 4 percent.

Big Leap
Meeting its organic revenue targets will require a significant jump in Danaher's core sales growth in the second half of the year. It may not get there.
Source: Bloomberg
Note: Data for full year goal reflects the midpoint of Danaher's 3 percent to 4 percent guidance.

Company executives danced around the issue, saying only that they expected organic sales growth of "ballpark" 3 percent in the third quarter and then "better than that" in the fourth quarter. Given its results so far, that would seem to imply Danaher will at best be at the low end of its forecast. The shares dropped as much as 5 percent. The company has pledged to treat the dental unit as it would a new acquisition, consolidating brands and facilities to wring out cost savings. But the ongoing woes raise the question of whether it should instead be treating the business as a new divestiture candidate. Margins are also toward the low end for Danaher's businesses.

Then there's Dover, whose results Thursday actually looked more like Danaher's typically do, with strong second-quarter organic sales that easily bested analysts' estimates. The biggest contributor was Dover's energy unit with a 39 percent rise in core sales.

Progress Report
Dover is still trading at a discount to its 2014 peak, but with a 25 percent rise in the shares over the past two years, some of the recovery in its energy business has been priced in
Source: Bloomberg

Dover is reaping the benefits of an upturn in spending on energy equipment, but the volatility of that business has overshadowed what is otherwise a fairly profitable, cash-generative company. Inevitably, the pendulum will swing back the other way and speculation has been rising that Dover may sell the business before that happens. CEO Bob Livingston has been wary of parting with it too early and depriving investors of the full benefit of its recovery. William Blair & Co. analyst Nick Heymann estimates the energy unit will account for as much as 70 percent of Dover's earnings growth in 2017 and 25 percent to 30 percent in 2018.    

There's a fair argument for waiting, but, as Vertical Research Partners analyst Jeff Sprague recently put it to me, there's also a risk in trying to time the oil market to both reap the earnings benefits of a recovery and sell at a peak price. The recent roller-coaster in crude prices has been a good lesson that no one really knows where oil is going. Dover's latest results and boosted guidance show the energy business is finding its footing, but general wariness about oil markets and the sustainability of Dover's progress make an argument for not waiting too long.

The breakup clock is ticking.   

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net