About a year ago, I concluded that it was time to fly for shares of Parker-Hannifin Corporation (NYSE:PH) following an increased focus on its aerospace business. The company saw strong momentum at the time, welcomed as the company was looking to close on the acquisition of Meggitt PLC.
Amidst a recent pullback in the shares (at the time), valuations looked a lot more reasonable, creating a foundation to stick to a long position.
A Well-Respected Business
Parker-Hannifin has been around over a century, being a well-respected business which is active in a number of differentiated segments, supported by a decentralized organizational structure, focus on engineered and IP products, and products with long product life cycles and low capital requirements.
Some of these activities include pneumatics, electrochemical activities, filtration activities, fluids & gas handling, climate control and sealing. Like so many (industrial stocks), the company has seen a preliminary peak around 2018 amidst the Trump America-first policies, when shares traded around $200.
Pre-pandemic, the company was a business posting $14.3 billion in sales and operating profits of $2.1 billion, with earnings of $1.5 billion coming in at $11 and change on a per-share basis, with shares trading at a non-demanding 15 times multiple at the time. A 2 times leveraged balance sheet would increase following a $3.7 billion deal for LORD in April 2019, and a $1.7 billion deal to acquire Exotic Metals Forming later that summer, pushing up earnings power, but leverage ratios to about 3 times as well.
Pre-pandemic, shares traded around the $200 mark as shares rose to the $270 mark by year-end, as shares hovered around the $300 mark during the market boom in 2021. Despite a setback to $250 during the uncertain periods in 2022, shares have risen and now trade at $356 per share, trading within imminent reach of the high levels seen so far.
If we look at the operating performance, the business was hit in 2020, but it saw a swift recovery, and in fact the company moved on to announce an $8.8 billion deal for UK-based Meggitt in the aftermath of the pandemic. With shares trading around 15 times earnings based on $18 in earnings power when I picked up coverage at $270 last year in May, it was time for shares of Parker to continue to do fine, following increased aerospace exposure.
Doing Well
Since May of last year, Parker’s shares have been doing quite alright, driven by resilience in the underlying business. Fiscal 2022 sales rose 11% to $15.86 billion, as adjusted earnings of $18.72 per share rose in a convincing manner from a roughly $15 per share number in 2021. GAAP earnings only came in at $10.09 per share, with the vast majority of the gap explained by losses on forward contracts related to the Meggitt acquisition. For the fiscal year 2023, the company guided for 2-5% organic sales growth and adjusted earnings between $18.10-$18.90 per share, seen rather flattish, with the guidance explicitly excluding the still pending deal for Meggitt.
That GBP 6.3 billion deal eventually closed in September of last year, as the first impact of the deal was seen (partially) in the first quarter results for the fiscal year 2023. First quarter sales rose 12% (on a reported basis) to $4.23 billion, with adjusted earnings reported at $4.74 per share. Net debt was reported at $13.4 billion (or just over $14 billion if we factor in pension labilities), with quarterly adjusted EBITDA approaching the billion mark.
With the Meggitt deal contributing entirely in the second quarter, quarterly sales were up 22% to $4.67 billion, with adjusted earnings reported at $4.76 per share. Actual earnings growth was limited amidst rapidly rising increase expenses, with quarterly EBITDA reported at $1.05 billion. The company hiked the full year guidance, calling organic sales to be up 6-8%, with full year adjusted earnings seen between $19.20 and $19.70 per share.
Amidst this better operating momentum, albeit with a leveraged balance sheet, the company announced a convincing 11% hike in the quarterly dividend to $1.48 per share, the 292nd consecutive quarterly dividend being paid out to investors.
In May, Parker announced a 24% increase in sales to $5.06 billion as the accelerating growth was actually seen on the bottom line as well, with adjusted earnings up 23% to $5.93 per share. Following this quarterly report, the company hiked the organic sales guidance to about 10%, with adjusted earnings now seen between $20.60 and $20.90 per share. With quarterly EBITDA numbers reported at $1.22 billion, the earnings power is improving, all while net debt (ex pension liabilities) is down to $12.9 billion.
And Now?
The reality is that Parker has been very aggressive with regard to dealmaking in recent years, but it seems to have paid off. Earnings power now trends about $20 per share in a tough economic environment, with shares now trading at 17 times earnings based on the prevailing share price of $356.
Note that this multiple is now seen in a higher interest rate environment, and that Parker has traditionally traded at a lower multiple (although the performance is solid). On the other hand, there is still some debt apparent (although that relative leverage ratios are quickly coming down) and the concern that margins and thereby earnings might not be sustainable in a slower economic environment. Despite an uncertain economic environment, Parker-Hannifin Corporation is actually on fire in terms of its operating performance.
I can only conclude that Parker-Hannifin Corporation continues to defy my expectations and with leverage down to a 2.6 times leverage ratio, I like the progress on that and the earnings power front, yet fear the cyclicality and higher than historical margins. Given all this I am still happy to hold a rather modest long position which I initiated pre-pandemic, but see no reason to add here, despite the solid operating performance, as Parker-Hannifin Corporation investors have priced in some of these achievements already in recent months.
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