2023-12-29 05:59:12 ET
Summary
- Parker-Hannifin has seen strong growth and successful integration of recent acquisitions, leading to solid financial performance.
- The company's decentralized structure and focus on engineered and IP products contribute to its long product life cycles and lower capital expenditure requirements.
- Shares have experienced a post-pandemic rally, driven by real growth in the business and the successful completion of a multi-billion-dollar deal with Meggitt PLC.
In June, I believed that shares of Parker-Hannifin (PH) were flying high, perhaps too high. The company has turned itself into a dealmaking machine in recent years, as it has integrated these transactions well, translating into solid growth and shareholder value being crated. This made me upbeat on the shares in the long haul, although I believed that quite some good news was priced into the shares already over the summer.
A Long Term Performer
Parker-Hannifin has been around for over a century, as it is a well-respected business which operates in a number of differentiated segments. Despite its larger size, Parker run a decentralized organizational structure which focuses on engineered and IP products. Typically, these products have long product life cycles while they have lower capital expenditure requirements.
Products and applications to think of include pneumatics, electrochemical activities, filtration products, climate control and sealing activities used in industrial and aerospace applications.
Pre-pandemic this was a $14.3 billion business which posted operating profits of $2.1 billion on which it reported net earnings of $1.5 billion, equal to about $11 per share. Trading near the $200 mark, valuations were rather fair, or even could be called appealing.
There were some moving parts as the company pursued some deals. This included a $3.7 billion deal for LORD in 2019 and a $1.7 billion deal to acquire Exotic Metals Forming soon thereafter, transactions set to bolster earnings power yet on the other hand they would increase leverage ratios to around 3 times as well.
A Post-Pandemic Rally
Shares rose to levels above the $300 mark in 2021, after which shares consolidated at levels around the $250 mark in 2022. What followed was a strong 2023 as shares rose from the $300 mark at the start of the year to levels around the $350 mark early this summer.
This was driven by real growth in the business, as 2022 sales rose by 11% to $15.9 billion, with adjusted earnings coming in at nearly $19 per share. The company guided for modest 2-5% growth in fiscal 2023 sales, seeing earnings at a midpoint of $18.50 per share.
There was another moving factor, that of a multi-billion deal for UK-based Meggitt PLC, a deal which closed in September 2022 and started to contribute to the business as well. This deal increases the aerospace component of the business to about a quarter of total sales, with the remainder generated from the core industrial markets.
As of this summer, the company has quite some good news to show with organic sales growth for 2023 guided at 10%, as the business posted sales at a run rate of $20 billion including Meggitt. Adjusted earnings per share were seen at a midpoint of $20.75 per share. Leverage was rapidly getting under control with net debt (excluding pension liabilities) down to $12.9 billion, for a 2.6 times leverage ratio.
With earnings power of roughly $20 per share translating into a reasonable 17 times earnings multiple at $350, this looked quite upbeat, but leverage was still substantial as one can ask if the company enjoys above-average margins in relation to the economic cycle. Weighing the pros and cons I decided to hold onto a modest long position, which I initiated pre-pandemic, as I was a happy holder, seeing no reason to sell out of my position yet, but not willing to increase my position either.
Momentum Continues
Since the summer, shares have risen another $100 dollar to highs of $458 per share here, with shares trading within immediate sight of their 52-week highs.
In August, Parker-Hannifin posted a 22% increase in fourth quarter sales to $5.1 billion on which it posted net earnings of $709 million, equal to $5.44 per share (or adjusted earnings of $6.08 per share) based on a share count of 130 million shares. This was aided by the Meggitt deal with full year sales reported at $19.1 billion, on which GAAP earnings of $16.04 per share were reported, with adjusted earnings reported at $21.55 per share, and these adjustments looking fair.
The company guided for relative stagnation in its fiscal 2024 results. Full year sales were seen up 3-6%, which compared to the $19.1 billion number for 2023 comes in around $20 billion. This is more or less in line with the annualised results for the fourth quarter. Adjusted earnings per share are seen between $21.90 and $22.90 per share, again, largely in line with the fourth quarter results, or even a bit less. Net debt ticked down to $12.1 billion, amidst the strong earnings reported in the meantime.
In November, Parker-Hannifin reported first quarter sales of $4.8 billion, up 15% on a reported basis compared to the year before (when Meggitt did not contribute yet) as organic sales were seen up 2%. Adjusted earnings were reported at $5.96 per share, with net debt down to $11.7 billion, again ahead of pension liabilities.
The company actually cut the midpoint of the full year sales guidance by half a percentage point, yet increased the adjusted earnings guidance to a midpoint of $23.00 per share, up sixty cents from the original outlook. With EBITDA trending around $4 billion here, in fact a little bit above that, I peg leverage ratios around 2.8 times, all in a rapidly low interest rate environment.
And Now?
The relentless rise in the share price since last summer has lifted expectations. While earnings come in a stronger than expected, shares have mostly risen on the back of valuation multiple inflation, pushing up the valuation from about 17 times earnings to about 20 times earnings, all while leverage still requires some work.
Calling and believing that the re-rating is largely complete, I am not just tempted, but am actually puling some chips off the table, after a very strong rally during 2023, leaving the shares more than fully valued here. That being said, I am actively looking for a dip to buy into this quality player again, but for that shares would need to fall back to the $400 mark as a minimum pullback, preferably fall to levels somewhere in the $300s.
For further details see:
Parker-Hannifin: Re-Rating Nears Completion