Parker-Hannifin Corporation (PH) Earnings Call Transcript & Summary

Good afternoon, and welcome back to the Wolfe Industrials and Transports Conference. My name is Nigel Coe. I'm the firm's multi-industry analyst. Today is Wednesday at 1:00 p.m. -- Wednesday, 26th of May. Very, very happy to be welcoming Parker-Hannifin back to the Wolfe conference, specifically, CEO, Tom Williams. Tom, thanks for your time. Always a great opportunity to have a chat with you. Tom, I think you're going to run through some slides for 5 minutes or so, and then we'll get into Q&A. So Tom, over to you.

No, sounds good. Thank you, Nigel. It's great to be part of this conference. So if you go ahead and go to the next slide. Everybody is familiar with the forward-looking statement, and we'll pass through that. So I wanted to start with talking about the breadth of our technologies, and we have 8 motion and control technologies, which is really unmatched in our space and allows us to create a distinguishing value for our customers in a way that nobody else can. These interconnectedness of these technologies really is meaningful to our customers so much so that 2/3 of our revenue comes from customers that buy 4 or more of these technologies. This is especially evident as we start to move to more clean technologies around the world. These technologies are really coming to bear, which is on the next slide. So if you look at this example. This is an electric vehicle, which I talked about in the earnings call. On the left-hand side, the applications that change when you go from a combustion engine to an EV. On the right-hand side are our technologies, whether it's safety, weight, thermal management or just other critical protection systems. We have a significantly bigger bill of material. We're helping to enable a more sustainable future. And additionally, we're actually having to grow faster with this movement. So whether it's on automobiles, construction vehicles, ag, forestry, we're going to see this bill of material plus type of movement throughout our portfolio as we move to a more electric world. Go ahead. One of the things I wanted to show and, again, I showed this last earnings call. This falls into the picture is worth a thousand words to kind of talk about how the company is different in 2 ways, how we're just different from historical performance, how we're different versus the PMI. So to orientate you to the slide, the gold bars that you see here are our adjusted EPS. The blue line that overlays that is global PMI plotted on a quarterly basis. If you look from when the Win Strategy 2.0 was launched, which was the middle of -- towards the end of FY '15, calendar FY '16 fiscal year, you see a significant change to trajectory of EPS. We've more than doubled EPS from $7 to our $14.80 guide. I'll show you the EBITDA margins on the next slide. But you can clearly see, if you look at that dotted green line, a clear divergence versus global PMIs and how we've been performing. There's really 3 factors that's on the bottom of this page in that take away. Our people and the engagement of their efforts, the engagement scores that we've been seeing in their ownership has driven the performance of the company. The portfolio changes we made with 3 acquisitions that we did in the last number of years and the performance, which was really driven by Win Strategy 2.0 and 3.0, definitely transformed the performance of the company. So you see it on EPS and you see it on the next slide related to EBITDA margins. So over this period of time, it's grown 630 basis points. We don't guide to EBITDA margins. So what you see on here are just our year-to-date EBITDA margin, but significant progress. And we haven't necessarily had any wind at our back during this time periods. This is a lot of self-help driven by portfolio and strategy things. Go ahead. So I wanted to close with a summary of Win Strategy 3.0. There's a lot of content on 3.0. So I'm just going to give you kind of the cliff notes version of what changed. The first would be on simplification, which we launched in 2.0. So build on the things we were doing related to structure and organizational design in 80/20, what we had is Simple by Design, which is after going after the product cost, which is about 70% of our product costs are tied up in how we design the product. If you look at where most people spend their time, they spend things on making, buying and so on, which are important activities, but we want to spend equal time on the design excellence things. We want a company as design excellence and operating excellence, and that's what Simple by Design is all about. On innovation, we added a couple of updates to our Winovation process, and that's the process from idea to launch. And what we did is we added one tool to help train our engineers to have a more outside-in look at how we've developed this. And that's called new product blueprinting. So we've trained all of our engineers on that. So it teaches them how to be better observers, how to be better interviewers of our customers and the end users. Add to that, we put a metric in place, PVI, product vitality index, which measures on a rolling 5 years the percentage of new products that we've introduced as a percentage of our total revenue. The next bullet is digital leadership and think about it as digital customer experience, digital products or IoT, digital operations, so bringing that into the factory, factory of the future and digital productivity, which is where AI sits. So digital leadership is a big initiative underneath customer experience. We're going to continue and expand and grow distribution, in particular, internationally, like we introduced with 2.0. In 3.0, we brought in the concept of Kaizen. If you put Kaizen together with our high-performance teams with lean and with safety, I would say that's circle of those 4 things having driven engagement at a much higher levels. If you plot our engagement survey scores, you'll see a direct correlation to that trajectory and the trajectory I just showed you earlier on EPS and on margins. We want to continue to be the consolidator of choice as far as acquisitions. We acquired 3 great companies: CLARCOR, LORD and Exotic, that were all accretive on growth, margins and on cash. And so we'll be looking to do the same thing as we -- our balance sheet is in a much better condition. We can put it to work now as we go forward. And then we're introducing a new incentive plan that replaces our current annual incentive plan called RONA. We'll be phasing this in over the next 2 years and think of it as a much simpler formula. It's going to focus on the division's earnings, cash flow and growth. It's easier to explain. It's higher correlated to TSR. And we piloted it in a couple of areas so far, and we've seen very strong positive feedback about this, sort of what it does to help drive the right kind of behaviors. And just people feel closer alignment to it, easier to understand, and it reinforces growth both organically and inorganically. If you put all this together, it's really the Win Strategy 3.0 and our purpose that's going to drive the performance of the company in the future. And we feel very bullish and put this on top of what I think will be a time period going forward where we'll have a little more winner back, and we feel very good about what the future will hold. And with that, I'll turn it back to you, Nigel, for the Q&A.

Thanks, Tom. That was a good foundation for our discussion. Let me just get my camera up. And for the folks on the webcast, again, just a reminder that happy to take your questions. So if a question, use your textbox on the webcast or IM me, and we'll get to those halfway through. Tom, you touched on a lot of really important strategic initiatives in your slides. If the exit is still down to 3 key objectives for the next 12, 24 months, what would they be? What would be the top 3 top of the mind issues here?

That's pretty easy. So I want to be a top quartile company versus our proxy peers, be a great deployer of capital, a great generator of cash, redeploy our capital, and then live up to our purpose, enabling engineering breakthroughs that lead to a better tomorrow, which is over my left shoulder here. And if we do those 3 things, we're going to be a company that the people are listening are going to want to invest in, and our customers are going to want to buy from. Of course, most important is that we have an organization that people want to work for. And if we do those 3 things, that's -- I think the far one on those, obviously, a lot of things that are needed to help create that, but those will be the 3 big.

Okay. And then just kind of coming on that thread about top quartile performance, margin performance has been absolutely exceptional. There's no question about that. Free cash flow conversion has improved dramatically. Balance sheet is in good shape. Organic growth has not been top quartile. You haven't had helpful cycles for the last decade. So it's very hard for us to judge how your market share has been trending through those cycles. How do you measure your share performance within your markets versus your competitors?

So we measure share as a total company and we also measure by key account. So for customer A, customer B, without naming names, where you go through that every quarter. But what we don't want to do on growth is we want to grow 150 basis points faster than the market. Now there's a lot of different proxies you can use for the market, but what we use is global industrial production growth and something you can publicly get. It has more white goods manufacturing in there, so it's maybe not a perfect proxy, but growing faster than that is what we want to do. The 150 basis points, we did a lot of work on that. That's a best-in-class number because very few industrial companies consistently do that. And that's, I think, the great -- not we need to crack going forward. We'll do that in a couple of ways. One, continue to change the portfolio in such a way we add companies that have better growth trajectories in the legacy Parker, which we've done in the last 3 deals and then continue to look at things that we'll do on innovation, Simple by Design, our incentive plans, continue to grow international distribution, strategic positioning, all of the things that would create a more growth -- organically growth-driven company. And I see a lot of traction on that. So I'm looking forward to, I think, the next several years. We have an opportunity to outperform that market. And more that we do that in addition to what we've been doing on margins, I think is really going to be a great time to invest in Parker.

Great. I mean, it seems like we may be on the cusp of a real sectoral recovery here. There are some debates around that, of course. But we've had -- post financial crisis, we've had very anemic recovery. We've had several so mini recessions during that time frame, 1 in Europe in 2011, 2012. We had one in the U.S. in 2015 and, of course, we've had COVID. And then 2019 was a tough year as well. Do you think that we now have a more sort of classic recovery ahead of us? Anything that you're seeing right now that might suggest that this might not be sustainable or are you very optimistic as you look forward?

Yes. I'm pretty bullish. I've had an opportunity to talk to a number of our customer CEOs over the last 4 months. And I would tell you that the tone from them is probably about as positive as I've heard. So right from our end customers, our distributors are feeling positive. You mentioned a lot of the things, Nigel, as far as that you can see macro-wise in interest rates and pent-up CapEx needs, infrastructure spending, all those kind of things. So those are all positives. But I think there's also some unique disruptive investments that are going to happen, and I would put it around the whole climate investment, clean technologies. And I think that in addition to the other macro things, it's going to make this next several years different, more sustainable. And you can't always predict the future. And part of what I look at is that -- so in my tenure, it's been 2 industrial recessions and a pandemic. And so I just build in my odds. The odds are what we do for better times. But besides just, I think, good fortune, I think there's a lot of secular things that are going to help us, and our portfolio is built with that clean technology shift.

Yes. Two recessions and a pandemic, not many CEOs can say that they've lived through those landscapes. But hopefully, some better look going forward. You touched on energy efficiency, infrastructure and 1 or 2 other factors. We all understand that more sort of construction activity, more fixed asset investment is good news for all industrial companies, Parker-Hannifin perhaps a bit more so. But what are the ways does Parker-Hannifin benefit from more EVs, more wind turbines, just more electrification? How do you capitalize on these trends?

So if we take say electrification as an example, the one I showed earlier, the automobile, that bill of material is 10x what it is for a combustion engine. We just have a lot more content. So the automobile is kind of a unique example because, over the years, we've divested a lot of things if we were omni automobile couldn't find a way to make money. We just focused on material science. Now we're in the factories making the cars, but the onboard content we kind of narrowed to an engineered materials piece. And what changed over time is that our content as we added LORD -- so we already had sealing and shielding technologies, some thermal management. And we added motor thermal management, much more extensive with LORD. We had a vibration control, coatings and adhesives. And so our bill of material grew quite nicely with that. And so to use an example, LORD grew 11% last quarter. And LORD is not 100% automotive. It's 1/3 automotive, 1/3 industrial, 1/3 aerospace. So it's not really getting much help on aerospace, as you might imagine now. And its industrial piece would look like, say, Parker's industrial. So it gives you an idea how much the automotive is growing. But then if you take that example and then move in to other equipment that might be electrified. So whether it's a construction equipment, forestry, ag, et cetera, mining, they're all going to need the same technology that we have today. So all those 8 technologies that was on my very first slide, what changes is the power source. So instead of it being a diesel engine, it might be a smaller diesel engine, the batteries, it might be a hybrid. It could be all EV, could be a fuel cell, could be a hydrogen-driven combustion process. And so we have opportunities because we're going to keep all the same functions that we have, the work functions, how do the implements move on the vehicle. Those all stay the same, but now all the electrification things you have to add to it. So you need a motor controller software, and we're in the middle of developing all those and working with customers with some of their initial platform changes. But then that same change on material science will happen with these -- this equipment as well, because it needs more thermal managers. It's going to have -- it's going to run hotter. It needs vibration control, needs adhesives. It needs to have all same lineup. So this is a bill of material plus look on equipment. And then we have the opportunity of the infrastructure. So if you take hydrogen as an example, there's very little hydrogen infrastructure around the world to bring that to market. So there's going to be infrastructure needs. If you go to fuel cells, it will be needs around that. Just like if you think about the battery itself, there was an infrastructure build around the batteries. So we see onboard and infrastructure as being opportunities. The automobile example, probably being the classic first-mover example of that, but that's going to translate to other pieces of quote.

Great. Moving on to aerospace, and I mean it's incredible that you are probably the third most aerospace-centric industrial, certainly ones that I have kept on the coverage. Not that far beyond Honeywell actually, and Honeywell is viewed as very much an aero-centric industrial. So the recovery in aerospace could be quite impactful for you, and give you a lot of duration on that recovery. Aero was a little bit weaker in the last quarter, sequentially pretty flat, very consistent with what we saw in the market. Based on what you're seeing right now on both the OE build rates and the aftermarket, passenger volumes, et cetera, how encouraged are you that we've finally turned the corner on aerospace and we've put in already kind of multi-year recovery here?

Yes. So we're clearly at the beginning and the thing to great debate is just what does that trajectory look like and when does it start. But sequentially, we started seeing some improvement in commercial MRO, about a 13% improvement on that piece. Commercial was pretty much flat. So that's still tied to production rates, and those really haven't moved noticeably. And I think it might start seeing some of those move in our FY '22. Military continue to be strong for us, and we have good visibility on the military side. So I think the trajectory turn is all on what happens with commercial, what happen with the current commercial aftermarket. Aftermarket being the first one to turn. And I like -- I think this is a great time to invest in aerospace because you're at the beginning of a new longer cycle, where our fixed costs are in a great position. We've been very aggressive in sizing the business to where it needs to be. I have a lot of experience from my aerospace days and reacting promptly and aggressively to get yourself positioned for a long cycle, and it's not fair to our people. While it was a difficult reduction in force, we did 2 of them and impacted a lot of people. It's better to get that behind you and so that everybody that's here knows that, "Hey, my future is not tied to a death by 1,000 cuts in it. So the team knows that. We're on the right platforms. The Win Strategy is alive and well, with that group is also. And so I think it's -- we put up 19% margins last quarter in a difficult environment. So it speaks to -- we don't need to get back to pre-COVID to have aerospace margins get back to, say, peak margins. We have an opportunity to get there faster based on the fixed cost change we've made in the Win Strategy. And Exotic will do well as it starts to -- if I look at how well Exotic has done and it took 2 punches. It took the 737 MAX grounding, and it took the pandemic and still performed really, really well. It speaks to how resilient that acquisition was for us.

All right. And 19% of the trough margin is not a bad trough margin for sure. It wasn't so long ago that we were looking at mid-teens margins in aerospace through the cycle. And maybe what's changed? Is this Win 2.0 sort of 3.0 in action here or is there just different parts of investment cycle? I mean, what's changed in aerospace? That seems to be the most dramatic example of a changed story.

I think it would be twofold. It would be this Win Strategy changes, but also the R&D percent that we needed to invest. If you go back maybe even longer period of time, say go back 10 years ago, we were heavy R&D. We were 10% to maybe 12% R&D as a percent of sales. And now if you were to look at a steady state, it's going to probably be in that 4% to 5%, if you go out to the next 5 years, say. And so you have that relief, but then they've done like everybody else. That improvement you saw in EBITDA margins for the whole company that 600 basis point plus, aerospace is the same thing. Everybody lifted up. Aerospace had a couple of things that changed structurally around their R&D profile. I don't see it move back to that kind of super cycle investment for aerospace. I've been in the industry on and off for 40 years, and those happen very frequently. I think the industry will be much more selective on its investments. And what we want to do with our R&D is to stay ahead of it. We want to stay ahead with developing those system network component technologies that are ready for that next request for proposal, and that's what the team is working up.

Great. Yes, it doesn't feel like there's going to be a huge R&D pickup anytime soon in aerospace. But I was going to touch on acquisitions later in the conversation, but you mentioned a great time to be a buyer in aerospace. I'm not sure whether you meant aerospace equities as in Boeing or whether you meant actually Parker-Hannifin. And you've got 8 technology platforms. Would you consider all of those to be candidates for inorganic acquisition dollars? And would you be a buyer of aerospace at this point in the cycle?

Yes. So my comment is monitor investors. This is on a couple of fronts. One, I think if you're an investor, looking at companies that are well positioned to win on this next cycle, which would put us in that class. We're -- for us to invest organically, so anything that we need to invest organically and develop within aerospace and then inorganically. So the inorganic investment, which is what you're after, Nigel, those 8 technologies I showed in the first slide, we would like to be the consolidator of choice across all 8 of those. Meaning if there's a property up there, we want to be at that. And we may not swing at everything, but we want to be at that looking. All things being equal, if we only have so much money, which, of course, you don't have intimate money, of those 8 technologies, we'd focus on aerospace, instrumentation, which is really 2 technologies, process and climate control, filtration, then engineered materials business. If you look at what we've done in the last 3 deals, 3 of those deals were in 3 of those 4 technologies. We just hadn't done the right property instrumentation wise. But then the other aspect of our acquisition strategy would be those near adjacencies. LORD is a classic example of that. So it's a near adjacent. What I mean by that is where common customers, common channels, where you add complementary technologies because they added more thermal management. They added coatings, adhesives, vibration control, which was complementary technologies that we had in our portfolio. It's almost like if you look at where you are in an infrastructure or on a piece of equipment, and you draw a circle around it, what are those natural things around that -- within that circle that would help you be more successful. A good example, take you back historically in the mid-'80s as we get into filtration, where pumps and valves and conveyance and they needed to be filtered. We got into hydraulic filtration and that morphed into engine and mobile, morphed into pharmaceutical filtration, air, water and is now one of our larger groups. So those near adjacencies, where you don't swim out of a lane, you have no clue what you're doing. But you swim in a lane that you understand the customers, you understand the channels and those technologies are just very complementary to you. That's what I mean by the near adjacencies.

Okay. And then just thinking about the portfolio, that's a good segue. How important is balance? When you think about the pipeline opportunities out there and I'm thinking here about Eaton just sold its hydraulics business. And arguably, Parker-Hannifin would have been the most natural buyer of that business. Not sure if it could have been done from an antitrust perspective. But conceptually, would you have been prepared to do a big hydraulics acquisition recognizing you're really #1 in that market?

Yes. I think on the balance side, it kind of gets back to that first comment about being the consolidator of choice. We would still look at hydraulic properties, to look at a fluid connector property and may actually -- maybe call it the traditional beginnings of the company. Because we were #1, we want to continue to stay #1. I think the Eaton-Danfoss deal makes a lot of sense for both companies. Eaton had moved more into power electronics and power management. It was a national presentment. Danfoss was looking to see if they could build out the same grouping and technologies that we have, and we still have a distinct advantage versus what they have because we have these 8 technologies and they're competing with 2 or 3. So that's -- we still want to be at there. But that's my point. That's why that second cut is there, is that all things being equal, I'd invest probably in these other properties that I mentioned, because they're a little more resilient and strong over the cycle. But I think for me, whether it's a hydraulics property or it's engineered materials or aerospace is that can it come in within the synergy time period, which typically say 3 years and be accretive on growth, cash flow and margins? And if it can do that, then I'm happy because it's going to drive future EPS, drive future cash flow for the company. And so I'm happy to look at any properties if they meet those kind of criteria.

Okay. Channel strategy is another point in your slides. Last time I checked, you have about 2,300 Parker stores. If that's a wrong number, please correct me. That's a pretty extensive kind of captive channel. I'm not sure there's many industrial companies with that kind of reach. What is the right number? It seems that international is still an area where you want to expand your footprint. What is -- what are your ambitions around this?

So let me start with maybe what makes our distributors different than everybody else's is that, over time, our distributors have invested, not just in traditional distribution things like inventory, but they've invested in having system capabilities, application expertise. They bring, maybe not all 8 of those technologies, but a lot of them have multi-technology. They might have 4 or 5 technologies they bring to bear. And they do that in a way that adds that value. So we can do it direct with the OEMs, with our system engineering teams, our application engineering teams, but they do it also as well in the aftermarket and with small and medium-sized OEMs. So they bring -- because that's the differentiator. Everybody can put parks on a shelf, but can you help me sell my problems with my engineering talent, with my application expertise and that's what our distributors do. Now we're looking for what we want is kind of the ability to bring value across multiple spectrums of distribution. So what I just described as a multi technology distributor, and that requires a certain investment level and a certain size. And so we look at where they stand around the world and we have singular technology. So if you look at those 8 technologies, we might have some distributors that are experts in these particular technologies. And then we might have even more finite, somebody that's really good in the specific product or a couple of product technologies. So we look at that kind of -- that white space, again, making sure we have a nice mixture of those 3 disciplines on distribution. Then we also look at the retail sites. You mentioned our partner stores. So we want to make sure we've got that retail coverage, both on the store itself or bringing the store to you which meaning we have the Parker store sitting in a mine where we have the hose doctor, which brings the store mobility. We're going to look at doing a lot more digital things with our distributors. We have a digital advisory council with our distributors. And what we could be doing together is so that they can be world class on their websites and we can be world class in supporting them digitally. And so there's been a lot of good work that happens on that. But to your point, one of the points you were getting was international. So in North America, round numbers would say 55% distribution. The balance direct OE and international started off at 35%, and we've now made it to 40%. And we'll update you at IR Day coming up, but it will be north of 40% now as I look at the data as it's coming in. And I think what we want to do is keep growing at about 100 bps a year. That mix shift and eventually get international to 50-50. So there's a couple of things. One, it makes the top line more resilient because think of our distribution revenue. It's not immune but it tends to be more resilient versus direct to OE. And its profit margins are 10, 15 points -- basis points -- 10, 15 points higher than direct. And so as a margin lift, it's a more resilient lift on the top line. And so you'll see us keep moving in. And one of our tricks that we did was that distribution road map that I just described earlier. But we moved about 165 of our people into distribution in either leadership positions or ownership positions. And I don't normally like losing people to that kind of volume, but to our distributors who are as close to Parker as you could be without being a formal team member, and they're a big part of the family. And so we're happy to do that, and that was the secret sauce in North America. It's having people that know Parker well, be part of that leadership team and also maybe -- might be part of the ownership of that, and that's part of our success.

So Tom, you haven't been shy about talking about upside to your FY '23 margin targets. I think the word you used -- the phrase you used is blow past those targets. Would the IR Day in March of 2022 be a good forum for maybe just raising the ante on those margins?

Absolutely. That's what we plan to do. We're going to give you an update on that. I think we're going to try to go out. What we've done is in the past is we typically went out 5 years. So I think we'll try to go out with a new 5-year look, and we'll go down the list. I think the revenue target, growing 100 basis points faster than the market, is not going to change. I think that's -- everything we've seen that's world-class. And if you could do that consistently, you would be world class in that. But we'll go through everything else, the EPS, CAGR growth, segment operating margin, EBITDA margin, free cash flow and update you with what we think will be numbers there. What we've done in the past, we've always -- we've refreshed that 5-year look, and we want to be top quartile. And we just don't want to be top quartile kind of on the edge. We'd like to be probably somewhere in the middle of top quartile. And so we'll be trying to project that and what we think we can do and what all of our initiatives can yield. My whole point was that regardless of when we updated because we've been fortunate to be hitting these targets about a year, 18 months ahead of schedule. We don't stop. We don't say, "Hey, we'll wait until Tom and Lee announce some new target. We're all looking to some improvement because we've recognized that everybody that's listening here has choices. And for us to stand out in a crowd, we need to run faster. We need to be that best-in-class company. And the best way to do that is to look at those key metrics that you all look at and how do we distinguish ourselves differently. And that's why we picked that suite of metrics. It's all about growth, margins, earnings growth and cash and where do you stand, and we'll keep updating on that. But rest assured, that continuous improvement mentality is alive and well here.

I've got a question from the audience, so I want to touch on here, but I did want to just follow-up on your comments there about best-in-class. I know that you're a great admirer of the 80/20 principles in ITW. They are at kind of 27%, 28% EBITDA margins. I'm not sure your business model with your OE mix can get to those levels. I mean, correct me if I'm wrong, but do you think a mid-20s EBITDA margin is insight for Parker-Hannifin, the current portfolio?

So now you're trying to tease out the number, Nigel. You're good at that. I won't commit to that. But if you look at the margins today, top quartile is right at 21%. And you mentioned ITW is probably the top end of that. So somewhere in between there is kind of middle of that pack and wherever that middle of that pack be a couple of years down the road, and we want to set a target that is stale the moment it comes out of the gate. So we'll -- that's part of our thinking on that. The one thing that we always talk about though, which doesn't get a lot of play externally is we want to grow earnings. And that is -- we talk about our breakthrough objectives. So we have the Win Strategy. We have the -- you could look at the back of it, there's probably 20 metrics in there, but we have 4 breakthrough objectives. The first is to engage people with zero safety instance. Second underneath customer experience, so likely to recommend target, think of it as an Net Promoter Score target. Underneath growth, it's 150 basis points faster than market. Underneath financial performance, yes, there's a bunch of margin targets, but the breakthrough objective is to grow earnings 10% year-over-year. And the reason why I come back to that is we don't want to be the highest margin company in the world that doesn't grow and doesn't generate incremental earnings and incremental cash flow for our shareholders. So we want to hit that sweet spot, and we don't think we're anywhere near exhausting our margin capabilities. But we want to grow earnings. That's the overall -- overarching breakthrough because TSR is linked to earnings growth and cash flow. That's the focus.

Great. And I wasn't trying to tease out the target early. On -- I think there's a question here on your EV content and how that looks versus traditional highs. How does Parker-Hannifin's content compare EV to size?

Yes. So the difference is about 10x. And I've been careful because we've not disclosed bill of material in dollars per application because if you imagine -- might imagine the amount of applications we're on, we would -- that's all we'd ever do is report on all those. And that's a very sensitive topic for customers and we've been asked across the whole spectrum of aerospace and industrial companies to not disclose the actual dollar content. Once you have an F-35 or 737 MAX or on an EV, but it's a 10x difference for us, combustion versus EV on the automobile. Now when we go to those other applications I was talking about, construction, ag, et cetera, it will not be a 10x, because recognize that when we were on the automobile, the onboard content was fairly focused. Our onboard content for our construction people is pretty big. So it's not going to multiple it by 10, but it's going to go up. And what that goes up is kind of yet to be determined. But as we look through it, the way I'd describe it, it's going to be bill of material plus. It's going to be some element of existing bill of material plus something. That's the equipment side. I think the other upside for us is just the infrastructure needed to support that change, whether it's for batteries, hydrogen, et cetera. There's going to need to be some build-out of infrastructure, and we can participate in that.

Okay. Great. FY '22 guidance is looming into view here. I'm not going to ask for a revenue range, but I would like to dig into how you think military might fair FY '22? It's probably the only end market that I'm aware of, where you might have some headwinds. I'm just curious what your view is on the military side of your portfolio.

I think military will be fine. We're starting to get to higher levels of F-35. And so it's going to start to round out and plateau. And most of our military exposure in the company is in aerospace. We have some ground military applications, but it would not be material to this discussion. It's going to be in that low single-digit to mid single-digit range, the military, both OE and aftermarket. And we'll see exactly where it is in that range. But it's going to continue to be a nice steady growth, maybe not quite as -- if you look at the OE side, you saw some more significant ramp-up towards the F-35 was coming up to production rate. And as it starts to come up to that, it's going to gradually start to thin out to a low to mid-single digit.

Great. And then on margin, the current margin for next year, I mean, there's lots of moving parts here. We've got some temporary costs that might roll back into the P&L, I think $225 million of temporary cost this year. How much of that do you think maybe comes back in next year? And then price-cost. We've got inflation pressures hitting. Parker has typically been very good on price realization. Do you remain confident you can offset inflation with price?

Yes. So I'll start with the $225 million. So those of you maybe that aren't familiar that was the discretionary cost, which was predominantly wage reductions that we did during the pandemic. For the most part, you have some travel living, obviously, which -- I do the travel living. A lot of that will probably continue as a saving. We're not going to go back to 100% travel. We'll go back to some number, call it, 30% to 50% of where we were. So we'll have some of that saving, but the bulk of that savings was wage. And most of that's already in is back end. So if you look at what we just guided, our implied guide for Q4 to be back into the incrementals, that's a good example of FY '22 because those costs are now back in. And so that's -- we'll hit the ground running with that with '22. So the 30% that we implied for the industrial, more or less, I think is a good number. If you backed out the discretionary apples-for-apples, that was about a 50% incremental, which is kind of what you would expect Parker to do at an inflection point as we ramp up. And with all the cost work that we've done, you would expect to have something north of 30%. 50% is probably kind of our limit of doing really, really well. But I think as we look at next year, with 30%, even with the discretionary back in there is still a good number for us. On the price-cost, you're right, Nigel. We take a lot of pride. We have a good system in place. We've had for 20 years a sales price index and purchase price index, division by division. We look at that all the time. And we stay margin neutral. We want to cover costs. We cover margin. It won't be dilutive to us, and we've proven this in multiple cycles. Remember, so half of the company goes into distribution, and our distributors, provided we give them enough lead time, don't mind price increases because of what it does to further balance sheet and what it could do for MRO support. And with our customers, those are always tough discussions. Some of them are built into commodity indexes that we have part of the contracts, that tends to happen automatically. Others, you have to have a discussion. And so we're going to happen all those discussions now, but it will not be -- it's not unknown territory for us. We've navigated this before. We will be fine.

That's great to hear. And then my final question is really around free cash conversion again in FY '22. Are there any exceptional working capital or even capital investments to make in FY '22? Are we still looking at that sort of 100% free cash conversion target in sight for next year? And then just if I can just add another point to that. Are we in the mode of [ pulling sip ] of capital next year?

Yes. So the free cash flow conversion, we do that on a reported net income. And yes, we think 100% number is a good number. That's been a number we've pride ourselves in hitting, and we'll continue to target that and we think that's very achievable. We don't see any headwinds. When I think about working capital, obviously, as you grow, you have a little bit of headwind on receivables. But we think we can make up with that as a little bit of work on inventory. So I think the growth in operating income will outpace any kind of growth we have in working capital, and we'll be able to sustain that 100% plus. And then I think you wanted to comment on this...

The capital allocation. How we are looking? Yes.

Yes. So we're in a position now because the serviceable debt has all been paid off. Commercial papers paid off. All the term loans are paid off. Our next bond payment is not until September next calendar year. So we're in a position where we didn't -- we never stop looking, even when we were digesting the last 2 acquisitions. So we've learned over time to keep the acquisition pipeline alive, keep building those relationships, keep looking at those targets. So we're doing it. And I would say the pipeline is active, but it's active. But it's always hard to know whether it's actionable. We're working it, but you had to find a willing seller and a willing buyer. But I think as you look over the next 12 to 24 months, clearly, we want to deploy that in terms of acquisitions. If we don't find the right properties, we're happy to buy our own shares. We think we're a great investment. It will be a great investment for the future, but our preference would be to do deals. Anything that grows cash and grows earnings, it's always a winner for shareholders. And I think you'll see us stay in the same kind of vein, meaning that not immediately every time, but within the synergy period, we bring on an asset to the company that is accretive on growth, accretive on margins, accretive on cash flow. And that will be a good thing for the portfolio and a good thing for shareholders.

All right. So I'm going to leave it there. Thank you very much for being very gently in time. Good luck, and look forward to seeing.

Thank you, Nigel, and thank you to everybody that's listened in. Take care.

Thanks.