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

Great. Well, it's my pleasure to have up next Parker-Hannifin, Todd Leombruno, Chief Financial Officer. So Todd is going to start off with a few slides, and then we'll go into the main Q&A.

Julian, thanks for having us. It's been a wonderful conference so far. Thanks for everyone for attending. I just have a few slides here. I'll try to go quickly. I know most people in the room are familiar with us. We are Parker-Hannifin. We've been in the motion control business for over 100 years. We've never been bigger. We've never been more profitable. We've never generated more cash than we are today. And I would tell you, the company is even more aligned on achieving margin expansion, changing the way we grow differently and, of course, trying to do the best we can on generating cash. If you look at our guidance, we're guiding roughly $20 billion this year in full year sales. And we're really buoyed by strength in the aerospace business right now, it really is now 30% exposure of end market standpoint across the company. And we are very much focused on our operating system, we call it The Win Strategy. We are fiercely dedicated to our decentralized operating structure. And we're really focused on gaining market share within our space. We have a plan to get to 20% market share over the long term and the company has never been more focused on that. If you look at our performance [Technical Difficulty] is just a snapshot looking back pre-pandemic. So you take out all the noise over the last couple of years. We have grown a top line by CAGR of 7%. We've expanded margins by nearly 600 basis points. if you look at EPS, we've done a 13% CAGR over that time period. And maybe one of the things that we're most proud about is as we've more than doubled the cash flow -- free cash flow generation that the company has had. So that is something that really our people, our portfolio changes that we've made, both through acquisition and through organic, has been a real driver of that, and we're not done yet. Well, we're proud of where we've been, we're really even more focused on where we're going. We have a plan to reach $30 of earnings per share by FY '27. We are well on track to do that. That's a 25% increase from where we are forecasting this fiscal year to end. And we're going to grow more cash. So 20% more cash, we should be a little over $3.5 billion by FY '27. You may ask yourself what's going to do that, it's more of the same. It's The Win Strategy 3.0. It's really strengthening our value proposition with our customers, better delivery, better quality, better value that we're bringing to our customers. It really is a different company than it's been over the last 5, 10, 15 years. Our performance has been radically different. Our portfolio is radically different. And we've never felt more positive on some of these things that we've talked about from a secular trend standpoint. And that's why we really changed our growth target from being a factor in the market, to being more 4% to 6% over the cycle. So really proud of our past, really much more excited about our future. So I think that's our last slide. Julian, I'll turn it over to you or the crowd for questions.

Fantastic. Thanks very much, Todd, for that. Maybe we'll just start off with a question around the overall macro environment. Aerospace seems very set demand wise at least. But on the industrial side of Parker, orders have been down for a bit. History would say, maybe that bottoms out in the next 6 months. Kind of any thoughts around that industrial piece?

Well, you're absolutely right. On the Industrial business, our International business has been slightly negative for 5 quarters. The North American business, slightly negative for 4 quarters. When you look at the total company, the total company is still forecasting positive organic growth, right? It's 1.5%. It's really buoyed by that 30% exposure to aerospace that I talked about. We started the year thinking aerospace was going to be about 8% organic growth. We moved that to 10% after our first quarter. We've now subsequently moved that to 12% after the second quarter. On the Industrial business, you're right. The Industrial business has been slow growth. I would remind everyone that, that is after 2 years of double-digit organic growth. So what gives me some comfort is while these order figures and even the top line numbers are slightly negative, they're really still at very high levels, if you look at where we've been historically. And if you look at what we're guiding this year, we're guiding 140 basis points of margin expansion. And even though we did slightly tweak the organic growth numbers between the industrial business down slightly and then obviously, aerospace up slightly, we still raised our margin forecast for [Technical Difficulty] this year. So I think what the company is doing is we're very focused on the things that we can manage and control. Margin expense is probably never ending [indiscernible]. There's always things that we can do better. And I would tell you the company is there a bit more focused on that. Our operating system is called The Win Strategy. It really is centered in the fact that our team members want to win. And it has felt good across the company over the last number of years, and we are really focused on continuing that trend.

Perfect. And when you think about the longer-term goal, it's that 4% to 6% organic growth ambition? How quickly do you think we get back into that mode? Is it like a gradual recovery in Industrial?

Yes. I think, again, I would highlight, I think aerospace is going to be robust for the foreseeable future. That will be a driver in that growth. When we've looked at this over time, we're basically about a year into this destocking cycle. Historically, that's been no longer than 1.5 years. So I feel like we're getting close on that. I think what we're hearing is some positive sentiment from our distribution network. We're hearing some positive sentiment from our international team members. But I think we still have some time, a few more months, quarters to get through that. But again, what I would tell you is that the company is really focused on improving our end customer experience and really making sure that we are cost leaders when it comes to managing our business.

One point on the sort of caution out there. I guess investors always ask on the top line about destocking from large machine OEMs. So maybe just sort of frame the scale of that business for Parker and how you see that destock...

Yes. I mean it's a big part of the business. When you look at specifically the industrial side of our business. One thing that I would point to is that distributor network is 50% of the industrial volume globally goes through the independent distribution network. The other half of that goes through the large OEMs side of the business. So when you look at the mix of the company, obviously, now with 30% levered towards aerospace, it is still a very important part of the business, but it has become smaller than it's been in the past. So we're managing that. The beautiful thing about Parker is we are fiercely decentralized. We manage those end market demands by region, by division, by product type, and we're not waiting for some kind of signal from somewhere to say it's time to resize the business. And I think you're seeing that in our results. So we've never been more proactive with this. We've never been more driven by that, and I think that's what's keeping us moving. So really, to answer your question, we want those large OEMs to get back to growth, but I think it's not as big an issue as it maybe used to be for Parker of 5 or 10 years ago.

And on the sort of the self-help element of the top line, you talked about that 20% market share goal. Maybe any kind of key product areas or technology platforms where you're most excited about that share gain potential?

Well, yes, it's a great question. What we've talked about our portfolio, it is really -- it's got the widest breadth in the motion control space. We look at 2/3 of our portfolio today is really [indiscernible] and assisting the conversion to clean technologies. And there's a lot of positivity out there that's happening. It's still early days for that, but we think that, that is going to be part of our longer-term growth algorithm on how we can -- differently and we achieve that [ 36% ] target that we said. So we're seeing things in hydrogen. We're obviously seeing things in all forms of electrification, [indiscernible] 18:03 seeing this in all of the technologies. Filtration has got a lot of exciting things going on within Engineered Materials. But even some of the classic fluid power elements of the company are benefiting from this from a conveyance standpoint. And it's really something that I feel is going to be a very positive. On top of that, these mega projects that you're seeing all around the country [indiscernible] benefit from those activities. I think it's still early days from that. Some people were asked hey, when are we going to start seeing that? And it is a little bit harder for us to grab those numbers. But if you look at what's going on with the orders and if you look at our backlog, that is something that's different from Parker-Hannifin today than it's been in the past. And I would tell you, Julian, you followed us for a long time, there's been very few times, probably never in the history of the company, that we've had 12 months of negative orders, and we've still been able to generate positive organic growth in the fiscal year. So I want to ensure that I think some of those mega projects are [ already in ] the run rate, but I think that will continue to grow as they mature and develop depending on where they are [Technical Difficulty].

And you mentioned, Todd, that the backlog sort of scale and revenue coverage is very different to Parker's history, both because of big aerospace waiting, but even within industrial. How do you see the kind of sustainability of that backlog strength in industrial, let's say, that's maybe the surprising area.

It's a great question. It's been very robust. It's been very resilient. If you look at it, we've shared this externally. Both our aerospace backlog and our industrial backlog is basically 2x the coverage of what it used to be. So a lot of that is the portfolio changes. A lot of that has been where we have focused our resources, our internal investments, where we have challenged our teams to grow. And it's been like that for the last year. So the entire time that we've been in this negative order environment, that backlog has remained pretty resilient. And believe me, we have [Technical Difficulty]. We have verified that these are real demand items and they're going to be shippable. So some people have been concerned that maybe it was just a reaction to the supply chain environment. I think we've proved that out that it's come down just very slightly, but still at that [Technical Difficulty] of what it's been. It gives us great comfort. Certainly, it allows us to be better demand planners. One of the focuses internally has been around demand and capacity planning. We want to be world-class when it comes to that. We think that, that is obviously a significant cost driver, but also a growth driver. And we are world-class at that. It will help us continue to grow the company and make it [Technical Difficulty].

Great. And then on aerospace, there's still some sort of catch-up element driver on the top line back to trends. How much runway is left on that multiyear still to go on...

Yes. Right now, it is unbelievably robust. We still have not got back to pre-COVID air traffic. We're getting very, very close. Demand is unbelievable. One of the nice things about the Meggitt transaction was it really expanded our aftermarket exposure. If you look at what we just did last quarter, 47% of that aerospace business is within the aftermarket. All of this air traffic helps grow that aftermarket piece of the business. So when I talked to our team in aerospace, they are very much focused on making sure they work their supply chain, they deliver to the customer. They make sure that they were getting the customers what they need when they need it. [Technical Difficulty] really not end of seeing that. We think at the minimum that would be high single digits for the foreseeable future. So that's a nice plus that we have in the company that, again, being the size of our aerospace exposure, it's never been higher than what it is today, and we think that, that is going to be a positive.

On the Meggitt side, maybe just give us an update around the integration there. And not just kind of cost out, but again, like your top line wise have been really good. So...

Yes. Meggitt, we couldn't be happier with that transaction. It's going unbelievably well. You can see it's being helped by just the overall demand environment in the aerospace markets. It's more than doubled our aerospace business. But what I find really special about the Meggitt transaction is these broad technologies to us that we didn't have before, this is braking, sensing, fighter suppression, a lot of sustainable aviation, a lot of electronics. And when you look at the customer list, if you look at our top 10 aerospace customer list, we have gotten bigger with every single one of those customers. So that has been meaningful in the sense that we can go to those customers with a larger product offering. We are brought in for engineering application challenges and it just really means a lot for us, not just today, but really looking out in the future for what we can bring from a [Technical Difficulty] those customers. It's wonderful synergies have been ahead of schedule. We just raised the amount that we committed to for this just -- we're [ nearly ] in year 2 of the integration, we have committed to achieving $300 million of cost synergies -- revenue synergies but cost synergies. And we have a clear line of sight to that by the third year of ownership. And we feel really, really confident about it. I think you're seeing it in our results. You're seeing it in our top line and in the bottom line, which is really more powerful.

And on kind of overall margins, I think you're running sort of [ 26% ] of the aerospace right now. The targets you laid out a couple of years ago from why sort of mid-20s [indiscernible] margins, you're slightly above that in Aero, very close to it in Industrial. What's the -- is there any kind of benchmarking for what the entitlement is of -- over a longer term? Or now -- you put a margin leverage each year and no reason that doesn't keep going?

Yes. I mean what we really are driving our team to achieve is what we call top quartile performance. That's top quartile performance within our peer proxy group. And that's been in the top 5 of those 20 companies that are in our proxy group. It is not easy. When we committed through our FY '27 target, of 25%, we had not closed Meggitt, but we were in that process of closing Meggitt. So we included all of that in our targets. Are we committed to getting Meggitt alone to a 30% EBITDA margin? We are well on the path to do that, and we don't think there's a reason why our entire aerospace business can't be at that level of margin. That's more of a longer-term view. We think that aerospace should be the margin leader within the company. What's nice about our company is the aerospace business and the Industrial business, it's the same exact technology. Aerospace just happens to be things that leave the ground, whether it's an aircraft or helicopter. And that's where you really need superior performance. So that demands a margin, that demands engineering IP, and that's really where we win in that space. We're not yet to our [ 25% ] margins. We've to do well out there. We're probably ahead of schedule there. But that [ 25% ] is not the end, right? That is just a milepost on [indiscernible]. We believe that we will be top-quartile margin performers, and we focused on that. And I would tell you, we don't just want to be top quartile from a margin standpoint, we want to continue to grow segment operating income dollars, and we want to continue to have that be the main driver of our EPS growth. And I guess we're very proud of where we've been. But I think we've convinced the entire organization that we can be the safest and best industrial company on the planet. And I'd tell you what the team has never been more aligned. So I feel really good about that.

What's the -- on the industrial side, where at least right now that there isn't a big sort of cost synergy to [ feed up ] -- what's this kind of incremental margin and entitlement that once that business gets back to growth?

We've benchmarked this Julian for a long period of time. We challenged our team to get 30% incremental. So if you look at that, that is best-in-class. If you look over the last 5 years, we've been better than that and we've had a couple of organic growth tailwinds. We've obviously had some synergy tailwinds, not just from Meggitt, but also from [ award ] in that time period. So that's kind of been like an outperformance because of that. But we really think 30% is the right number. Even though our margin has never been higher, we still think the teams can do that. And there are so many things. If you look at our Win Strategy in depth, every one of those items on that strategy of the merchant enhancement. And one of the things that I think is the most powerful is just our continuous concept of [ Kaizen ], everything over and over and over again. We are constantly refining our process -- just constantly taking cost out of the business, and that has been an element of our success for a long period of time. The other thing I would add to that would be, you know about this, Julian. We've talked about this. It's our concept of simple by design. What we really are looking at, sharing and reuse and commonality within the way we [ design ] products. And that is still early days on that process, but it is bringing significant cost savings on many of the projects through that [ models ]. So we feel really good about that. So there's no shortage of margin expansion drivers that we think we have yet to achieve. And I think at this point, this year is an unbelievable example of that where, not really super top line growth, but 140 basis points of margin expansion. So that is a testament that the strategy is working.

Great. Well, I think maybe now we'll switch to the audience response survey questions, please. If we could get those up. So the first question, do you currently own Parker-Hannifin shares?

Hopefully, there's a lot of yeses in the room, Julian?

Do you want to comment on those?

The anticipation here...

Okay. So it looked very balanced.

[ I mean ] there's opportunity. Yes, got to convince the piece on [ underweights and no ].

Either [indiscernible] and those. Okay. So I think we did that one. So we could...

It was pretty balanced [indiscernible].

Yes. Okay. So the second question.

Got more yeses this time.

General bias -- general sort of bias or impression of the stock regardless of ownership. Number three, what's through cycle earnings growth for Parker versus, say, the multi-industry peer group?

This has got to be #1, Julian, and this is going to be above peers -- mix 1 or 2 probably.

So some below. Okay, we can talk about that in a minute. Next question, what should Parker do with excess cash? Because I think the leverage will be 2x...

Yes. We can [indiscernible] very soon. Choice is there.

Yes. So very even split?

It's a tough crowd [indiscernible].

Very balanced everywhere...

Can I put my [indiscernible], 5 year growth of my [indiscernible].

Question 5. So what PE should Parker right at calendar [ '24 ]...

[indiscernible] that's there.

There's an old [ debenture ] as well, years ago or the market [indiscernible] a lot.

Oh, God. [indiscernible] 18%...

I don't understand, less than 10...

Are those things working? Are those?

I don't know. It's very -- it's suspiciously...

What kind of cybersecurity...

Lot of your competitors are hacked into it. And the last question, [indiscernible] significant headwind like what's the reason why people don't own more of Parker's stock? That's a better way framing that question.

Oh my god, [indiscernible].

It's pretty even with the rest...

Okay. Yes, we're focused on every single one of them...

There's a mismatch...

There's is -- I think I would be in the #1 category there, but I would tell you, we're very proud of our performance, but we're very focused on the future. The company has never been better. We've never been more profitable. We've never generated more cash. And I would tell you, the alignment is kind of [ stellar ] across [indiscernible].

One question, Todd, will be around, sort of -- it came up on the balance sheet options. People have a broad range of views on what they think you should do with the cash. You'll be sub-2x leverage in 6 months' time. What's -- Parker over the last 8 years has done sort of 4 larger calculations? Is that some other companies do it a month? Do you see Parker sticking to that larger transaction? And then I guess the scope of it, Meggitt has been a great success, but it was all or most of it was in the Aero division. So should we expect [ air fuel ] to be less likely to get the next bulk of M&A [ cash ]?

That's a great question. We have been very proud of the transaction that we've done. And I know a lot of people have followed us for many, many years. We have been a exclusive there for a long time. But we did make a big step up in 2017 with CLARCOR. And all of these are a significant amount of work. And what we have found is that some of the larger ones, it's just a little bit easier to move the needle. We would not have the growth that we have, we would not have the margin expansion that we have. We would not have the EPS growth, but we certainly wouldn't have the cash flow generation that we had if we did not do those 4 things, right? So that has been really transformational for the company. And our preference is to deploy capital, just like we did on those last 4 deals. Meggitt was obviously the largest one that we've ever done. And I would say we're not trying to like top ourselves and do one bigger. We're not afraid to do one bigger by any stretch of imagination. But what we're really still focused on is doing the right deal for Parker, the right deal for the shareholders. We want to make sure that all those financial metrics, we have a clear path on having to grow the company differently, expand margins differently, certainly grow earnings per share, certainly exceed our cost of capital within the synergy period. And we're not going to stray away from that. We are in a huge space. We have a leading market share, but by no stretch is that anywhere near being to the point where there's not an ample list of targets. So we're going to continue to be disciplined, and that would be our majority. If it gets to a point where those don't look like they're doable or if we don't see that there's a path to achieve our financial return, we have no problem pulling any of those other capital deployment levers that were on our side. So what we know is that we have got a strong balance sheet. We're going to be active with it. That's something that we learned over the last 8 years, that -- our results, our TSR, the way we generate cash is all better when we're active in the balance sheet.

And is there -- the overall margins, as you said, close to that mid-20s operating level now, does that constrain the type of thing you can buy, because you don't have a lot of dilution from the initial acquisition...

I haven't felt that yet. When we -- a great example would be Meggitt. When we did Meggitt, they were roughly 19% EBITDA pre-COVID. They dipped down to like almost 16% in COVID, and we're on a path to get them to 30%. So it really just significantly calls out power of our strategy, the power of our company. And I don't think that would keep us from doing any deal as to worry that it's going to be margin dilutive.

Got it. Then market-wide, sort of industrial, aerospace, fairly agnostic. And I guess how would you -- trying to make Parker less cyclical to [ some degree ], does that lend itself to -- should you try and buy more recurring [ petro type ] businesses, but they'll carry a very high multiple. So any?

Yes. If you look at what we've done, there's been a significant aftermarket expansion, starting with CLARCOR, obviously continuing all the way through Meggitt. But also, LORD is a great example of some adjacent technologies, some adhesive technologies, some thermal management technologies that really lend themselves into some of these secular growth trends that are ultimately positive for a long period of time. We think we have the right technologies, so it's nothing that we think we need to get rid off. I think there is plenty of targets in that space. Aerospace is 30% of the company. There's no reason that we have [ to get ] bigger. Most of these targets have a little bit of exposure across just like us, very diverse markets. And I think I said it earlier, but the only difference between our aerospace business and our industrial businesses, those aerospace products leave the ground.

Yes. And we should expect acquisitions to be still in that material science hardware...

When you look at it, we've been very purposeful on growing filtration, growing engineered materials. It's really material science business for us, growing aerospace. And one of the areas that we still like to continue to grow is our instrumentation business. But we believe that all of these technologies are growth platforms. If there's anything that helps us capitalize on electrification, clean tech, digitization or mega cap projects, we would do that in any of the traditional technologies as well. So we like our strategy. We like our platform. We know these markets. We know these technologies. We know we can get synergies from these targets. And we're only going to do it if we see a [indiscernible].

And maybe last question is -- we're out of time. You mentioned sort of elements around clean tech, digital electrification. If you think about sort of the aggregate Parker revenue base, is there -- maybe defined on how much is touched by some of those...

It's a great question. We are having an Investor Day, May 16, the afternoon, in New York. We're going to touch on some of that in that Investor Day. So stay tuned, and I think you'll be surprised to see on that excellent portfolio, really our future growth algorithm more...

Thank you, Todd, we're looking to that.

Thank you, everyone, for your attention.

Thanks so much. Appreciate it.