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

All right. Thank you, everybody. I'm super excited to be up here with Parker-Hannifin. We have CEO and Chair, Jenny Parmentier. Jenny, thank you so much for joining us today.

Thank you for having me.

Absolutely. Parker has really differentiated itself over the last 5 years, like incredible margin expansion, really good M&A integration and value add. I know a lot of this like ultimately rolls up into the Win Strategy. But can you just talk a little bit about what this means to you and the company and ultimately, how it's translating to the profit and loss that we all look at?

Sure, sure. Well, I know that there are people listening in today who can't see me holding my Win Strategy, but this is our business system. This is our guide to operational excellence. It's a proven strategy, and it works. We really believe in our decentralized operating structure. We have 85 general managers who are working closely with the customers. They're in charge of growing their business and full P&L accountability, and they use this strategy every day. At the first pillar of the Win Strategy, which is the most important pillar is engaged people. Two metrics that we track at the plant level, all the way up to the group and enterprise level are safety and engagement. And those are the 2 most important metrics to us. The Win Strategy is designed to go from engaged people, give a good customer experience, ensure that we grow profitably and that we deliver the financial performance expected by our shareholders. The key is you have to get the first pillar right. You will not have sustainable performance in the rest of the 3 pillars unless you get that first pillar right. So very important to us, and we hold the general managers accountable to this. And you can go in any Parker division, any Parker factory, and you will see the Win Strategy prominently displayed. You will see day by hour board. So we track our performance on an hourly level at the value stream or the assembly cell level, and that gets rolled up into weekly and monthly metrics and the cadence that we have wrapped around all of this is very robust. And it's what allows us to continue to expand margins the way you've seen us do for the last 10 years.

Yes. One -- another thing that really stood out to me as I was learning about Parker, was the distributor network. Can you talk a little bit about why it's differentiated versus others who sell into distribution and ultimately, like what value and opportunity this brings for shareholders?

Yes. So 70 years, over 70 years, we've built this global independent distribution network. And these distributors are truly an extension of our engineering teams. Their application expertise allows them to provide value to their customers that is unmatched to the competition. I've said many times that this distribution network is the envy of the competition. They shelf our premier motion and control products. We take a good part of that shelf, and we're very proud of that. They're very dependent on the interconnected technologies on having the full portfolios to provide to their customers. And the distribution business is great for us. It's 10 to 15 points higher in margin than our OEM business. So these distributor partners are very important to us. 50% of our industrial sales goes through distribution, and we protect this channel and consider them truly business partners.

I think some of the biggest questions I get on companies right now are pricing power, obviously, with tariffs inventory levels in the channel, what could that mean for short cycle. Can you talk about your relationship with distribution and kind of how it helps you guys on that price or inventory visibility that's out there?

Yes. So we -- I mean, obviously, like I said, they're business partners, right? So we're very aware of the inventory that they're carrying. What I would tell you now is that their inventory is in line with the current demand. We went through a destocking period. I think that's been over for quite some time. We haven't seen restocking yet, but we get a lot of good intel from our distributor partners, and they tell us where they're winning, where they're quoting. They're currently very, very positive about the quoting activity. So that close partnership allows us to really keep our finger on the pulse of what's going on out there. And that close relationship with our divisions and the -- that application engineering expertise that they really bring allows us to partner with them and grow our businesses together.

Yes. Maybe moving over to M&A. Obviously, a couple of very high-profile successful deals for you guys, Meggitt, maybe most namely. Integration has gone well. I think it's given you guys a lot of credibility in the market as an acquirer. So I guess kind of how should we think about the M&A pipeline moving forward? And are there any specific areas of focus or whether it's a vertical or even a product category, geography?

Yes. Well, first of all, the question I get a lot is what's the size going to be. And we do have things in the pipeline of all sizes, small bolt-ons, similar to the Curtis we just announced, and we have larger deals as well. For us, the success has not only come from perfecting our integration playbook over time and really utilizing our talent in these roles. But it's been with technologies that fit into our interconnected technologies that we have today, customers that we know, markets that we know when we can have a higher content on the customer equipment than we have today, that's when we win. So those are some of the things that we're looking at for the future. That's criteria that we always have when we're looking at our pipeline. It's a robust process. A lot of times, it's about timing, right? It's about when we're ready and when they're ready, but we never stop working on it.

And is there any -- are you overly focused on industrial versus aero? Or is it kind of just pretty agnostic to where the best opportunity...

I would say it's agnostic, right? There's opportunities across all of our technology platforms and our operating groups. And we work hard to develop those relationships and make sure that we're knowledgeable and that we're ready when they're ready.

Yes. Maybe moving over to North America industrial. Maybe outside of a cycle and policy that could maybe lift the industrial economy, what are some things that Parker is doing to improve the growth profile of that company relative to history?

Well, I would say what's been done over the last 8 to 9 years, we've already changed the way we grow with the transform portfolio, right? We doubled the size of filtration with the acquisition of CLARCOR. We doubled the size of Engineered Materials with the acquisition of LORD. LORD is a really good example where that's 1/3 aero, 1/3 auto, 1/3 industrial. And then obviously, with Exotic and Meggitt, we doubled the size of aerospace. So we've had positive organic growth across the company, even for the last 2 years has been very soft from an industrial standpoint. But I would say that our teams have gotten more mature on strategic positioning. The Win Strategy is their business system. They're guide to operational excellence. But these divisions are specialists in their products and their technologies with close relationships to the customers. So our expectation is that they position their business to where they can win, who they want to be, who they don't want to be, what are the resources they need, what are the investments that they need. So we've seen a real maturity in that. And we expect with this portfolio and the industrial business turning, we're going to even demonstrate more how we grow differently. We've had an emphasis on growing international distribution over the last 8 years. We've grown that 100 basis points a year. We were about 35%. We're about 43%, 44% now. We think that can go higher. So that's been something that we really focused on. We've also remained very disciplined to market-driven innovation, making sure that we are using our resources and our investments on really developing the right products for our customers. And then for the whole company, not just the industrial piece, but we changed our compensation plan, our annual compensation plan for nearly all of our 60,000 team members. And that is sales, earnings and cash. And it's easily understood. If you're a plant manager or a general manager and you have your monthly plant meeting, you can talk about how the performance in that plant is going to show up in your ACIP, we call it. That's our acronym in your ACIP check. And that's powerful. It's also powerful to have all of our team members thinking about where are we tying up cash. If we overbuild, if we bring too much inventory in, if we have higher scrap. So it's put a real focus on the performance, but it's also put a real focus on the top line and meeting our sales goals and from anyone from the production cell to the shipping deck.

I appreciate that. And then I guess on North America Industrial and the cycle, you guys have had positive orders, I think, for the last 3 quarters. Are you seeing signs of momentum in that market? Is the orders just kind of more of the longer cycle stuff? Like do you feel like that short cycle is starting to see positive rate of change?

Yes. We're seeing some bright spots, right? If we just quickly go through the verticals, I'll start with the one that's the most challenged with transportation, right? We see that -- we're still forecasting that to be negative, but we see it getting better in the second half. If I look at off-highway, construction was better in Q4 than we expected. So we're seeing some growth there. Ag is still weak. It's going to take a little bit longer for that to recover. But when I look to implant industrial, we're forecasting positive low single-digit growth this year. So we hear from our distributors some spots where they're winning business and they're seeing some pull on demand. It's just still not across the board. You still hear about some project delays. But again, very positive on the amount of quoting activity. But when we look at energy, power gen is solid. Oil and gas is still weak. When we look at HVAC, coming off a nice year of high single-digit growth, primarily residential. We have low single-digit growth in for this fiscal year, and that's really more about commercial and refrigeration, but it will still be some nice growth. So we see some bright spots. But as you can tell from our guide, we're forecasting 1% organic growth on the industrial side of the business and really a gradual recovery.

Yes. No, very much appreciate that. On the implant industrial getting better, I guess, is that just a view that production rates are going to go high and there's more MRO needed? Is that whether it's some companies maybe shifting activity into the U.S. where possible to avoid a tariff? Any reason why that one is maybe showing a little bit more momentum?

We get the intel from our distribution channel. We think they're going to benefit. They're already benefiting some, but we think they're going to benefit from some customer supply chain actions. And they talk about some of the things that they're already winning and that they're going to be doing. And we feel that it's time for this to turn, right, as well as they do. And we think the opportunities are there. It's modest growth for the year, but we think it's going to be there.

One thing we've heard from a lot of short-cycle industrial companies, and it seems like you're kind of saying something similar is that there's a lot of optimism in the market. Distributors are optimistic they're quoting, but it's just not really converting into revenue or even maybe orders to that level. I guess, a, is that what you're saying? And then b, like what could kind of cause that to converge? Is it just like uncertainty needs to lift? Like how does that get better?

Yes. I think it's uncertainty around tariffs and an interest rate reduction, I think, would help. I think some of those things are just keeping people cautious about pulling the trigger on whether it's projects or those capital investments they've been waiting to make. That's what we hear the most of. Nothing significant outside of that, just really clearing up some of the uncertainty.

Yes. Has there been any changes in customer conversations post-Trump election, then there was tariffs, then there -- so tariffs raising the cost of imports, the one Big Beautiful Bill trying to lower the cost of domestic production. Like is that resonating in the market? Is it still too early? What are your thoughts on that?

I think it's still too early. It's not in a lot of the conversations that we're having. I agree, there's a lot of positive sentiment out there. But again, I think we have to reduce some of this uncertainty, but we're not hearing big impacts yet.

And then I guess, kind of on that Trump policy, do you feel like distributors were pulling forward inventory just because there was very well telegraphed price increases coming?

No, we don't really have any evidence of that, and we keep a close eye on that with the way we analyze our demand versus our capacity. So we don't have any real evidence of a pull ahead from the distribution channel.

I appreciate that. And then I guess, maybe looking at the international side of the house, can you just kind of maybe talk about what the outlook there is? What verticals are doing well internationally? Any geographies doing better or worse?

Yes. So I would say EMEA is -- continues to be challenged. We've had 6 quarters of negative organic growth. We're forecasting this quarter we're in right now to be negative. Slightly positive for international in total. But when you look at EMEA, implant and industrial is still weak. When you look at transportation, still weak, especially in automotive. When you look at energy, power gen looks good. Oil and gas, a little bit stronger in EMEA than I would say in North America, but power gen is stable. One area that we think will be positive for the future is with all the announced stimulus and defense spending, not only will our aerospace business benefit from that, but the industrial side of the business will benefit as well. What is positive is it's 2 quarters of positive orders. So while it's still very challenged and we have a very modest growth forecast, we think some of this uncertainty that we're just talking about could help that area as well.

I appreciate that. And then both sides of industrial have shown better orders. Is that strength more so driven by some of these longer cycle exposure that you have? Or are you seeing positive rate of change on some of the shorter cycle verticals as well?

There's pockets of positive change on some of those verticals, but we do have a longer cycle mix now, right, in our portfolio. So for instance, at the end of Q3 in March, we saw some really strong longer cycle orders, especially in international in aerospace and defense, power gen, electronics. They didn't necessarily repeat in Q4, but strong orders that will ship into the future. So that longer cycle means that we get more visibility, but you won't see it convert as quickly as you do with that true short-cycle business.

And is there any way to think about -- I think historically, everyone expects these orders for you guys to convert very quickly. You guys, I think it's mostly, I think, industrial ramps in the back half of the year. So is it like a 4-quarter kind of conversion? How should we think about the new conversion rates or time lag?

Q4 was a pretty good example of order rates and shipments and organic growth being very close, the tightest we've seen in a while. So I'd hate to say that it's 6 months or it's 9 months because it really just depends on the business. The aerospace business, those lead times are pretty long. So some of that aerospace that comes into the industrial side could be 12 months. But it's definitely different than it has been in the past. It takes a little longer for it to convert. When we see the distribution side of the business pick up, you'll see some of that conversion be quicker.

When I think about Trump policy, it feels good for the U.S. industrial economy. He's doing a lot to try to drive investment in production domestically. But I worry that it's not good for the international industrial economy because maybe their biggest customer might be pulling back. I guess what do you -- do you think there's a risk that these international markets could get worse from here? Like do you think they're a loser on the policy? How do you see that developing?

Well, I think that for Parker, like I said earlier, some of the stimulus and defense spending with our global manufacturing footprint and serving these global customers, I think we're in a position to grow. I think it's anybody's guess to say what will these policies do to different individual customers, but we're not forecasting it to get worse. We're not hearing anything as a result of recent policies or discussions that are putting any fear out there. So based on what we know today, we're looking at these market verticals with the intel we have and the modest organic growth target that we've put out there.

Yes. No, I appreciate that. Maybe flipping over to Aero. At least in Q2, Parker avoided the destock that plagued many other in the industry. I guess why is that? Are you confident that you guys won't be impacted by that moving forward?

We did not experience that destocking. We were a little surprised when we heard about that. But I will tell you, we are very close to our customers, and we're very aware of what their inventory levels are and what rates they're hitting on a daily and a weekly basis. So we stay very close to them. We monitor their inventory. We adjust our inventory. We make sure that we have the capacity for the next rate increase. So we didn't see any bullwhip effect of destocking or restocking. But we have invested quite a bit in our supply chain and helping them be stronger and making sure that we're sending them the right signals. And that we're planning our factories to the right demand from the customer. So we're spending a lot of time on that, we think we've become a better supplier, but we've also helped the supply chain in their healing process. So we just didn't experience that at all. If anything, we've seen the rates increase.

Yes. Do you think -- is it important for you guys to continue to scale Aero and just become more important as a supplier to these companies?

I think we absolutely have the opportunity to do that. And I think that comes through good service. It comes from having a seat at the table for future platforms. It comes from using the power of our entire portfolio with Meggitt in the aftermarket with our defense customers. We've had a lot of success with our public-private partnerships and repair depots. And it's one of the reasons we're very confident about a high single-digit growth as a long-term target for Aerospace.

And I guess like how -- Aero has been growing above trend for the last 3 or 4 years. You guys are calling for, I think, 8% this year. How long is the runway for Aero to grow above normalized levels? Do you feel any kind of slowdown on that cycle?

We don't feel a slowdown. It's been fantastic, right? We just ended 3 years of double-digit growth. We have a long-term forecast of high single digit. We have 8%, as you said, out for fiscal year '26. We have an amazing portfolio now. We're a 50-50 aftermarket OEM mix. We're 50% wide-body, narrow-body. We have these proprietary technologies on all the premier programs. And we're just in a really good position to benefit from what we're seeing. And again, we -- for the foreseeable future, long term, we put these targets out last year when we launched our FY '29 targets, we see high single-digit growth.

And we're seeing OEM production rates ramp back. It doesn't seem to be slowing the aftermarket to -- at least not to a significant degree. I guess like how do you kind of think about the relationship between those 2? And is it just, yes, production rates are going higher, but it's just kind of not enough?

It may be a little bit of that, right? There's some catching up to do, but we're definitely forecasting higher commercial OEM growth in this fiscal year than aftermarket. We had low double-digit commercial OEM growth, high single-digit aftermarket. But the global air traffic is high and the fleet that's out there will be there for some time. So that will continue to drive aftermarket growth. We think they're both going to be growth areas for us into the future.

One thing that kind of stood out to me was after you guys acquired Meggitt, the organic growth profile of the company picked up, and it seems like the performance relative to the industry also improved. Can you talk about revenue synergies or cross-selling opportunities that come from the deals you've done and also how to think about that for future deals?

Yes, absolutely. I mean, like I said, one of the things I think that's made us very successful with the acquisitions is really being disciplined about these have to be technologies that fit into our interconnected technology play. And when we can go to the customer with a larger product portfolio, we get more content on the piece of equipment, whether it's aerospace or industrial. Meggitt added multiple complementary technologies. And I've said it often gave us a bigger seat at the table, right? So that poises us for growth well into the future. It really is about having those products with customers that we know and markets that we know and bringing that full Parker value to the customer.

Yes. I guess maybe going from aero over to defense. We're seeing defense budgets go higher. Can you just kind of talk about what you're seeing on that side and the outlook there?

Yes. I mean the outlook is good. We're hearing about all of it. I haven't seen any of that materialize just quite yet. But it's one of the reasons that we think we could have some nice growth on the international side, right? Because we have that footprint, a higher defense footprint since we acquired Meggitt. And we have the capability to supply those customers in that region. And the industrial side of the business will benefit from that as well. But we haven't quite seen it yet.

Yes. What about on the domestic defense side? Has there been any impact from DOGE or some of the government efficiency savings initiatives that are out there?

We've continued to see nice growth on the OEM and the MRO side of defense. We're forecasting mid-single-digit growth. So we haven't seen any slowdown there. But we do have those public-private partnerships for the repair depots. We've been very successful at those. We've been able to grow that at a higher rate than maybe some of the competition with having the Meggitt portfolio to bring to the party. So that's been really good for us.

Maybe moving over to margins, which have been an incredible story for the company. I think running at 26-ish percent from like mid-high teens, not all that long ago. But I guess we are -- you are starting to almost -- a good problem to have run into the incremental versus 30% to 35% incremental. Can you talk about the opportunity for margin expansion? What do you see out there? And why are you confident that there's still more upside here?

Yes. So we're very proud of what our teams have accomplished, especially in a negative growth environment on the industrial side of the business. There is an expectation to expand margins no matter what's going on with the top line, and the teams have done an extraordinary job. Like you said, the target for years and years was 15%, and then it was increased to 17%. And in the beginning, that probably seemed like -- it did seem like, oh my gosh, 17% because if you were a general manager, your goal was to get to 15%. And then it was 17% and then it was 19% and then it was 21%, and then it was 25%. And now it's 27%. And 27% isn't the final stop for us. We really believe in the power of the Win Strategy. I believe in it personally. I've used it as a plant manager, as a general manager, as a Group President. There's a lot of power in all the tools. The general managers are responsible for margin expansion every year. So we think there's still opportunity out there to expand margins. We have -- one of our strongest tools that sits right in that engaged people is the use of high-performance teams. And when you have a high-performance team wrapped around a value stream or even a work cell, they're measuring their performance. They're determining when they need to have a Kaizen. They're determining when it may be time to automate. They're doing problem solving on a daily basis, on a weekly basis. And that allows them to drive out costs and continue to expand margins. So that culture of continuous improvement, our lean tools, our simplification tools, they are things that you're never done with. I often get asked what inning are we in? Well, it's early innings because there's always opportunities for continuous improvement.

The company has expanded margins. And if you look at Industrial expanded margins with down volumes the last couple of years. Is that just costs are coming out? Is it price cost is improving and offsetting some of that volume deleverage? Like how do you grow margins in that with down volumes?

The Win Strategy -- Win Strategy. I mean we've always been very good at price/cost management. And we have had to pass on price for some of this extraordinary inflation that we've experienced. Obviously, pricing is part of our tariff mitigation. It's not all of it, but it's part of it. But again, the expectation is to expand margins using all the tools in the Win Strategy. And our teams have plans for that. Our teams all have goals for higher margin than they entered this fiscal year by the end of the fiscal year. And they know how they fit into the FY '29 target of 27%.

On that commentary around price cost, we're seeing tariffs continue to move higher, the latest 232 metal tariff. Is that impacting your gross tariff exposure? Is it something that you think the company needs to price for?

It's an additional impact, and we have the tools to price where we need to. But we also really greatly benefit from our global footprint, our local-for-local strategy, our increased emphasis on dual sourcing that we started even prior to COVID. So while we're not immune to tariffs, pricing isn't the only lever to pull when it comes to tariff mitigation. And in some cases, it's been opportunity for us, too, opportunity for share gain with being able to utilize the footprint that we have.

Yes. I mean I think the track record of the distribution network, I think there's obviously a lot of confidence in your guys' pricing power. You have shown that time and again. Do you feel though, like there could be some pricing fatigue in the market? Some companies I talked to, it sounded like in April, it wasn't that hard to get the price, everyone expected it. It feels like as time gone on, it seems like it's getting a little more difficult. Is that your sense for Parker?

When it comes to, as I call it, the extraordinary inflation, we went out early and often. We have the tools and the ability to analyze very quickly what we need to do. And those are never easy conversations, but we're transparent with our customers on how it's impacting us and how we need to pass that on. Same with tariffs. We have the ability to analyze quickly and figure out how we're going to mitigate those actions. You can't constantly go without a reason for pricing. And we have long-term relationships with many of our customers, and we value those. So we can't price without having the evidence, the need to back it up. So I don't think anybody -- like I said, customers don't like it. And those are tough conversations. But I think we've built the credibility with our tools and this being a very strong function within Parker that when we need to get it, we can get it.

You talked about the local for local. Do you think that between that model and the Trump tariffs, you guys are seeing competitive tailwinds in the U.S. market versus others that don't have that same local for local strategy?

I think there's some opportunities there, yes. And there's some examples where we've been able to pick up some business or take some share based on our ability to manufacture in different regions of the world. So yes, I think there's some opportunity there. But obviously, our first goal is to serve our customers well through all of this kind of uncertainty, right, and make sure that we have the continuous supply and that our supply base can react.

No, I appreciate that. I wanted to ask just kind of finishing up on some of the growth outlook for some of the respective business lines. When we look at Aero, it's generally been, I'd say, modestly decelerating, but still at very strong levels over the last couple of years. It seems like you guys this year kind of guiding for roughly 7% or 8% growth kind of flat every quarter. Do you -- and that's also the long-term target. Do you feel like Aero is just kind of getting back to like that normal -- maybe not normalized, still healthy, but kind of hitting a more steady state on the growth?

Well, I mean, 3 years of double-digit growth, right, and still forecasting high single-digit growth. So I think it's pretty strong. We have an all-time high backlog of $7.4 billion in aerospace, and it goes beyond a year. So it's still a very, very healthy business. But obviously, you can't convert that backlog any faster than the customers are building or using the product. So we're not seeing a slowdown, but these are some pretty tough comps that you're coming up against, right? So it's still very healthy growth, and it's why we're confident in it.

Absolutely. Moving on the industrial side, the guide is essentially for kind of continued, I would say, modest pressure in the first half and then very modest recovery in the back half. And I know the growth profile of all the verticals is different. But do you expect them all to follow that similar trajectory of getting better into the back half? Or are there some where you have more confidence in that and others where that's really not what you're expecting?

I would say the ones that we're forecasting low single-digit growth, we feel like they're going to recover or do better in the second half. But as I was mentioning earlier with transportation, it's mid-single-digit negative for the year, but we see it a little bit better in the second half. So they all won't be at the same pace, but obviously, we're forecasting in some improvement there.

On that transport side, do you -- is that just a function of the comps are getting easier? Or do you feel like there could be some positive demand signals and just higher activity?

A little bit of both. I mean heavy truck is pretty weak. And auto, a little bit better, but still weak. So I think it's a combination of the comps, and then we're thinking about a little bit of improved growth in the second half.

And then on the off-highway side, I guess, how do you think about those into the back half? And any difference on the construction versus the ag side?

Yes. We think ag is going to take some time to recover. We're not forecasting any ag recovery. Construction, like I said, in Q4 was better than we thought. And we're seeing some positive inflection there. So we think there's a little bit of recovery in construction.

Has the conversations on the construction side changed at all? We have started to see the Dodge Momentum Index get better. There's obviously a lot of hope for rate cuts out there. Have the conversations gotten any more constructive on that side?

I would say no real change. I think you said it. I mean when a rate cut happens, maybe when there's some more certainty around the future of tariffs, then we'll see something a little bit better.

Well, we're up on time. So thank you so much, Jenny. Really appreciate you coming.

Thank you Chris. Yes, thanks for having me.

Thanks, everybody.