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

Good morning, and welcome to Parker-Hannifin Corporation's conference call and webcast to discuss the company's announced agreement to acquire Filtration Group Corporation. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to turn the call over to Todd Leombruno, Chief Financial Officer. Please go ahead.

Thank you so much, Nikki. Good morning, everyone, and thank you for joining us today. As Nikki said, this is Todd Leombruno, Parker's Chief Financial Officer speaking. I'm here today with our Chairman and Chief Executive Officer, Jenny Parmentier. Before we get started today, we did want to recognize that today is Veterans Day, a national holiday here in the United States. Today is a day meant for us to reflect upon the dedication and sacrifice of those who served. It is their courage that has safeguarded the freedoms we all enjoy today. Thank you to all the veterans for your service. Now we are very excited to announce that Parker has signed a definitive agreement to acquire Filtration Group Corporation. On Slide 2, you will find the company's safe harbor disclosure statement addressing forward-looking statements. Items listed here could cause actual results to vary from our forecast. This morning's press release, this presentation and all reconciliations for the non-GAAP measures are available under the Investors section of parker.com. A replay of this webcast will be available approximately 1 hour after we conclude the webcast today. We have planned about 30 minutes to give you an overview of the Filtration Group transaction, its strategic fit within Parker and how it aligns with our long-term strategy and create shareholder value. We'll then open the call up to any questions. And now I call your attention to Slide 3, and Jenny, I'll hand it off to you.

Thank you, Todd, and thank you to everyone joining the call this morning. I'd like to welcome all of our shareholders, analysts, Parker team members, and a special welcome to all Filtration Group team members that may be listening in this morning. It's an exciting day for us as we announced another strategic addition to Parker. Filtration Group is a great company with a great culture, and we really look forward to welcoming everyone to the Parker team. The acquisition of Filtration Group adds complementary and proprietary technologies for critical applications while expanding our presence in life sciences, HVAC/refrigeration and in-plant & industrial market verticals. The combination of Parker Filtration and Filtration Group creates one of the largest global industrial filtration businesses, with expected sales of $2 billion in calendar year 2025 at 23.5% adjusted EBITDA margin. This acquisition will increase Parker Filtration aftermarket sales by 500 basis points. We will leverage our business system, the Win Strategy, to achieve approximately $220 million in cost synergies, and we expect this deal to meet our disciplined acquisition criteria of being accretive to organic growth, synergized EBITDA margin, adjusted EPS and cash flow. This strategic transaction continues our investment in high-quality businesses that continue to transform our portfolio, accelerate sales growth, improve profitability and drive shareholder value. I'll turn it back over to Todd to review the transaction summary.

Thanks, Jenny. All right. I'm on Slide 4. Let's take a look at some of the numbers on the transaction. We are acquiring the Filtration Group for $9.25 billion in cash. This will add roughly $2 billion of highly recurring filtration sales at an adjusted EBITDA margin of 23.5%. That purchase price equates to a multiple of 19.6x on expected calendar year 2025 adjusted EBITDA. Incorporating synergies, that synergized multiple would be 13.4x. We are expecting $220 million of cost synergies over a 3-year synergy period. In addition, we expect incremental cash benefits of about $140 million at a net present value. The transaction is on a cash-free, debt-free basis, which we plan to fund with a combination of new debt and cash on hand. Upon funding, we expect our net debt to adjusted EBITDA leverage to reach approximately 3x. I think you all know this, but we have built a great track record on rapid deleveraging after each of our previous transactions, and we are -- we remain committed to operating around a net debt to adjusted EBITDA level of 2x. After the Meggitt transaction, we delevered in 7 quarters. That was our largest transaction ever. That 7 quarters was the fastest that we returned to a 2x leverage. And our goal with this transaction is to delever even faster. Our target is to return to 2x leverage in just 6 quarters. As Jenny said on the previous slide, this transaction meets all of our financial criteria. We expect it to be accretive to EPS in the first year of ownership, and it will achieve synergized EBITDA margins in the mid-30s and deliver a high single-digit ROIC by year 5.

Slide 5, please. This slide shows a breakdown of Filtration Group by market vertical, sales by region and sales mix. These are markets that we know well, with a life sciences business that expands our presence in this market. Good global presence, very similar to Parker's Industrial business and a robust aftermarket that again increases Parker Filtration aftermarket sales by 500 basis points. Filtration Group's complementary capabilities and strong aftermarket presence enhances our ability to serve customers globally. Slide 6, please. Filtration Group brings a diverse portfolio with strong brands, material science capabilities, highly engineered products, embedded application engineers and multiple R&D centers. This enhances our exposure in life sciences, HVAC/refrigeration, in-plant & industrial and transportation. Within life sciences, we have solutions for medical, diagnostic and test applications that include consumable separation technologies, pharmaceutical protection, special chemistry and material science solutions. Within HVAC and refrigeration, our complementary products and advanced media capabilities that ensure indoor air quality in places like hospitals, schools, museums and airports. Moving to in-plant & industrial. Filtration Group brings proprietary media for liquid, air and gas filtration, increasing both safety and productivity for customers. And within transportation, our transmission filters and desiccants engineered to an application-specific form factor. Slide 7, please. When we combine the Filtration group with our existing filtration offering, we will have one of the largest industrial filtration businesses at nearly $5 billion in annual revenue. Much like our previous acquisitions, this is highly complementary, bringing new capabilities in existing applications as well as near adjacencies, thus expanding our addressable market. This is aligned with our acquisition strategy to acquire high-quality businesses with complementary technologies that accelerate organic growth. Slide 8, please. And we know from experience that cultural alignment is key to a successful integration, and we see this once again with the combination of Parker and Filtration Group. It is the safety, engagement and ownership of our people that is the foundation of Parker's culture. With Filtration Group, we share an entrepreneurial culture and belief in a decentralized structure, with P&L ownership at the local level. We are committed to being great generators and deployers of cash and living up to our purpose of enabling engineering breakthroughs that lead to a better tomorrow, thus making the world safer, healthier and more productive. We look forward to welcoming the very talented Filtration Group team members to Parker. Back to Todd to review the synergy opportunities.

Thanks, Jenny. As I said, we are confident and committed to achieving this $220 million of expected cost synergies. That is roughly 11% of sales. Our integration plan utilizes a proven playbook and leverages our business system, the Win Strategy. Key focus areas are similar to what we've done in past successful transactions, and that includes our simplification process, supply chain, lean and obviously, productivity. These expected synergies are in line with what we've achieved in past transactions. The structure of the Filtration Group business is -- very much complements our existing filtration divisions. It's an extremely good fit. The increased scale of this transaction also brings significant opportunity for our combined filtration business. We're very confident in achieving these synergies.

Moving to Slide 10. This is a different Parker. Filtration Group enhances our technology offering with complementary and differentiated filtration solutions. This transaction will further expand our filtration and engineered materials technology platform, where material science serves as a common differentiator. Our past acquisitions of CLARCOR, LORD, Exotic, Meggitt, Curtis and now Filtration Group have meaningfully changed our portfolio, as you can see with this comparison back to fiscal year '15. We value all of these technology platforms as they are critical to our distribution and aftermarket channels, give our application engineers a competitive advantage when solving customer problems and provide us with a powerhouse of interconnected technologies. This is why we win. Parker is clearly a different, more balanced and more resilient company than ever before. Slide 11. For those of you that have followed us for a while, this slide remains unchanged. We are on track to be approximately 85% longer cycle, secular trend and aftermarket revenue mix by fiscal year '29. Our acquisition of Filtration Group, which brings an 85% aftermarket sales mix, continues this transformation. Slide 12. And all of this has worked. When you look at the metrics over the last decade, we have a 6% revenue CAGR, adjusted operating margin expansion of 1,130 basis points, 16% adjusted EPS CAGR, and 10% free cash flow CAGR. It's our people, strategy and portfolio that drive top quartile performance. Slide 13. The first 4 acquisitions on this slide have been a big part of our transformation. Curtis is still early days, and we are very excited about the Filtration Group. Just a reminder that we have compounded EPS at 16%, and approximately 60% of this has come from the Win Strategy in our legacy businesses, while approximately 40% has come from acquisitions. The acquisition of Filtration Group will continue our track record of accretive acquisitions. Slide 14. This is the same slide where we started, another strategic addition to the Parker that demonstrates our capital deployment strategy of driving shareholder value. In our final slide, 15, a reminder on what drives Parker. Safety, engagement and ownership are the foundation of our culture. It's our people and living up to our purpose that drives top quartile performance that allows us to be great generators and deployers of cash.

Okay, Nikki. Before we begin the Q&A, we need to apologize to Mig Dobre with Baird and all the shareholders we were planning to meet with this morning at the Baird Conference in Chicago. We are obviously not in Chicago. We're here in Cleveland this morning. As you can imagine, we've been working very hard on diligence, and we are not going to be able to attend that conference today, but we look forward to engaging with all of you very soon in the future. Okay. Nikki, we are ready to begin the Q&A session.

[Operator Instructions] We'll take our first question from Mig Dobre with Baird.

Appreciate the kind words, Todd. If there ever was a good reason to cancel the conference, well, I guess this would be it. Congratulations on the deal. My first question, the business you acquired here, Filtration Group, has got an interesting exposure to life sciences and HVAC. Can you maybe talk a little bit about how this fits in your portfolio, some of the gaps that it's filling? And in life sciences specifically, I know Jenny and I -- we've talked about this before. What are your ambitions in this vertical, maybe even beyond Filtration Group longer term?

Well, we'll stick with today's ambitions, Mig. But life sciences and specifically, health care filtration, is mostly a new thing for Parker Filtration. So within that, Filtration Group brings some porous polymer components that are used in drug delivery devices. As I mentioned before, some diagnostic testing and venting for medical devices. So this is a pretty new space for us. But there are many solutions here in medical. And what we like about it is material science solutions, right? That's a sweet spot for us, and these products really characterize that. And we think this is a good expansion of life sciences market for us. So we're really excited about adding it to the portfolio.

Understood. And then maybe a follow-up on the go-to-market for Filtration Group. Maybe a little bit of detail on that and how that matches or maybe is different than your core Parker business.

Yes. So the one thing that I would say is very similar to Parker is these deep customer relationships, these engineer-to-engineer relationships, products that are deeply embedded with the customers, long track record of innovation and really specialized application expertise, which is something that we have said, gives us a competitive advantage for many years inside of Parker. Distribution is about 30% of the business, and about 70% of the business goes direct with obviously a lot of aftermarket flowing direct.

Mig, one thing I would also add is if you look at the breakdown geographically, the breakdown of the Filtration Group almost exactly mimics the breakdown of Parker's Industrial segment. So it adds nice scale, and it's in geographies that we already operate in, and we think we can leverage some synergies out of that.

We will move next with Jamie Cook with Truist Securities.

Congratulations on a nice acquisition. I guess just 2 questions. Jenny, I don't know if you can give us any history behind the deal, how long you guys have been talking other bidders, just the history behind this and why the timing now is correct? And then I guess just my other question, food protection and life science is a new sort of area for you. Just wondering if as we think about M&A in the future, should we expect Parker to continue to want to grow in these markets? And then I guess just last, is there any sort of investment required from Parker's Hannifin side in this business?

Right. So Filtration Group is a business that we've admired for a long time. It's been in our pipeline for a long time. And as you've heard me say -- many times, it's about the timing, right? But it is about developing relationships throughout the years and staying close to these type of businesses. This was an auction process. But obviously, we're very excited today to be announcing this deal. As far as life sciences and future acquisitions, it's always going to be about really following that disciplined criteria we have, right, and making sure that it fits inside of our portfolio, complementary technologies, and that meets all that financial criteria that we talk about. So we're not announcing a major shift in any strategy here. We've found a business here that is a very solid business, great technologies, great innovation and engineering, having to have a great life sciences business, and we're excited about it.

Jamie, I would just add, the investment profile is very similar to Parker. This is low R&D, almost exactly what we see in our total business, and the CapEx is similar to our industrial businesses. So no overly needed investments, just continue to invest just like we invest in the rest of Parker.

Congrats again.

Our next question comes from Scott Davis with Melius Research.

Jenny and Todd, I'm sure Jeff is there somewhere. But congrats. It's a good asset. I -- since it's a private asset, though, we don't have a great sense of the kind of history as it relates to core growth. And perhaps you could give us a sense of what the growth rates have looked like in the past and maybe how you would expect that to be equal or better in the future?

So Filtration Group has had a mid-single-digit organic growth CAGR from before COVID to today. The business, with 85% aftermarket, has historically been very resilient through the cycles. So we don't expect much cyclicality here. And I would say that recent growth rates have been better than Parker's industrial business. So it's a healthy growth business.

And is it a business, Jenny, where you're able to generally get a regular inflationary price increase every year because there is so much aftermarket?

I mean, listen, we'll use the same tools that we've used with every acquisition. Strategic pricing is a strong muscle for us. So just like you've seen us do in the past, we'll be implementing those tools.

Fair enough. Best of luck. I'll pass it on.

Our next question comes from Andy Kaplowitz with Citi Group.

Congrats on the deal. So cost synergies of $220 million seems relatively good, but I think Meggitt had slightly higher versus sales. And I imagine you have, as you've said, Jenny, a lot of overlap with Filtration Group. So could it be viewed as maybe a little conservative, and do you see a relatively significant portion of these synergies that could come in year 1 after close?

Well, listen, this is 11%. We've historically been at about 10%. So we think that this $220 million is a really, really good target. Like usual, we'll be phasing this in. There'll be multiple phases to the synergy plan, and we'll have our really robust and disciplined cadence wrapped around it. And we're going to use the Win Strategy, all the tools in the Win Strategy to get these synergies. So the team is going to go and get it.

Jenny, let me ask you a follow-up on that. Like just a little more color on the margin opportunity. Their margin is obviously significantly below yours. But maybe just talk about their market positioning. Is there anything that's been holding them back in terms of their margin because you seem pretty confident in getting it to 30% over the next few years?

I don't have any comments about their operational strengths or how they've gone to market or run their business. But I would tell you that I'm just very confident in our ability. There's a clear path to margin accretion here with the Win Strategy. These tools have been successful in previous acquisitions, and we know they're going to be with this one.

We will move next with Julian Mitchell with Barclays.

Congratulations. Maybe my question would just be trying to understand a little bit more on those synergies on Slide 9. Any way you'd characterize the focus areas maybe of what's driving those synergies in terms of the split of items you mentioned like supply chain and lean? Any impression of COGS versus SG&A savings, perhaps in comparison with recent large acquisitions you've done like Meggitt? And do we assume for now just a linear realization of that $220 million goal over 3 to 4 years?

Julian, I'll take that one. This is Todd. I think we've talked before, we are completely agnostic when it comes to taking cost out of the lines on the P&L. We look at every single line on the P&L, whether it's cost of goods sold, whether it's SG&A, and we don't see anything different with this transaction. Jenny said this, we're going to combine this with our existing filtration business. That business is going to be nearly $5 billion in annual sales. The scale there is significant. I mentioned how complementary it is to our existing businesses. So we see some opportunities there in the combination. But it really is leveraging the power of the Win Strategy, and that's all the levers that we use to expand margins across all of our businesses. Jenny called out, when you look at that expansion that we've had over the last 10 years, it's now 60% of that expansion has come from businesses that we did not acquire, and 40% came from the great transactions that we were successful on. So we don't see this any differently. It will be just like the last transaction.

And we're not providing a dollar phasing at this point in time for the synergies, Julian. But obviously, there will be multiple phases to the synergy plan. And like I mentioned, we have a really disciplined cadence wrapped around integration, and the team is going to go get it.

That's great. And then just my follow-up would be around the market share maybe in aggregate. So you have Slide 7, the details around the market footprint. I think you said that overall, you'll have a $5 billion-plus filtration revenue base pro forma for this deal. Wonder if you could give us any sense around maybe the addressable market size? How much larger do you think you might be than some of the other leading players here? Any color around that, please?

Yes, I would just say that we expect this to increase our total addressable market, but we're not disclosing that at this time. We don't have that. Filtration Group has a really strong position across diverse and growing end markets. And like I mentioned, it adds near adjacencies and expand the markets that we currently play in and bringing new products. So those complementary technologies are definitely going to help our position.

Our next question comes from Joe O'Dea with Wells Fargo.

I'll add my congrats on the deal. Just wanted to start with confirming that we're thinking about the -- some of the sort of key drivers of the ROIC framework correctly. It seems like something like 7% growth, 35% base incrementals, and then the synergies can get you to around 8% ROIC. And so are we thinking about those drivers correctly? And if we are, just any additional thoughts on that 7% growth, maybe it's a little better than what they've achieved over time, and how you think about getting to that?

Joe, this is Todd. I think you're pretty close there. We're a little bit more conservative on the growth line. We have them right in line with our stated 4% to 6% target. We do expect to rebound as industrial markets recover here. You've already seen, we're starting with a very good EBITDA, it's 23.5% EBITDA. We're modeling those at a similar tax rate to Parker as a total. I did call out there's $140 million of tax benefits that will phase in over roughly the first 3 years. And I don't remember if I called it out or not. But if you look at our expected cost of borrowing, it's about 4.5%, that's based on today's rates. So it's pretty attractive considering where we've been. And all that, you work in the synergies, and that's how we see a path to really being accretive to margins, being accretive to cash flow, being accretive to EPS and obviously delivering that ROIC hurdle.

I appreciate that. And then just in terms of the filtration business that you have today, where are those margins as we think about that? Any kind of blueprint or support for taking Filtration Group margins up? And along with that, as you've presumably competed against them a little bit over time when we think about the mapping you gave on end market exposure, sort of why you've won, why they've won, to understand some of the competitive advantages between the 2?

Well, I think, listen, like I said, we've admired this business for a long time, and this brings a lot of complementary technologies. I think we both won because we've had these deep customer relationships. We've been good at innovation, proprietary media, proprietary products and being able to solve customers' problems. The Filtration Group has built a very impressive suite of brands that are well known in these markets, and these are markets that we know. So I think this just puts us in an even better position from a competitive advantage and really helps us hit that 4% to 6% organic growth.

What we've committed to on this transaction is EBITDA margins greater than 30%. I would just call back to what we saw when we had the Meggitt announcement. We committed to getting Meggitt specifically above 30%. And at that time, our aerospace business was below 30%. And we very quickly realized that synergies come from the entire business, not just the acquired business. And if you look at that business today, that business in total is operating greater than 30%, and we really have a clear path to our filtration business doing the same.

We will move next with Joe Ritchie with Goldman Sachs.

Congratulations. Yes, look, I think 11% synergies is certainly a healthy number. I just -- it doesn't seem like you've got much footprint rationalization embedded in that number. And I just want to touch on that point, just going back to some of the learnings from CLARCOR back in the day in terms of making sure that you guys feel very comfortable in achieving those synergies, and there isn't a lot of footprint associated with those synergies as well.

Yes. So what's been so good is that with every acquisition, this playbook has just become stronger and stronger, right? And we really have some great, great people running these integration teams that when it comes to things like footprint, and it's no different with this deal, the footprint of Filtration Group's businesses will be reviewed and thought out very carefully. We're not giving individual bucket areas right now, but we value the global footprint with this business, and we want to ensure that we continue to be able to meet the global demand and the in-region supply for customers. As you know, that's our model, and that's important to us to be local for local and be able to serve those customers in those regions.

Got it. That makes a lot of sense, Jenny. And look, my follow-on question, it's interesting to see an aftermarket business, 85% of the mix, but predominantly, most of the business sells direct. As you kind of think about the different channels going forward, and maybe it's too early or too premature to start talking about this, like is there an opportunity to even -- maybe even optimize the channels going forward and maybe sell more through distribution? I'm just trying to understand like the path forward from here.

Yes. We obviously will be looking into that. As you know, our distribution network has been very successful for well over 60 years, makes up 50% of our industrial business. And while we think Filtration Group has a great go-to-market story here, we'll obviously be looking for those opportunities. It's something we know how to do.

Joe, just to reiterate, the $220 million, those are cost synergies. We don't have any sales synergies baked into the justification of this transaction. We know there will be some, but we didn't use them to justify the transaction.

Our next question comes from Chris Snyder with Morgan Stanley.

This is obviously a pretty sizable deal for you guys at over $9 billion. Can you talk about bandwidth to continue to push forward on additional M&A, both from just a balance sheet and then just like a management operational bandwidth perspective?

Chris, that's a great question. We're very much focused on the integration planning for this transaction. The Curtis transaction is in process as we go now. That team is set. When we put these integration teams together, we take the best talent from both organizations and we give them the playbook and we give them opportunities to shine, and it's been unbelievably successful. The company as a whole has never been larger. It's never been more profitable. Core Parker itself is generating over $5 billion of EBITDA. That's in our FY '26 guide. Both of these transactions are obviously accretive to that. But I would tell you, we remain committed to maintaining that net debt to EBITDA and operating in the around 2.0x space. We've done that for the last 1.5 years roughly. This will push us slightly, right? It won't be nearly as high as what we've been in the other transactions. And just the cash flow generation of the company is so strong. We will very quickly return to a 2.0x. This is roughly just 6 quarters. So we talk about it all the time that the relationship building, the pipeline, the work that occurs across the organization never stops when it comes to what's next. But right now I would tell you, we're very much focused on integrating these 2 transactions properly, making sure the model achieves what we expect it to believe -- what we expect it to achieve and generating great returns.

I appreciate that. And then to follow up, Jenny, you often referenced that Parker's distribution network is the envy of the industry. So I just kind of wanted maybe some color on how expanding the company's portfolio impacts or helps with that distributor network, whether it's bringing new distributors into the fold or maybe even more importantly, making Parker more important to the existing distributor network, which could have positive implications elsewhere. So just any thoughts on that, the scaling of the portfolio and what it ultimately means for the distribution network.

Well I'll tell you, we are always all about making our distributors stronger and healthier. They are truly an extension of our engineering teams. They are our partners. And whatever we can do with products in this portfolio, like I said, that we'll evaluate that. And whatever we can do to help them have more products on their shelf, be able to solve customer problems with these products and these solutions, we're going to do that. So most of the time, our distributors are very excited about new products coming into the Parker family.

Nikki, this is Todd. I think we have time for one more question here, so we'll take whoever's next. Thank you.

All right. We will move next with Jeff Sprague with Vertical Research Partners.

Congrats. A lot of ground covered. I did want to come back to the synergies just one more time. I also thought 11% was a large number for, I think an ostensibly very well-run private company versus Meggitt, right, like ostensibly a poorly run public company with layers and the like. I guess my question is, obviously, you had to undertake Meggitt with very little actual due diligence, right? You had to make your own judgments from the outside looking in, which were obviously thoughtful, but now you didn't have a whole lot of information. Given this situation, have you really been able to get deeply inside the organization and sort of map out the synergies? Or is this still more sort of kind of a high-level Parker playbook, we've done it before, and we're going to do it again in terms of how you approach things?

Well, it is. We've done it before, and we're going to do it again. That's for sure. Obviously, we were able to do more diligence on this deal than we were with Meggitt for sure. One of the most exciting things to me was to be able to meet some of the team members to meet some of the leaders and see the talent that is in the organization. That's from my comments, speaking to culture and how important that is. So that is, I think, the foundation for a successful integration, the buy-in to the Win Strategy, the similarities in our culture. So we feel really good about the way we've mapped out these synergies here, and I'm confident that the team's going to go get them.

And then just on the aftermarket side, too. Obviously, a lot of the aftermarket is going to be tied to utilization of assets, and we've had a period, obviously, of weak utilization in in-plant in a couple of these markets. Did the aftermarket business stay positive through sort of this kind of channel inventory liquidation dynamic that we just went through in parts of '23 and '24 and even into '25?

Jeff, we don't have details on the inventory levels and obviously, not as close to it as we were with our own business. But as I mentioned earlier, with this 85% aftermarket mix, very resilient through the cycle. And mid-single-digit organic growth from COVID to today. And growing faster than Parker's Industrial business. So a nice resilient business here.

Yes. No, it looks like a perfect fit. Congrats and good luck with it. I appreciate the time.

We appreciate it. Okay. This concludes our webcast on the acquisition of the Filtration Group Corporation. Our Investor Relations team with Jeff Miller and Jenna Stuckey will be available if anyone has any follow-ups or model questions. We really do appreciate your time and attention, and we wish everyone a wonderful day. Thank you.

And this does conclude today's program. Thank you for your participation. You may disconnect at any time.