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

Great. Thanks, everyone, for being here. It's my pleasure to have up next Parker-Hannifin Corporation; Todd Leombruno, Chief Financial Officer. Todd has, I think, a couple of slides to go through. And then we'll get into questions after that.

All set? Well, Julian, thanks to be here. It's great to see so many people in the room. It's a wonderful time to be here to talk about Parker Hannifin. I just have a few slides to give an overview, for those people that aren't familiar. We are now 109 years old as a company, and we have been in the motion and control space that entire time. You could just see here, our sales, we're guiding to be $21 billion in sales this year. And what is really nice is it's almost equally split across our businesses. The company now has 31% of our sales exposure in Aerospace -- in our Aerospace segment. In our Diversified Industrial segment, we split that into North America and International, and you can see here it's about 30% International and about 40% North America. If you're looking for a little additional color, you could see our technology platforms, which we break out just to give a little bit more color. And again, Aerospace is 31% of the company. Filtration and engineered materials is now nearly 30% of the company. Flow and process control, a little over 20%. And then motion systems is 17% of the company. So all of this is interconnected. It all works. The portfolio is extremely focused on serving customer needs in that space. What's a unique concept about our portfolio is 2/3 of our portfolio comes -- or is sold to customers that buy from 4 or more of those technologies. These things can be interconnected in any way that creates value for our customers, and that we have been trying over the last 10 years to shift the portfolio from more short-cycle business to more longer-cycle business. And I think we've been pretty successful with that process. We try to give you a breakdown of our markets. This is end market exposure. You could see our largest is Aerospace and Defense. You may say, well, why is that not 31%? We do have technologies in our Industrial business, mainly filtration and sealing technologies, that go to Aerospace end markets. We just keep them with the technologies that are in the Industrial business. That's how we get to 35%. But our second largest market is in-plant and industrial equipment, you can see that's 20%. Transportation would be #3 at 15%. We go off-highway at 13%. And then obviously, it's a nice energy and HVAC exposure. And I already said this, we're guiding to $21 billion in sales this fiscal year. If you ask yourself, well, how has Parker Hannifin been able to win? We have an unbelievable operating system, we call it The Win Strategy. We are fiercely decentralized when it comes to our operations. We have 85 individual P&L owners across the business that are responsible for growth, for margin expansion, for cash flow generation. Those are their expectations; that's how their team is compensated. And it has worked wonderfully. Our products are innovative. Some people have thought maybe these are commodity-based products. These are technologies that we apply to solve customer problems in ways that no one else can do, with our offering. We have an unbelievable distribution network, .50% of our Industrial business goes through this distribution network. That is mainly serving the aftermarket, but also small to medium-sized OEMs across the globe. And all of that could be put together in a system if a customer finds value in it or we could sell an individual technology if there's more value in that transaction as well. So a very strong competitive moat. That's why we believe we're the leader in the space. And it has all worked. I love this chart. This is just a 10-year look at what we've been able to do. As a company, you could see we've grown revenue at a 6% CAGR over a 10-year period. We have expanded margins unbelievably, 1,150 basis points of margin expansion over that time period. We've grown EPS at a 16% CAGR over the last 10 years. And we've grown cash flow at 10%, which is you could see greater than what we've been able to grow sales. So all of that has worked. And it's not over yet. When we look at how we grew EPS 16%, roughly 60% of that growth came from implementing The Win Strategy in legacy Parker Hannifin businesses. And you can see we've added 5 wonderful companies to the portfolio, CLARCOR, LORD, Exotic, Meggitt and, just recently, Curtis. All of that has accounted to 40% of our EPS growth. And then you probably have seen, we just recently announced the agreement to acquire the Filtration Group. We expect this trend to continue as we go into the future, and we expect Filtration Group to be just another addition to the portfolio, that we're very much looking forward to close. So I believe that's my last slide. So Julian, I'll take questions from wherever, and we can get started.

Great. Thanks so much, Todd. Maybe first question, I think a lot of investors here are kind of wondering about, is there a real U.S. industrial recovery, something picking up in short-cycle MRO or CapEx, wallets being opened a little bit wider? How do you see that environment right now in the U.S.? Any changes in kind of recent months?

Well, I can't start without mentioning the strength in our Aerospace business. Obviously, that's a separate segment from the Industrial business. But that business has been unbelievably strong. I think we're in year 3 of double-digit organic growth in Aerospace, and it just continues to perform beyond expectations. So we expect that to continue. What is promising is, on the Industrial side of the business, we've started to see some movement. Obviously, we've had 2 years of negative organic growth in that space. But our orders have turned positive. That has been trending upward. We have raised our organic growth guide. We started with 1%, we went to 2%. We just recently updated to 2.5%. So we feel really good about that on the North American side of the business. We're starting to see some pickup in the in-plant and industrial equipment. That has been really positive. Off-highway has been positive. Things like mining, construction have been really positive. Transportation still continues to be a more challenged market. We are expecting still softness in that market. And then there's starting to be some growth in energy. Certainly, power gen has been a nice positive spot there. Our oil and gas markets are showing some positivity, which is nice. And then lastly, I would say, on the HVAC side, the commercial side of the business has been positive. Residential is still pretty soft, but the commercial has shown some strength. So we think it's real. We think it's time. We have been preparing for this. And I would tell you, our operations are ready, I believe our supply chain is ready, and we're ready to see that organic growth trend continue.

And what do you think underpins some of that -- I mean, different end markets have idiosyncratic drivers, but any broad-brush trigger for the animal spirits kind of warming up?

Well, obviously, this has been a pretty dramatic times with tariffs and geopolitical noise and all of that. And I think we're starting to see at least we've been able to kind of deal with it, right? Tariffs, we've got some clarity on; interest rates are moving lower. I think our -- both our distributors and our OEM customers have done a great job leveling inventory levels to demand. I think they've been at a good level. They've been matching demand for some time now. But we're starting to hear a little comments around restocking. It hasn't been material enough yet to get overly excited about. But we view it as a good sign and we view it that it's a good sign for our future demand.

Got it. And when you think about that split of sort of distribution type channels versus OEM customers in the Industrial side of the company, any difference in sort of behavior on orders or sales between the 2, or it's pretty consistent?

Like I just mentioned, inventory levels, we think, are at a good level in both parts of the channel. There's been positive sentiment in the distribution network for some time. And we're starting to see a little bit, I would say, pockets of activity, right? Some things around data centers, some things around power gen, some things around oil and gas have been popping up as being positive. On the OEM side of it, I think we're almost there. We're starting to see some good stuff in mining that is driving that. I think ag still has a way to go before that becomes anything to talk about. But overall, I would say the sentiment is leaning positive in both.

Got it. And in-plant equipment, a big end market vertical for you. How do you see that kind of globally looking at present? It's been a difficult 2 years, manufacturing PMIs globally, tough for a while.

Yes. North America and Asia Pac, I would say, are showing some signs of growth. Europe continues to be, I would say, struggling, bouncing around the bottom. What has been really fantastic about our team is our team has been able to generate record margins in all 3 segments, in every business by utilizing tools within The Win Strategy, being proactive, managing the demand levels as they are and preparing for the rebound. So I couldn't be more happy with the teams, that we've been able to generate these record margins even in a not-so-great growth environment.

And you mentioned a good sign of pickup in orders in different parts of Diversified Industrial recently. To what extent is that kind of longer-dated activity, or do you see the longer and short cycle both...

It's a great point. It's something that we've talked about. It's something that we've strived really hard to transform our portfolio into longer cycle. Orders have been positive for a number of quarters. Usually, historically, that would immediately turn into positive organic growth. It's been a little bit more stretched out. There's been some Aerospace orders, those are very long cycle. There's been some power gen orders, which are certainly longer cycle. And when we dig into the detail on the orders, we're seeing more longer-cycle orders than we've ever had. So that is just kind of changing that relationship to orders and organic growth. But we're happy that they're both positive. If you look at our backlog, our backlog is at a record level. Aerospace has been extremely robust. But even on the Industrial side, we finally returned to growth on that Industrial backlog, and we expect that to continue.

I think automation investment by customers is an area Parker had mentioned recently as seeing a bit of a pickup. Any way to frame -- and I realize the definition of automation is a bit subjective, but what the sort of...

Yes. Well, I would tell you, we are doing it within our facilities. I think we're doing a measured job at that. We always use Lean first. We always take waste out of the process before we even think about automation. We have really focused on what we call the 4 Ds: dirty, dull, dangerous or difficult. So the tasks within the facilities that fit those criteria, those are the first ones that we strive to automate. And we've been really conscious to not make big monuments when it comes to automation, but to be very flexible, very focused and making sure that we do the right things for the business and our team members in that process. When it comes to customers, we're seeing a lot of the same stuff, right? Our products are, in many cases, driving some of those automation things when it comes to robotics or even material handling-type applications. So it's a good fit. And I think the customer base and ourselves, I think we're learning together and making great progress.

Great. And as you said, The Win Strategy has had phenomenal success. I think you pointed out the margins are up 1,150 basis points. How do you make sure I guess the business, in what is a decentralized structure, keep reinvesting sufficiently, make sure they don't get too focused on margin percentage expansion?

Well, it's a great concept. We did raise our CapEx, our internal CapEx budget. For years, we'd been between 1.6% and 1.8% of sales. We did move that to 2.5%. So I think that we're appropriately investing in things like automation and productivity. In some cases, capacity, where we need it in the world. So I feel like that is a great sign. But it is clearly a balance. And when we have these 85 units, the team that is running those units, they're responsible for growth, they're responsible for margin expansion, they're responsible for EPS growth and they're responsible for cash flow. So all of those things kind of goes into that equation. And I feel like it's the right formula. I think we're investing the right amount. I don't see it spiking above that 2.5% of sales. And it is generating the results and we can see them in the P&L.

Great. And then on the Aerospace side, more of a focus now, I suppose, on OE production rates picking up in commercial; defense, a lot more discussed for 18 months now. How would you say Parker's positioned on the military side of the Aero segment?

Yes. Whether it's military or commercial, we are unbelievably positioned. With the addition of Exotic and with the addition of Meggitt into our business, you see it's now 35% of our exposure. So we're able to do things for both commercial and military applications that we never had been able to do before in the past. Things around safety, things around fluid conveyance, things around actuation, things around braking and landing systems, that just gets you into deeper conversations with those OEMs. We have a nice mix between our commercial and defense business. We see the world clearly needs more defense, and we're ready to react appropriately as that comes. So it's a great space to be in. It's been part of our growth story up to now, and it will continue into the future.

And I think within Aerospace, as an industry, commercial aero aftermarket has been huge driver the last 5 years. As those other areas start to show high growth as well, is there much of a margin mix impact we should watch for?

We're not concerned about that. We now have -- it's basically a 50-50 mix between OEM and aftermarket. We are glad the OEM is ramping. You need the OEM to ramp to have aftermarket into the future. We are in the business for the long run. What we say about the OEM ramp is there's clarity. It's very clear what you need to do. It allows you to take efficiency and wastes -- or improve efficiency, take wastes out of your business when you know what the deliveries are. And if you look back at what's been happening on the commercial side, there was a lot of noise based on delivery demand and all that kind of stuff, that I think create a drag in the P&L. And with volumes ramping, we're able to take all of that noise out. There's new platforms coming. We are going to win those platforms. We're going to invest appropriately in this business. And we're going to love this aerospace exposure for a long time. So we don't expect to have a margin drag from OEM ramp.

And the absolute margins in Aerospace has been a huge increase, partly top line growth leverage, partly Meggitt synergies coming through.

Yes. It's been wonderful.

Any sort of natural feeling you worry about there? Or no, it's about operating leverage...

No. I mean it is wonderful what you can do with the business when you have 3 years of double-digit organic growth. Coupled with some synergies, coupled with great aftermarket mix, and it really has been stellar. It has allowed us to get closer to our customers. I said this already, but the offering that we have now has never been more robust. And the capabilities that we have across the portfolio, applying things like filtration, things like material science, things like thermal management, in the Aerospace markets, we've never had more capabilities than we have now. So we really like the space and I think we're positioned to win.

One thing that's come up with some other companies in commercial aerospace, OE, other suppliers has been kind of contract renewals and sort of catching up on many years of inflation in sort of one go with a program renewal. Is that a thing to watch at Parker or there's a lot of different programs in the...

There's countless programs. And I would tell you, we've been very active. We feel that we are a partner with our customers. In many cases, we have frank discussions with the customers. If the environment has changed from the time that the contract was made, we think that merits a discussion. These things are long term in nature and there's give and take on both sides. But I don't feel like we've been disadvantaged by the contracts when it comes to Aerospace. It's been an unbelievable time of inflationary increases, but the pricing muscle at Parker Hannifin is unbelievably strong, and that would include the Aerospace business as well.

Within Diversified Industrial, again, there's been a lot of price increases. Do you get any impression of price fatigue by customers or...

Like I said, it's been an unbelievable time on inflationary pressures. We reacted quickly. We went often. We didn't wait. We didn't have large price increases. We did that kind of in line. We are back -- outside of tariffs, we are back to like a normal pricing cadence, a normal pricing discussion. And we've always said this on tariffs, "This is something that wasn't agreed upon when the PO was issued, when the contract was made, so that is a discussion that we have to have." And that is when they go up and when they go down. So the thought is that we'll be flexible on that and we'll make sure that works. But I don't sense that there's any pricing fatigue in any of our end markets.

And I think in the last earnings deck, you had a good slide sort of focusing on the off-highway exposure, and it seems like some share gain has been happening there. Maybe flesh out kind of why you think that's happening. Is it something to do with the broad kind of systems sale that Parker can do? And do you see that in other verticals beyond off-highway?

Well, we certainly do. We've been trying to highlight maybe one vertical a quarter when it fits into the space that we have in the earnings call. But it really is a testament to the portfolio of Parker Hannifin and being able to apply conveyance and electronics and hydraulics and filtration and sealing, shielding, thermal management. And we believe that we can integrate that better than anyone else in the space. And if there's value to be had, if a customer sees value in it, if that brings a clear, documented value to their product, then we're going to win on those applications. The off-highway market is just one example of that. When you look at what technologies we're selling into that market, we tend to win when there's more than one technology on that application. And it's really not different from any of the end markets that we play in. It really is very thoughtful on what we invest organically in and what we invest in via acquisition.

And on the acquisition front, a large transaction will close later this year, Curtis closed last year. Any impression you could give us around kind of organic growth profiles of those businesses?

Well, one of the things that we have really focused on when it comes to our acquisition pipeline is, do they have a history of growing faster than our legacy businesses? In both cases, Filtration Group and Curtis, they had displayed the ability to grow slightly better than our legacy businesses. And obviously, we haven't closed Filtration Group yet, but I could tell you, on Curtis, it's doing exactly what we expected out of that transaction. And what is really unique about that is it's completely paired with our electronics offering, and that is now one business, 1 of our 85 businesses, combined with our existing electronics business, and the integration is underway.

And maybe kind of walk us through -- because, yes, the upcoming acquisition is pretty large, how should we think about, I don't know, first sort of 100 days?

Yes. Well, we've already created the integration team. So our integration team is staffed. That has been one of the key elements of success for every one of the transactions that we've done in the past. We are talking to and meeting with the Filtration Group team. Obviously, we're 2 different companies, so we're operating totally separately up until close. But we're starting to lay out the plans for how we would do that. The first thing that we would do would be a win immersion session, where we would welcome the Filtration Group team members to the Parker Hannifin team, and show them how we've created so much value over the past 10 years. And that usually is a wonderful process that both parties benefit from. So that's really kind of where we're at now. And I would say that we're on track [ for a lot of the ] transactions to work their way through the system.

Perfect. And when you think about the -- I think, the channel, as you said, or distribution is a key strength of Parker, how easy is it to kind of use that channel push through different product? What's been the experience...

Yes. So it's an unbelievable benefit that we have. The best benefit that we have through our distribution network is the offering that Parker Hannifin has. We could cover every element of the motion and control space. So that there is very little competitive pressures within our distribution channel. And what we'll do is we'll add the Filtration Group to that, just like we will add Curtis to that, just like we added LORD and CLARCOR to that channel. So it is a benefit that will drive growth and margins for years to come.

And then kind of firm-wide operating margins, that '29 goal is on track, I think, this year. So -- yes.

Yes. We set '29 targets, I guess it's been 2 years ago. And the team has totally outperformed. So it's been great to be part of that. We set a 27% segment operating margin target for FY '29. We're right up on top of that right now as we speak. Aerospace has totally outperformed. Some of our longer-cycle Industrial businesses have totally outperformed. When we look at those margin targets, it's not just the margin target that we're looking for. It is the organic growth target. We have a range of 4% to 6%. It is an EPS CAGR; we want to be plus 10% every year. And of course, we have cash flow targets that we are very focused on. We also have a dividend record that we're very proud of, 69 years of raising our dividends every year. We're not going to let that record break. So we look at that holistically. Is '27 the end of margin expansion? No. It certainly is not. And we'll set a new target when we need to on that. But certainly not the end of margin expansion. I don't expect us to see a slow in margin for the foreseeable future.

And when we think about the kind of portfolio today, do you feel confident that you can get to x 100 bps higher operating margin firm-wide with the current mix? Or does there have to be a change in mix or?

No. I think the company is unbelievably set up right now. You could see on those technology platforms, it's pretty balanced. You could see the aftermarket OEM mix across the company is 50-50. That includes Aerospace and the Industrial side of the business. We've never been in a more favorable aftermarket to OEM mix. We see continued opportunities to expand the aftermarket. Filtration Group is a great example; it expands our filtration aftermarket exposure by 500 basis points. So we continue -- we expect to see continued expansion across all of those businesses and all of those channels for the foreseeable future. So we don't have to do anything structurally different to continue our margin expansion story. A lot of it comes from just executing The Win Strategy over and over and over again. If you look at that Win Strategy, every item on that strategy is a margin expansion tool.

And then capital deployment, you had the big announcement a few months ago. How do we think about sort of M&A cultivation or pipeline, like do you go into a 12-month digestion period or?

It's part of our DNA. It's part of our muscle. We never rest. We never put pencils down. Some of these transactions that we've been able to do, we had been working with, talking with, understanding for 10 or 20 years. And you never know when you're going to get to yes. We've been fortunate enough to get the yes 6 times over the last number of years, and that has been unbelievably meaningful for the company, and our goal is to continue that. We're not naive about this. We know that a bad deal can do a lot of damage. Our goal is to not do a bad deal. And that's because we have not strayed from our financial metrics, we have not strayed from our strategic philosophies on what is a good Parker Hannifin business. We have not needed to reach out into some other technology that we're not expert in. And we're going to be $21 billion, $23 billion when we close the Filtration Group. It's a $150 billion plus space that continues to grow and flex as the world needs more motion control technologies. So we have room to grow within that space.

And with that, we'll pivot to the audience response. Survey question, please.

This is my favorite part of the show.

The first one is current ownership of Parker Hannifin.

Yes. It's been a great stock to own over the last 10, 5, 2 years, no matter how you look at it. Hopefully, this is won. There we go. Thank you for your support, everyone.

We'll get that 39% over the line.

Yes. And we've got opportunity with the 39.4%. That's great.

The second one is around kind of current bias or attitude aside from ownership.

Yes. I don't want to bias the audience, but I've never seen a more positive environment around Parker. I've been with the company 33 years, so.

You've seen a lot of cycle.

A lot of smiling faces on share owners, yes. Look at that. Fantastic, 78%.

And thirdly, it's around EPS growth profile, and the peer set here is kind of multi-industry.

I mean this is something we worked really hard on. I got -- I gave you the answer, 16% over the last 10 years. I think that is pretty good.

Should be above.

Yes. Look at that.

It's 93%.

Jeff, take a picture of this one. We'll take this one back. We'll take this one back to the team.

I can send it afterwards.

Good work.

There we go. Time for the picture. All right. Perfect. Next question is around, we touched on this, but uses of excess cash, I suppose this is sort of post the acquisition close.

Yes. This one should be fun. A lot of choices here, it's going to be a split. All right, M&A is the big winner.

Yes. 80%.

But we agree. We agree. We're going to -- we're going to continue to select and integrate thoughtful businesses.

This one is sort of year 1, calendar '26 PE multiple.

Yes. Just a high-quality industrial right there. Yes. You guys are great. I've stopped here every year. You guys are great. I love it. We always didn't use to get these answers.

And it's honest responses. It's not just my team faking it. And then last one is...

Can you tell how many people are voting? It's not just people?

My team.

Right.

And then what's the main kind of anchor on the valuation or headwind at present?

Well, we got 1,000 basis points of margin expansion that we've done there.

It shouldn't be a number.

We've put $30 billion of capital to work. I think our strategy...

The #1, I guess.

Yes. That's no surprise. Good work.

Good. Well, thanks very much, Todd. Great discussion. Thank you for being here.

Thank you, everyone. Really appreciate it.