Parker-Hannifin Stock Re-Rating Nears Completion NYSE PH

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In June, I had my eye on Parker-Hannifin (NYSE:PH) and thought that the stock was flying high, maybe even too high. The company has been on a dealmaking spree in recent years, integrating these transactions well and resulting in solid growth and increased shareholder value. This made me optimistic about the long-term prospects of the stock, although I felt that a lot of good news was already priced into the shares over the summer.

Parker-Hannifin is a well-established company that has been around for over a century, operating in various segments. Despite its size, Parker uses a decentralized organizational structure that focuses on engineered and IP products with long product life cycles and lower capital expenditure requirements.

The company's products and applications include pneumatics, electrochemical activities, filtration products, climate control, and sealing activities used in industrial and aerospace applications.

Before the pandemic, Parker-Hannifin was a $14.3 billion business, with operating profits of $2.1 billion and net earnings of $1.5 billion, or about $11 per share. At trading near the $200 mark, valuations were considered fair, or even appealing.

The company pursued some significant deals, including a $3.7 billion acquisition of LORD in 2019 and a $1.7 billion deal to acquire Exotic Metals Forming shortly after, which were expected to boost earnings power but also increase leverage ratios.

Shares reached levels above $300 in 2021, then consolidated around $250 in 2022. In 2023, the stock saw a strong rise from $300 to around $350 per share early in the summer.

This growth was driven by real business growth, as 2022 sales increased by 11% to $15.9 billion, with adjusted earnings of nearly $19 per share. The company projected modest 2-5% growth in fiscal 2023 sales, with earnings expected to be around $18.50 per share.

A significant factor was the multi-billion-dollar deal for UK-based Meggitt PLC, which closed in September 2022 and contributed to the business. This deal increased the aerospace component of the business to about a quarter of total sales, with the remainder generated from core industrial markets.

As of the summer, the company had positive news to report, with organic sales growth for 2023 projected at 10%, and sales at a run rate of $20 billion, including Meggitt. Adjusted earnings per share were expected to be around $20.75 per share. Leverage was also getting under control, with net debt down to $12.9 billion, resulting in a 2.6 times leverage ratio.

With earnings power of roughly $20 per share, translating into a reasonable 17 times earnings multiple at $350, the outlook was positive. However, leverage was still substantial, raising questions about the company's margins relative to the economic cycle. After weighing the pros and cons, I decided to maintain a modest long position, initiated before the pandemic, as a satisfied holder.

Since the summer, shares have continued to rise, reaching highs of $458 per share, trading close to their 52-week highs.

In August, Parker-Hannifin reported a 22% increase in fourth-quarter sales to $5.1 billion, with net earnings of $709 million, or $5.44 per share (or adjusted earnings of $6.08 per share) based on a share count of 130 million shares. The Meggitt deal contributed to full-year sales of $19.1 billion, with GAAP earnings of $16.04 per share and adjusted earnings of $21.55 per share.

The company projected relative stagnation in its fiscal 2024 results, with full-year sales expected to increase by 3-6% to around $20 billion, in line with the annualized results for the fourth quarter. Adjusted earnings per share were forecasted to be between $21.90 and $22.90 per share, with net debt decreasing to $12.1 billion.

In November, Parker-Hannifin reported first-quarter sales of $4.8 billion, a 15% increase on a reported basis compared to the previous year. Organic sales were up 2%, and adjusted earnings were reported at $5.96 per share, with net debt down to $11.7 billion.

The company slightly lowered the midpoint of its full-year sales guidance but increased the adjusted earnings guidance to a midpoint of $23.00 per share, up sixty cents from the original outlook. With EBITDA trending around $4 billion, leverage ratios were estimated at around 2.8 times, in a low-interest-rate environment.

The relentless rise in the share price has raised expectations, with shares mostly increasing on valuation multiple inflation, pushing the valuation from about 17 times earnings to about 20 times earnings, while leverage still requires some work.

Believing that the re-rating is largely complete, I have decided to take some profits off the table after a strong rally in 2023, leaving the shares more than fully valued. However, I am actively looking for a dip to buy into this quality player again, but for that to happen, shares would need to fall back to at least the $400 mark, preferably to levels in the $300s.