Parker-Hannifin Corporation (NYSE:PH) Q2 2024 Earnings Call Transcript

Parker-Hannifin Corporation (NYSE:PH) Q2 2024 Earnings Call Transcript February 1, 2024

Parker-Hannifin Corporation beats earnings expectations. Reported EPS is $6.15, expectations were $5.24. PH isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the Parker-Hannifin Fiscal 2024 Second Quarter Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Leombruno, Chief Financial Officer. Thank you. You may begin.

Todd M. Leombruno: Thank you, Diego, and good morning, everyone. Welcome to Parker-Hannifin’s Fiscal Year 2024 Second Quarter Earnings Release Webcast. As Diego said, this is Todd Leombruno, Chief Financial Officer speaking. And I’m here today with our Chairman and Chief Executive Officer, Jennifer Parmentier. We know that this is an extremely busy day for everyone, and we appreciate you joining us and we appreciate your interest in Parker. On Slide 2, you’ll see our disclosures addressing forward-looking projections and non-GAAP financial measures. Actual results could vary from our forecast based on the items listed here. Our press release, this presentation, and reconciliations for all non-GAAP financial measures were released this morning and are available under the Investors section at parker.com.

The agenda for today has Jenny starting with the highlights of our record second quarter. She’s also going to reinforce how our portfolio, our team members and the Win Strategy, our business system are driving margin expansion and position Parker for a very bright future. I’m going to add some color on the financial results and a few details on the increase to our guidance that we released this morning, and after that we’re going to open up the lines and Jenny and I will take any questions from those in the queue. I’d now ask you to move to Slide 3. And Jenny, I’ll turn it over to you.

Jennifer A. Parmentier: Thank you, Todd. Good morning to everyone and thank you for joining our call today. Q2 was a quarter of exceptional results, excellent operating performance driven by all of our team members executing the Win Strategy. Starting with safety, a 16% reduction in recordable incidents over prior Q2. Safety has been and will remain our top priority. Record sales of $4.8 billion in the quarter, a 3% increase over prior year with organic growth of 3%. Record adjusted segment operating margin of 24.5%, a 300 basis point increase over prior year with all segments expanding margins, and adjusted EPS growth of 29% along with 11.9% year-to-date free cash flow margin. Aerospace strength was a significant driver of our performance in the quarter.

We now expect to achieve $200 million in cumulative synergies in fiscal year ‘24, a $50 million increase to our original guide for this fiscal year. We remain committed to achieving $300 million in synergies by fiscal year ‘26. And our backlog remains resilient at $10.8 billion. We had a strong finish to the first half and as a result our increasing fiscal year ‘24 guidance, Todd will go over this later in the slide deck. Next slide, please. I’d like to spend a few minutes highlighting the power of the entire Parker portfolio. We have a technology powerhouse of interconnected solutions that delivers value for customers in both aerospace and industrial markets. Today two-thirds of our revenue comes from customers who buy four or more of the technologies you see across the top of this page.

And two-thirds of our portfolio product solutions that we have today enables clean technologies. Next slide please. Parker has significant content on leading aerospace programs. We have a comprehensive product offering with proprietary design on premier programs. On the upper left hand side of this page is our first half sales mix by application. You see a nice balance of commercial and military, as well as business jets, regional transport and helicopters. This diverse aerospace and defense exposure allows us to have multiple products and technologies on every major aircraft program globally, many of them seen along the bottom of this page. All of this adds up to be a compelling value proposition for all of our aerospace customers. Next slide, please.

And equally compelling is our global distribution network, a competitive differentiator for Parker. 50% of our diversified industrial revenue is through distribution, a high margin channel serving aftermarket and small to medium sized OEMs. Our distribution partners integrate Parker technologies that solve customer problems. They are truly an extension of Parker’s sales and engineering team. Building on the success of the North American distribution channel, we continue to drive an increasing revenue mix of 100 basis points per year in international markets. This past December, we held our North America National Sales Meeting for the first time since the pandemic. Nearly 100 distribution partners attended the meeting along with Parker divisions and sales teams.

It was great to have everyone together again, and despite the destocking we’ve been talking about for several quarters, the overall sentiment and tone was very positive for the future. Next slide, please. We continue to be very proud of our margin expansion progress. Our people, our business system, the Win Strategy and our portfolio have truly transformed Parker’s performance. The progress can be seen in every segment on this page. In addition to our core strategies on lean, pricing and procurement, Win 3.0 initiatives like Simple by Design, our focus on demand forecasting, zero defects and productivity and automation will take us to 25% adjusted operating margin and beyond. Every strategy and tool in the Win Strategy expands margins. I’ll now turn it back to, Todd.

Todd M. Leombruno: Okay. Thanks, Jenny. I’m going to start on Slide 9, and I’m just going to really quickly go through the FY2024 Q2 financial summary. As Jenny mentioned, the second quarter was an extremely strong quarter for us. It was a great finish to the first half of our fiscal year. And once again, the team set an unbelievable amount of records for the quarter. If you look at this slide, every number in that gold column is the second quarter record. We set new highs for sales, segment operating margin, EBITDA margin, net income and earnings per share. Total sales growth was plus 3% in the quarter, all of that 3% was organic. Just a reminder, this is the first full quarter that we have, Meggitt in both the current and prior year periods.

The net impact of divestitures and currency basically offset each other. Divestitures was slightly unfavorable at 0.3%, currency was slightly favorable at 0.5%. When you look at the margins, Jenny already mentioned this, that 24.5% was an increase of 300 basis points versus prior year, and adjusted EBITDA margin reached 25.7% that was an increase of 330 basis points versus prior year. If you take a look at net income, we did $802 million on an adjusted basis that is a 16.6% return on sales that was a 30% increase versus prior year. And lastly adjusted earnings per share a record for the quarter $6.15 that was up 29% from prior. Just an exceptional second quarter and again, unbelievable margin expansion and what I really like about it, it was consistent across all of our businesses as Jenny just shared on that last slide.

If you go to Slide 10, this is the earnings per share bridge and this chart really shows what a high quality quarter it was for the company. The 29% in adjusted earnings per share that amounted to an additional $1.39 of earnings per share in the quarter, main driver of this continues to be excellent operating performance. If you look at segment operating income dollars that increased by $173 million in the quarter that accounted for just a little over a $1 of that EPS growth and that equated to 74% of the increased earnings per share in the quarter. Clearly, aerospace systems was a major driver of improvement, but what is really impressive is both industrial businesses also contributed to the increase in segment operating income dollars. If you look at tax that was $0.18 favorable versus prior year again just driven by some discrete items, other expense was favorable $0.12 versus prior year.

That was mainly the result of currency changes and some favorable pension expense. Interest expense was $0.10 favorable versus prior, that really is a result of our successful efforts to reduce outstanding debt over the last 12 months. I’ll talk about that in a little bit later in the deck. Corporate G&A and share count were just both slightly higher than prior year, just a net $0.03. And those are the components of the increase in adjusted earnings per share. Really it’s just strong margin performance across the company continue with some great outstanding performance from the Meggitt business. If you go to Slide 11, we’ll talk about the segment performance that’s detailed on Slide 11. Couldn’t be prouder of the broad based margin expansion really driven by the Win Strategy, Jenny mentioned this, but our synergies are ahead of schedule.

We did increase that synergy number. Aerospace demand really remains very, very high. So, just a nice consistent execution across our businesses, across all of our global team members. You can see that segment operating margin 24.5% at the bottom of the page, up 300 basis points. Incrementals were stellar at over a 100% and orders remain positive at plus 2% versus prior year and backlog really remains resilient. Total backlog dollars did increase slightly sequentially as well. And Jenny mentioned this, but total backlog remains at near record levels, and aerospace activity remains especially robust. If you look at the North American businesses, sales volume reached $2.1 billion in the quarter. Organic growth was down 1.5% versus prior year.

That was driven by continued destocking, some channel rebalancing and really some softness in off highway markets. However, what is impressive out of the North American team is that adjusted operating margins did increase 240 basis points to a second quarter record of 24.2%. That was just really driven by excellent execution, some great efficiency improvements and really some tight cost controls. Orders in North America also remain consistent the prior quarter. They remain at down minus 4%. If you look at the international businesses, sales were $1.4 billion slightly positive versus prior year. Organic growth was essentially flat, which was better than we were forecasting. Organic growth in EMEA was positive at 0.7%, Latin America was positive at 9.2% and Asia Pac did improve, it did come in at negative 2.5% really just being pulled down by the slower than expected recovery in China.

But also what’s impressive there is adjusted operating margins did expand 110 basis points in these businesses and also finished at a second quarter record of 23%. That international team continues to be focused on productivity improvements, expanding margins and being very resilient across the segment even in a low growth environment, very impressive results. Orders in the international segment did improve. If you remember last quarter, they were minus 8, they did improve to minus 5. And finally on Aerospace Systems, they delivered another standout quarter. Sales reached $1.3 billion a 15% increase from prior year. All of that 15% is organic growth, and volume just continues to be driven by commercial aftermarket growth that was in the quarter up 25%.

Operating margins reached a new record increasing by 590 basis points to reach 26.5%. Really the healthy volumes, the favorable aftermarket mix, outstanding performance from the Meggitt business really all contributed to drive these record margins. We are increasing the synergies. Jenny went over that just briefly. Cumulative synergies were increasing from $150 million to $200 [million] (ph) and order rates in aerospace continue to remain plus 21% which is very robust. On the next slide, we’ll talk about cash flow. Let’s take a look at what we’ve done there. Year-to-date cash flow from operations is $1.4 billion that’s 14% of sales. That is an increase of 26% versus prior year, just fantastic cash flow performance. If you look at free cash flow that was $1.1 billion that’s up 11.9% also increasing significantly 29% increase from prior.

Our cash flow conversion is year-to-date 86%. We really have the team remaining focused on being great generators and great deployers of cash. You’ve heard us say that many times. Last week our Board approved a quarterly dividend of $1.48 per share. That is our 295th consecutive quarterly dividend. Just a nice solid testament to our belief that we can be great generators and great deployers of cash. When you look at the full year, we are increasing our expectations for free cash flow, we’ve increased that range to $2.8 billion to $3.1 billion. That’s moving the midpoint up $150 million to approximately $3 billion and of course free cash flow conversion will be over a 100% for the full year. On the next slide, let’s take a look at our progress on deleveraging.

We did reduce debt another $400 million in the quarter. And just a reminder, since we closed Meggitt just five quarters ago, we have reduced debt by over $2.2 billion now, and we’ve improved our leverage by 1.4 turns, both of those figures are ahead of what we’ve originally committed to. If you look at the metrics gross debt to adjusted EBITDA is now 2.4. Net debt to adjusted EBITDA is 2.3. And we continue to forecast just approximately $2 billion of debt paid out in the fiscal year. And now based on the performance we’ve got year-to-date, we expect to achieve net leverage of 2.0 times by June of 2024, just great performance across the board. Okay. On guidance, just a few details on guidance, you saw the increase to guidance we are reaffirming our full-year organic growth midpoint and increasing our margin and our earnings per share expectations for the year.

Our reported sales growth for the year is forecasted to be in the range of 3% to 5% or roughly 4% at the midpoint and they are modeled 49% first half 51% second half. In respect to organic growth, we are raising the aerospace organic growth midpoint by 200 basis points to 12% for the full year. We are also raising the international organic growth midpoint by 100 basis points to minus 2%. That’s slightly better than what we gave you last quarter. Those increases are offset by a decrease in the North American organic growth midpoint by 200 basis points to minus 1.5%. Full year organic growth for the entire company remains the same as last quarter at plus 1.5%. Moving on to margins, adjusted segment operating margin guidance is being raised to 24.3% at the midpoint that’s up 70 basis points from prior guidance.

And if you look at it on a year-over-year basis that would be 140 basis points of margin expansion versus prior year. Meggitt synergies we talked a lot of that, we’re moving that to $200 million. Corporate G&A interest and other are relatively unchanged from our prior guide. Tax raised, tweaked just a little bit. We expect the full year to be 22.5% that’s really based on the performance in the first half. We expect the second half to be 23.7% from a tax rate perspective. Full year as reported earnings per share increased to $20.30 and full year adjusted earnings per share has increased to $24.20 both of those are at the midpoint. And finally for FY2024 Q3, adjusted earnings per share we expect that to be $6 even at the midpoint. And as usual, we’ve included some more specifics in the appendix.

So, that’s it on the increase to guide. Jenny, I will hand it back to you, and ask everyone to move to Slide 15.

Jennifer A. Parmentier: Thank you, Todd. A few key messages to close this out. Q2, as we stated many times, was an exceptional quarter that closed a strong first half. We’ll continue to drive positive results and accelerate our performance using the Win Strategy. Our portfolio and strengthened customer value proposition, along with growth from secular trends, will deliver organic growth of 4% to 6% over the cycle. We remain committed to our FY ‘27 targets of approximately $30 earnings per share and greater than $3.5 billion free cash flow. We expect another year of record performance and we have a very promising future ahead of us. We look forward to talking to you about our promising future at our Investor Meeting on May 16, of this year. Back to you, Todd.

Todd M. Leombruno: Okay. Diego, we are ready to open the lines for Q&A, and we’ll take whoever is first in the queue.

Operator: Thank you. [Operator Instructions] Our first question comes from Joe Ritchie with Goldman Sachs. Please state your question.

See also 15 Cash-Rich Penny Stocks Hedge Funds Are Buying and 30 Countries with Highest Christian Population in the World.

Q&A Session

Joe Ritchie: Hi, good morning, everyone, and great quarter.

Jennifer A. Parmentier: Good morning, Joe.

Todd M. Leombruno: Thanks, Joe.

Joe Ritchie: Hi, the first place I’d like to start is just around North America. So clearly, good color, Todd. And what the guidance now implies, but it looks like your order rates are at least stabilizing there even though you took down the growth guidance for the year. So maybe just talk a little bit about what you’re seeing across those end markets and whether you’re seeing any stabilization or green shoots on your North America industrial business?

Jennifer A. Parmentier: Sure, Joe. This is Jenny. So, yes, we did see, as Todd said, a negative 1.5% of organic decline in Q2. We’ve had four consecutive quarters with negative orders now, but as Todd stated, the orders did remain the same as last quarter at minus 4%. What I would say is that, destocking in the channel continued. We saw weakness in off highway, primarily construction in Q2, some weakness in transportation and automotive and in heavy duty. We did talk last quarter about this inventory rebalancing and destocking, not only through distribution, but also at the OEM level with customers, dealerships, dealers, and that we did anticipate this to go into calendar year ‘24. So I would say overall, destocking is in-line with our expectation for Q2, but North America was just a little worse.

It’s been a year since it started and it’s going to continue into the second half here and that’s what we have in the guide. But backlog remained strong. We had this longer horizon of backlog strength and I would say that, as I mentioned earlier, distribution sentiment is very positive. We haven’t seen any major cancellations or push-outs out there right now. So, we lowered the guide, to 2.5% on this continued destocking and the softer off highway, we think was going to continue. We see, it’ll be construction again and AG2 this quarter, but we’re feeling good about this guide right now.

Todd M. Leombruno: Hi, Joe, this is Todd. I would just add, if you look at the total industrial business, right, in total it kind of came in exactly as we’re expecting. You’re exactly right. There was a little bit of a shift from North America into the international markets, but when you look at the total reported sales, at least what we’re guiding to, these are really very, very close to all-time highs when it comes to volume. So, we feel really good about that. We think we can continue to expand margins despite what’s going on with the choppiness in the order market. So, we feel really good about that.

Joe Ritchie: Yes, that’s great color from both of you. I guess my quick follow on there is, look, the margin performance despite the kind of weaker growth expectations in North America and really across your industrial businesses have been incredible. Last couple of quarters, you’re above 24%. So, I guess the question is like, is 24% kind of a new baseline for the industrial businesses going forward?

Todd M. Leombruno: Joe, it’s a great question. Like I said in the comments, couldn’t be prouder of the team. We talk about this all the time, the Win Strategy, every single item on that Win Strategy is a margin enhancing set of tools, and it really is rewarding to see the team put up numbers like that. We have a target set out there. We want the company to be at 25%. Segment operating margin, we have not achieved that yet. We will achieve that, there is no doubt. But we’re just keeping an eye on what’s happening with the topline and obviously we’re doing everything we can within the four walls of our facilities to make sure that we keep pushing that number higher.

Jennifer A. Parmentier: And Joe, I would just add, I mean, our culture is one of continuous improvement. And we’re just, we’re never waiting for a downturn. We’re using all of the tools in the Win Strategy to expand margins. And again, I have to echo Todd’s comments. We couldn’t be prouder of the team. They’re just really doing a really nice job in a slower growth environment. We expect that to continue.

Joe Ritchie: Great. Thank you, both.

Todd M. Leombruno: Thanks, Joe.

Operator: Our next question comes from Julian Mitchell with Barclays. Please state your question.

Julian Mitchell: Hi, good morning. Maybe just wanted to understand on the international business in industrial, orders have been down I think for five quarters now. You slightly took up the sales guide, what’s your impression of sort of where we are in that orders downturn? Maybe help us understand sort of what on the revenue side changed a little bit? And are we thinking it’s sort of a very gradual maybe we and a floor in the next couple of quarters and then a very gradual recovery thereafter across those main regions in international.

Jennifer A. Parmentier: Thanks, Julian. This is Jenny. So, listen, we’ve been saying it’s just been choppy in international now for several quarters. But, flat call it flat organic growth in Q2. As Todd said, orders did improve from minus 8 in Q1 to minus 5 in Q2. Europe, EMEA had positive organic growth of 0.7%. It was better than our forecast, as you said, really due to some resilience in our filtration business and favorable project business timing. We did see destocking continue. We see some softness in off highway and industrial markets. In Asia Pacific, Todd mentioned a 2.5% organic decline. China recovery is still slow. I mean, we did see some low-single-digit positive growth for China in Q2, but again, it was against a much easier comp from the COVID shutdown last year.