Parker-Hannifin Corporation (NYSE:PH) Q3 2024 Earnings Call Transcript May 2, 2024

Parker-Hannifin Corporation beats earnings expectations. Reported EPS is $6.51, expectations were $6.12. Parker-Hannifin Corporation 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. Welcome to Parker-Hannifin Corporation's Fiscal 2024 Third Quarter Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that today's conference is being recorded. At this time, I'll now turn the conference over to Todd Leombruno, Chief Financial Officer. Mr. Leombruno, you may now begin your presentation.

Todd Leombruno: Thank you, Rob, and good day, everyone. As Rob said, this is Parker's fiscal year 2024 third quarter earnings release webcast. This is Todd Leombruno, Chief Financial Officer speaking. With me on the call today is our Chairman and Chief Executive Officer, Jenny Parmentier. We appreciate your interest in Parker, and we thank you for joining us today. If we move to Slide 2, you will find our disclosures on our forward-looking projections and non-GAAP financial measures. Actual results could vary from our forecast based on the items listed here. The press release, this presentation and reconciliations for all non-GAAP measures that we will discuss today were released this morning and are available under the Investors section on parker.com.

We're going to start today with Jenny reviewing the highlights of our strong third quarter performance, and then she's going to highlight how the competitive advantage of our high-performance culture is getting our global team members to deliver consistent margin expansion. I will follow up then with some color on the financial results of the quarter, and I will provide some assumptions to our increase in the fiscal year 2024 guidance. We're going to end the call with a Q&A session, and we'll try to take as many questions as we possibly can. Just a reminder, please try to limit your questions to one and a follow-up, if needed, so we can get to all of those in the queue. With that, I now draw your attention to Slide 3, and Jenny, I will hand it over to you.

Jennifer Parmentier: Thank you, Todd. Q3 was another quarter where the team delivered outstanding results executing the Win Strategy. Starting with safety, a 17% reduction in recordable incidents over prior Q3. Safety has been and will remain our top priority. Record sales of $5.1 billion in the quarter, with organic growth of 1.2%, record adjusted segment operating margin of 24.7%, that's a 150 basis point improvement over prior year with all segments expanding margins. Adjusted EPS growth of 10%, along with 12.6% year-to-date free cash flow margin. Aerospace demand remains robust and was again a significant driver of our performance in the quarter. Our transformed portfolio and strong performance are driving an increase to full year guidance.

Next slide, please. Those of you who know us well know, this is the Win Strategy. This is our business system focused on the fundamentals. It is a proven strategy. We trust the process, and this is how we deliver results. Very simply put, this strategy works. I first used the Win Strategy when I joined Parker 16 years ago as a plant manager. I very quickly learned that it wasn't just words written on a piece of paper. I was trusted, empowered and expected to use the tools in the Win Strategy to improve my plan. I've since used it as a General Manager, Group President and as an Executive Officer of the company. Based on a solid foundation of culture and values, we pursue four goals: engage people, customer experience, profitable growth and financial performance.

Engage people is the first and most important pillar. As I mentioned on the previous slide, safety is our top priority, and it sits in the first position of this first pillar. One of the keys to our success is our decentralized operating structure. High performance teams at our 85 operating division utilize all the tools in the Win Strategy to deliver results. Our culture drives an ownership and entrepreneurial mindset, one that I appreciate it as a General Manager and respect today. We are excited to show you some examples of the Win Strategy in action at our upcoming Investor Day on May 16. Next slide, please. Embedded in the Win Strategy is our high-performance culture. This is a competitive advantage that has allowed us to build a better and more resilient Parker.

The structure of high-performance teams increases engagement and commitment at all levels of the organization. This, coupled with a disciplined operating cadence drives top quartile performance. Our approach is strength based, focused on building relationships and team member development. This structure reinforces our customer centric mindset and drive continuous improvement across the enterprise. Next slide, please. Our people, our high-performance culture that I just spoke about, our strategy, the Win Strategy and our transformed portfolio have driven the performance you see on this page. This is a snapshot from FY 2019 through our FY 2024 guidance, 7% revenue CAGR from $14.3 billion to our FY 2024 guide of $19.8 billion. 600 basis point increase in adjusted operating margin from 18.6% to our guide of 24.6%, 14% adjusted EPS CAGR and from $13.10 to our FY '24 guidance of $24.75 and 2 times the amount of free cash flow dollars, $1.5 billion in fiscal year 2019 and to our FY 2024 guide of $3 billion.

A lot of hard work. We are very proud of the global team delivering these results, and we have a very promising future ahead of us. And we're not done. I'll hand it over to Todd for the summary of our third quarter highlights

Todd Leombruno: Thank you, Jenny. It's great to see those results. Let's take a look at the quarter. This is just a high-level financial summary for the company. As Jenny said, Q3 was another strong quarter for Parker. Once again, every number in that gold highlighted box is a Q3 record for the company. If you'll see total sales, we did grow -- it's up slightly from prior year. We reached $5.1 billion in sales. Organic growth was just over 1% positive, slight negative impact from divestitures. That's just 0.3%. Our sales and currency did shift to a slight headwind this quarter, not terrible at 0.6%, but it's the first time the sheer currency has been a headwind. If you look at the adjusted segment operating margins, that's an improvement of 150 basis points versus prior year.

We did finish at 24.7%. And a similar story on EBITDA margins. We finished at 25.5%. That is an increase of 130 basis points from prior year. Moving to adjusted net income. We generated $851 million of net income. That is an loss of 16.8%. And adjusted earnings per share were $6.51, and that's a $0.58 or 10% increase from prior year. Net income is also an increase of 10% from prior year. Q3 was really just a solid quarter when you look at the sales, when you look at segment operating income, when you look at net income and earnings per share, each one of those generated the highest levels that we produced this fiscal year. So a very strong quarter. If we can move to Slide 9. This just shows the walk of that $0.58 or 10% increase in adjusted EPS.

I'm really glad to say again, the main driver of segment operating income dollars increasing. We increased by $76 million in the quarter. That accounted for $0.45 of the EPS growth. That's nearly 80% of the EPS growth in the quarter. Again, Jenny mentioned this, but it's just impressive operating performance across the company, but specifically, the strength in our Aerospace Systems segment was again a main contributor this quarter. Interest expense is again favorable. That really is the result of our successful efforts to deleverage after the Meggitt transaction. Tax was favorable $0.06 versus prior year. Simply, that's just a few discretes that are certainly hard to predict. Corporate G&A was higher from prior year, but really, that's just more a result of prior year favorable items not repeating this fiscal year and you can see other expense and share count were just a little bit higher than prior year.

So the theme really remains the same this quarter as it has in the first half of the year. Our team members are generating strong operating performance that is driving margin expansion, really in a tepid top line industrial environment. And our debt paydown efforts are really reducing our interest cost. So it's just great to see the team work together to generate those results. If we go to Slide 10, this is the segment performance. You can see we continue to see positive growth as a result of the higher concentration of Aerospace in our portfolio. Margin expansion does continue across all of our businesses. That is great to see. Order dollars did remain strong against a very tough comp in the prior year. Order dollars did improve sequentially from last quarter.

So we're happy to see that. If you look at the North American businesses, sales volume reached $2.2 billion. Organic growth was down 4.6%, as you can see on the slide, but that was in line with our expectations. It was driven by softness in off-highway and transportation markets specifically. We did continue to see destocking throughout the quarter, but I will say it did continue at a decelerating rate. Despite the down volume, margins increased 120 basis points to a third quarter record of 24.1% in the North American business. This just really is a shining example of operation excellence and how the teams continue to see opportunities to drive margins even higher. Order rates in North America did remain constant with last quarter. They finished at minus 4 in the quarter.

If we move to the international businesses, you can see sales volume reached $1.4 billion. Organic growth was down 3.1% on those businesses. But again, that was in line with our guidance. If you look at EMEA, that was the most negative at negative 5.1 and just some contraction again in highway transportation and implant industrial markets. Asia Pac growth was minus 2.8%. China remains generally soft. Latin America is a strong point. They continue to be positive at 19% versus prior year. What we're really proud about is the team, even on that lower volume, expanded margins by 10 basis points, and they also generated a third quarter record of 23.5%. Focus remains on productivity improvements and cost controls in these businesses with orders in the international businesses at minus 8.

In EMEA, we are seeing some choppiness on orders, while Asia Pac we are seeing some improvements. If we look at Aerospace, Aerospace delivered another stellar quarter for the company. Sales reached a record of $1.4 billion, that's the highest we've ever had in the aerospace business. Organic growth was 18% across every market segment we have in aerospace. This is the fifth quarter of double-digit organic growth within Aerospace. Aftermarket strength continues to be outstanding. This quarter, we were up 26% in the commercial aftermarket area and operating margins are fantastic, reaching a new record, increasing by 320 basis points versus prior year to come in at 26.7%. Demand just remains robust, aftermarket strength continues and the team is just doing great driving margins ever higher.

Order rates in aerospace continue to be very strong at plus 15. So just great performance across all of our businesses. If we go to Slide 11, let's talk about cash flow. So first of all, I think most of you have probably seen this last week, our Board approved a quarterly dividend payout of $1.63 per share. That is a 10% increase over the prior dividend payout. With that increase, this does increase our annual record of paying higher dividend dollars per year from 67 years to now 68 years, just an unbelievably impressive record. Looking at cash flow. We've got a record on cash flow of $2.1 billion of cash flow from operations, that's 14.6% of sales. That is a 20% increase over prior year. And I said it already, but it is a record. When you look at free cash flow, we did $1.9 billion that is 12.6% to sales and that also is a 22% increase versus prior year.

The team really remains focused on being great generators and great deployers of cash. We are reaffirming our full year target of free cash flow dollars of over $3 billion, and we certainly are committed to free cash flow conversion of over 100 for the full fiscal year. So great performance on cash. Let's move to Slide 12. I'm happy to give an update on our deleveraging progress. We did reduce debt by over $420 million in the quarter. Since we closed the Mega transaction, it was just six quarters ago. We have reduced debt by over $2.6 billion. That, coupled with the continued expansion in EBITDA growth, we have reduced our leverage by over 40% just since the close. Both of those are ahead of our original commitment. And you can see on the slide here, gross debt to adjusted EBITDA is now 2.3 times and net debt is down to 2.2 times.

We still feel confident that we will get the $2 billion of debt paid down in this fiscal year and we certainly are on track to achieve net leverage of 2 times by June of this fiscal year, just in two months. So if we go to Slide 13, just some color on our guidance. We are reaffirming our full year organic growth midpoint and increasing our margin and earnings per share expectations for the year. Our reported sales growth for the year is expected to be 4% at the midpoint. And on organic growth, we are increasing aerospace once again. We're increasing it by 300 basis points to 15% for the full year. Both North America and international diversified industrial businesses. Organic growth is now forecasted to be negative 2.5. But for the company, full year organic growth remains the same at 1.5% positive.

So you can see how aerospace is helping the portfolio on our top line. We're raising adjusted segment operating margins. We're raising that to 24.6. That's 30 basis points higher than prior guidance, and that now forces the full year margin expansion to be approximately 170 basis points versus prior year. Corporate G&A and interest, unchanged from prior guide. Tax rate is down a little bit, just really based on Q3 actual results. We expect that to be 22% now. Full year as-reported EPS has increased to $20.90 and full year adjusted EPS has increased to $24.75. Both of those are at the midpoint and there's a range narrowed to plus or minus $0.10 for the fourth quarter. Finally, if you look at the fourth quarter, our adjusted EPS is expected to be $6.13 at the midpoint.

So as usual, we've got some more specifics in the appendix if needed. And now, I'm going to hand it back to you, Jenny, and I ask everyone to turn to Slide 14.

Jennifer Parmentier: Thank you, Todd. A few key messages to close this out as we near the end of our fiscal year 2024, our high-performance culture built a better and more resilient Parker. We will continue to drive operational excellence through the Win Strategy. As mentioned a couple of times already, aerospace demand remains robust, and our transformed portfolio drives growth. And finally, Parker is and will continue to be a great generator and deplorer of cash. Next slide, please. We are looking forward to sharing our story at our investor meeting on May 16th. I will be joined by our President and Chief Operating Officer, Andy Ross, our Chief Financial Officer, Todd Leombruno, and our Vice President of Investor Relations, Jeff Miller.

Our key themes for the meeting are transforming the company, how we are positioned for growth from secular trends, operational excellence and financial performance. Thank you again for joining the call today. And I'll turn it back over to Todd for Q&A.

Todd Leombruno: Rob, we're ready to open the lines for Q&A, and we'll take whatever you got first in the queue.

Operator: Thank you. Our first question in the queue today is Scott Davis with Melius Research. Please proceed with your question.

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