As an industrial products manufacturer and retailer, Parker-Hannifin's (PH) core business walks lock-step with global industrial spending. Given the tumultuous economic environment, it is no wonder why skeptics emphasize Parker's anemic revenue and net income growth. However, upon closer inspection, long-term, deep-value investors will see that Parker-Hannifin is financially and operationally prepared for a global economic rebound and is an opportunity to monitor very closely.
Parker and Its Competitors
Parker-Hannifin operates in 47 countries stretching across Europe, Asia, North America, South America, and Africa. The business manufactures and retails components that move and/or control the operation of various machinery and equipment as well as other fluid control products and systems. The business has three segments: Industrial, Aerospace, and Climate and Industrial Controls.
Because Parker is diversified, each business segment has its own set of competitors. Direct competitors include the likes of Eaton Corp (ETN), Emerson (EMR), and Honeywell (HON). Parker's key competitive advantage is the coupling of its manufacturing arm and its distribution network. Many of Parker's products are technical and require specialized engineering training to operate. With 11,400 distributors globally providing 24/7 customer service as well as personalized engineering and maintenance support, Parker distinguishes itself as a manufacturer, retailer, and customer support network, offering a suite of services as a one-stop-shop for customers.
In terms of multiples, Parker has an attractive 11.25 trailing P/E to be compared with the S&P's 15.22 and the peer group's average of 16.95. Additionally, the 19% return on invested capital far exceeds the S&P industrial machinery sub-industry group average ROIC of 11.7%. Finally, the three-year annual average return on equity stands at 18.97% and the one-year ROE at 22.41%. However, multiples can produce misleading valuations, so let's delve into the financials.
Parker-Hannifin is no small guy. The company boasted almost $12 billion in sales and EBITDA of almost $1.5 billion last year. Parker has achieved operational efficiencies to be reckoned with. While gross margins trail the industry average (24% and 32% respectively), operating margins are slightly above industry average at 12% compared to 11%. Achieving these operational efficiencies and maintaining this core advantage will make or break Parker's success whenever global demand rebounds. From this, it is clear Parker's operations are prepared to weather any rough storm but equally ready to take advantage of future opportunities.
With a current debt-to-equity ratio of 35% and a quick ratio of 1.02, the industrial manufacturer enjoys a very comfortable financial position in this sluggish economic environment. This, with the almost $500 million of cash on their books, proves that PH will be under no strain and will be ready for the rebound. In fact, cash and cash equivalents would be much higher were it not for the five acquisitions picked up in the third quarter alone.
Finally, every investor appreciates a little income. Parker offers a steady 2% dividend yield. While this is no recording-breaking yield, their dividend issuance is tried and true and nothing but consistent.
The Macroeconomic View
With operational efficiencies maximized and a diversified line of products, it is clear Parker is well-positioned for a macroeconomic up-swing. Over the past twelve months, the PMI (Purchasing Managers Index) has decreased from 52.2 to 51.7 while industrial production has increased production increased 1.7% to 96.6 over this same time period. The month-to-month volatility of PMI and industrial production figures do little to appease investor fears, even when there are indications of expansion. In fact, the whipsaw may account for under-valuations within the industrials sector at this time. Further, analyst estimates indicate that though the first and second quarters in 2013 may be bumpy, we are on track for steady gains in the latter half of 2013 and thereafter.
Parker's beta is high at 1.54 so the stock is highly correlated with the markets. Business segment revenues are about equally weighted between North American and International. This can be a positive - in that risk is mitigated in the economic contraction of any particular region - or a negative - as it seems all regions are currently feeling economic strain. It is absolutely crucial that businesses have their house in order in this volatile period. Such businesses, Parker setting the example, will find tremendous opportunity in the economic rebound.
The Bottom Line
Parker-Hannifin is not suitable for the quarter-to-quarter investor; market correlation is much too high to make a rational bet one way or the other in this roller-coaster environment. However, for the long-term, deep-value investor, I believe Parker-Hannifin will prove to be a successful addition to one's portfolio.