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Parker-Hannifin had a tremendous run in 2013, increasing ~50%, while EBITDA contracted from 2012 levels. The current dividend yield of 1.4% will leave income investors hungry, but for the total return investor the ride will continue.

I. COMPANY OVERVIEW

Parker-Hannifin Corporation (NYSE:PH) is a full-line diversified manufacturer of motion and control technologies and systems, including fluid power systems, electromechanical controls and related components. The Company also is a worldwide producer of fluid purification, fluid and fuel control, process instrumentation, air conditioning, refrigeration, electromagnetic shielding and thermal management products and systems.

II. HISTORICAL PERFORMANCE

20092010201120122013
Revenue$10,309.0$9,993.2$12,345.9$13,145.9$13,015.7
% Growthn/a-3.1%23.5%6.5%-1.0%
Gross Profit2,168.72,189.12,973.73,200.32,937.4
% Margin21.0%21.9%24.1%24.3%22.6%
EBITDA1,242.21,280.01,846.92,003.91,721.9
% Margin12.0%12.8%15.0%15.2%13.2%
Net Income508.5554.11,049.11,151.8948.4
Avg Diluted Shares162.7162.9164.8154.7151.6
% Growthn/a0.1%1.2%-6.1%-2.0%

Note: All figures are MM's (except per share data) unless noted otherwise.

Parker-Hannifin has performed well over the past five years as it came out of the recession. The Company's revenue contracted twice in the past four years. In 2010 revenue contracted at a rate of 3.1% and to a lesser extent revenue contracted in 2013 at a 1.0% rate. The net result was a positive compounded annual growth rate of 6.0% since 2009. The gross margin has trended positively, although being relatively volatile for a company with this level of margins varying over a 3.3% range over the past five years (bottoming at 21.0% and peaking at 24.3%). Similarly, EBTIDA Margins have expanded from 12.0% in 2009 to 13.2% in 2013 (although recently contracted from the 15% level), resulting in EBITDA expansion from $1,242MM in 2009 to $1,722MM in 2013 (39% expansion) over the five year period.

Per Share Data
20092010201120122013
Revenue$63.35$61.34$74.92$85.00$85.86
% Growthn/a-3.2%22.1%13.5%1.0%
Gross Profit13.3313.4418.0420.6919.38
EBITDA7.637.8611.2112.9611.36
Net Income3.133.406.377.456.26
Dividends1.001.011.251.541.70
Payout Ratio32.0%29.7%19.6%20.7%27.2%
Dividend Growthn/a1.0%23.8%23.2%10.4%

Note: Per share data based on weighted average diluted shares outstanding.

On a per share basis, we need to view company-wide historical performance in a different light. The Company has changed their weighted average shares outstanding through share redemption from 163MM to 152MM over the period (a 6.8% decrease), resulting in a more favorable performance on a per share basis. EBITDA per share has expanded from $7.63 to $11.36 (a 49% increase as compared to a 39% increase at the Company level). The Company's dividends per share have been growing, increasing from $1.00 per share in 2009 to $1.70 per share in 2013 (a 70% increase or a 14.2% compounded annual growth rate) while maintaining a stable payout ratio in the 20-30% range.

III. CAPITALIZATION

Market / Par ValueEBITDA Multiple
- Cash and Equivalents$1,9461.1x
+ Total Debt$2,8421.7x
+ Minority Interest$30.0x
+ Market Capitalization$19,24511.2x
Total Enterprise Value$20,14511.7x

Note 1: Based on TTM EBITDA of $1,721MM as of 9/30/13.

Note 2: Market Cap based on 149.2MM shares outstanding and a $128.96 market price as of 1/15/14.

Parker-Hannifin has an low leverage capital structure. The Company is levered at 1.7x TTM EBITDA (0.5x net of cash) with a total enterprise value of 11.7x TTM EBITDA. Ideally, the Company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage the Company would have a low cost of debt and maintain significant financial flexibility while enhancing returns to the equity holders.

IV. PROJECTIONS

20142015201620172018
EBITDA$1,930.0$2,163.4$2,394.0$2,394.0$2,394.0
% Growth12.1%12.1%10.7%0.0%0.0%
Interest Expense89.089.089.089.089.0
Taxes388.7438.5487.8487.8487.8
Capital Expenditures275.7309.0342.0342.0342.0
Dividends268.6268.6268.6268.6268.6
Addl' FCF$908.0$1,058.2$1,206.6$1,206.6$1,206.6

Note: All figures are MM's (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for Parker-Hannifin are aggressive projecting a growth rate between 12.1% and 10.7% annually through 2016 at the EBITDA line (projections unavailable for 2017 and 2018). Under the consensus case, the Company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

20142015201620172018
Addl' FCF$908.0$1,058.2$1,206.6$1,206.6$1,206.6
Share Redemption Price$148.30$170.55$196.13$225.55$259.38
Shares Redeemed6.16.26.25.34.7
Wtd Avg Diluted Shares145.5139.3133.1127.8123.1
Dividends Per Share$1.85$1.93$2.02$2.10$2.18
Dividend Growth8.6%4.5%4.6%4.2%3.8%

The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The Company's share redemption would allow for a 4% to 5% increase in the dividend annually from the share redemptions alone. Additionally, the Company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the Company's earnings (using EBITDA as a proxy) would be increasing.

If the Company performs in line with the consensus estimates and pay dividends / redeems shares as outlined above, the Company would achieve the IRR / Cash on Cash returns illustrated below based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple
9.2x9.7x10.2x10.7x11.2x11.7x
IRR7.7%9.0%10.2%11.5%12.6%14.0%
Cash on Cash1.38x1.46x1.53x1.61x1.68x1.78x

V. RECOMMENDATION

Parker-Hannifin is a nice little business. The Company has increased its dividend consistently for the last 57 years and recently at a pretty good clip (14%+ CAGR since 2009). The paltry dividend yield of 1.4% and one year return of 40%+ certainly makes me more cautious, but total return investors will find a lot to like in this cyclical performer.

Source: Parker-Hannifin: Light Yield, Heavy Total Return