Published September 21st, 2016 by Eli Inkrot
If you were asked to quickly detail what business Parker-Hannifin (PH) was in, your answer might not be so quick. The company offers products ranging from filters and gas generators to refrigeration and O-rings to medical and dental equipment to flow control and piping to… well, you get the idea. Parker is a fairly diverse set of businesses all housed under one corporate roof.
The company officially describes itself as the “world’s leading diversified manufacturer of motion and control technologies and systems.” This might be about as close as you’re going to get to describing the business with a single picture:
Perhaps just as important to the income investor is the company’s record of not only paying but also increasing its quarterly dividend for 60 straight years. This makes Parker one of just 18 Dividend Kings; stocks with 50+ consecutive years of dividend increases. You can see all 18 Dividend Kings here.
The company will have you know that this is among the top five longest-running dividend-increase records in the S&P 500 Index.
On August 4th of 2016, Parker reported fourth quarter and fiscal year results. For the three months ending June 30th, Parker saw net sales drop by about 6% (as compared to the year-ago period) to just under $3 billion. Still, net income increased dramatically to $242 million, or a 35% increase, as result of substantially lower cost of sales, SG&A and taxes. Adjusted earnings were up about 33% for the quarter, coming in at $1.90 versus $1.43 during the same time last year.
For the entire fiscal year, net sales declined by about 11% to $11.2 billion. Net income was down about 20% to $807 million, but adjusted earnings-per-share were “only” down 11% partially as a result of fewer shares outstanding, but mostly due to other modifications. Adjusted earnings-per-share came in at $6.46 for the fiscal year as compared to $7.25 last year. To be sure Parker faced a challenging year, most notably from the agriculture, construction equipment, mining and oil & gas markets.
Parker also provided guidance for the upcoming year. For the fiscal year ending June 30th, 2017 the company anticipates continuing operations to generate between $6.15 and $6.85 per share in earnings, with adjusted earnings in the $6.40 to $7.10 range.
On August 18th, Parker announced a $0.63 quarterly dividend – marking its 265th consecutive quarterly payout (in addition to the 60-year increase streak) and the eighth straight payment at this rate. Given the timing of these increases, Parker has until next quarter to increase its payout in order to keep its yearly payout boost streak alive. Given all the verbiage surrounding the proud dividend record, not to mention expected earnings roughly 2.5 times that of the current payout, you’d anticipate an increase shortly.
Competitive Advantage & Recession Performance
Parker describes its strong competitive advantage as being in the number one position for the motion and control industry (owning roughly 10% of the market). The company focuses on delivering quality solutions on time, and claims to have engaged people leading the way. There are high switching costs involved – allowing the entrenched leader an advantage – and Parker can offer a complete line of solutions instead of just a piece of the puzzle.
Here’s a look at how the company performed before, during and after the most recent recession:
- 2006 earnings-per-share = $3.57
- 2007 earnings-per-share = $4.67
- 2008 earnings-per-share = $5.53
- 2009 earnings-per-share = $3.13
- 2010 earnings-per-share = $3.40
- 2011 earnings-per-share = $6.37
Three basic points stand out. For one thing, the earnings-per-share were certainly affected by the recession. You had profits of $5.53 in fiscal year 2008 fall all the way to $3.13 – a 43% decline – in just one year.
The second thing to keep in mind is that the dividend just kept on increasing during this time. A $0.61 annual dividend in 2006 turned into $1.25 – over double what it was – in this short time period.
Finally, we can see the “snap back” effect take place once times were good again. While earnings cratered during 2009 and 2010, they quickly jumped back to over $6 per share by 2011. Indeed, earnings-per-share has now been over $6 (and occasionally over $7) for the last six years.
Here’s a look at Parker’s record of earnings and dividend growth over the last decade:
- Earnings-per-share have grown at an average compound rate of 6.1% per annum.
- Dividends per share have grown at an average compound rate of 15.2% per annum.
Given this disparity we know that the payout ratio has been increasing in the last decade. Indeed, Parker has gone from paying out about 17% of its profits in the form of cash dividends to last year paying out 39% of earnings as dividends.
This is still a rather low comparative payout ratio, but it does influence the amount of funds that could go toward share repurchases and potentially decrease the per share growth rate of the security.
For intermediate-term growth, analysts are presently anticipating the company to advance in the 5% to 10% range per year. Obviously something on the higher end (or even better) can occur, but personally I like to error on the side of caution. Better to be pleasantly surprised instead of needing excellent performance to justify an investment thesis.
Valuation & Total Return
Over the past two decades, Parker has traded with an average P/E ratio around 15 or 16. Over the past decade and five years this number has been closer to 15. Obviously the overall range is much wider than this, but this has been a reasonable baseline over the years.
As I write this, shares are trading hands around $122. Based on $6.46 in adjusted earnings, this equates to an earnings multiple of nearly 19 – notably well above the company’s historical average. Yet this alone does not mean that all is lost.
Should the company be able to grow earnings and dividends by say 6% annually over the next five years, you might anticipate receiving $15 in cash dividends to go along with earnings-per-share of ~$8.60. If shares later traded at “just” 15 times earnings, this would equate to a future price of about $130. Added together you have an expected value of ~$145, or an average compound gain of about 3.5% per annum.
Certainly this is not impressive, but it does highlight two important notions. For one thing, it demonstrates that unless the P/E ratio remains where it is or goes higher, investment performance is apt to trail business performance in the coming years. Just as important is the idea that this factor alone does not preclude an investor from seeing positive gains.
In sum, Parker-Hannifin has been a fine company and regular addition to dividend growth investor portfolios for quite some time now. The dividend increase streak is in jeopardy of continuing if the next payout is not higher, but this is something that you would expect to occur. Aside from that you have a business that has stumbled recently, but otherwise hummed along. More pertinent for the prospective investor is the above average valuation.
This factor alone does not preclude you from seeing solid returns (faster growth could materialized or a higher earnings multiple could come about). However, personally, it does add a cautionary note.
The investment world, in a most basic sense, is a two-step process: thinking about quality and valuation. The quality has been there in the past, but the valuation leaves something to be desired.