Parker-Hannifin Stock: ‘ETF-Like’ Industrial Dividend Giant For Long-Term Gains (NYSE:PH)

Introduction

The other day, one of my readers brought up Parker-Hannifin Corp. (NYSE:PH) in a discussion about aerospace companies. Unfortunately, I do not remember which article that was.

What I do know is that we were discussing suitable aerospace stocks that benefit from what is now an environment of strong tailwinds from both defense and commercial customers.

For example, in a number of recent articles, I have brought up Airbus’ (OTCPK:EADSF) outlook, which foresees close to 41 thousand new commercial deliveries, with annual compounding passenger and freight traffic growth of 3.6% and 3.2%, respectively.

This is great news for Parker-Hannifin, as it has significant aerospace exposure. On top of that, it also has other diversified industrial products and services, which truly makes it an ETF-like company servicing various segments.

When I was researching the company, I thought on multiple occasions that it could replace 2 to 3 companies in my portfolio – purely based on its sector exposure.

Moreover, despite the fact that I have been on Seeking Alpha for many years with a focus on industrials, I have never discussed the PH ticker before (shame on me), which means it’s about time we take a closer look.

So, let’s get to it!

An ETF-Like Industrial Giant With Tremendous Growth Potential

Parker-Hannifin is a giant. The company has a $68 billion market cap, which makes it the third-largest player in the specialty industrial machinery sector.

Founded in 1938 in Ohio, the company has become a global leader in motion and control technologies, selling to customers through four platforms:

• Filtration & engineered materials (32% of sales).
• Aerospace Systems (27%)
• Flow & process control (23%)
• Motion systems (19%)

In the aerospace sector, for example, the company sells a wide range of products, including actuation systems, avionics, electric power components, engine components, fire detection and suppression systems, fluid conveyance systems, fuel systems, hydraulic systems, and many others.

These products are sold through regional sales organizations to OEMs and other end-users.

Across all segments, the company sells to roughly 550 thousand customers in more than 40 countries!

Last year, one-third of global sales were international sales, with 20% of total sales being generated in Europe.

Since 2015, the company has used organic growth and acquisitions to strategically expand its filtration and aerospace exposure.

This has resulted in 54% higher revenue, with roughly 60% of this coming from filtration and aerospace.

This brings me to the next part of this article.

PH’s Impressive Growth Has Legs

When I was researching industrial companies before the pandemic, some of the biggest winners were aerospace companies. The long-term growth opportunities were just so good – and they still are.

Hence, I’m happy to see that roughly two years after people stopped wearing masks everywhere, we’re seeing a return back to normal, supported by strong commercial aerospace demand and the absence of major supply chain challenges.

Moreover, the company employs what it calls “The Win Strategy 3.0“, which has been key in driving operational improvements.

According to the company, this approach leverages lean tools, Kaizen, and high-performance teams to improve efficiency and grow margins.

As we can see below, over the last five years, the company has achieved a 7% compound annual growth rate (“CAGR”) in revenue, a 600 basis point increase in adjusted operating margins, and a 14% CAGR in adjusted earnings per share.

On top of that, the company’s free cash flow has doubled from $1.5 billion to $3.0 billion.

Even better, and with regard to my aerospace comments, going forward, the company believes it is in a great spot to capitalize on several long-term secular trends, including clean technology, electrification, digitalization, and aerospace.

To add some details, the company’s clean technology initiatives, like hydrogen fuel cells and electrolyzers, are expected to capture a $5 billion market through 2030, with double-digit revenue growth.

Meanwhile, the company’s focus is also on electrification, mainly in aerospace and off-highway vehicles.

For electrification of off-highway vehicles alone, the company projects a $800 million addressable market by the fiscal year 2029, with a growth rate of at least 20%!

As one can imagine, this bodes well for the company’s longer-term outlook.

During last month’s Investor Day, the company revealed very ambitious long-term targets, as it aims for 4% to 6% annual organic growth, 27% adjusted operating margins, 28% adjusted EBITDA margins, 17% free cash flow margins, and at least 10% annual EPS growth by its 2029 fiscal year.

Three of these targets are higher than previously expected.

More importantly, by 2029, the company aims to generate at least half of its sales from longer-cycle and secular trends. In 2015, that number was roughly a fifth.

These secular trends include the aforementioned tailwinds like electrification, digitalization, and clean technologies, which are expected to drive the company’s 4-6% annual revenue growth goal.

All of this would not only grow the company but also position it for sustainable long-term growth and less demand volatility.

With all of this in mind, how reliable are the company’s estimates?

After all, it’s easy to make big promises.

So far, the company has set margin targets four times in the past ten years.

It’s on pace to exceed all of them.

What does this mean for shareholders?

Shareholder Value

In addition to growing margins, the company aims to grow free cash flow by 50% to $18 billion in the 2025-2029 period, compared to the 2020-2024 period.

This is expected to be achieved with a free cash flow conversion rate of at least 100%, which means the company aims to turn every dollar of net income into at least one dollar of free cash flow. That is a sign of high-quality earnings.

Going back more than two decades, the company has always maintained a very high free cash flow conversion rate.

This is also why the company has an impressive dividend growth history.

After hiking its dividend by 10.1% to an annualized dividend of $6.52 on April 25, it currently yields 1.2%.

This dividend comes with a five-year CAGR of 14% and a target payout target of at least 30% of the company’s five-year average net income.

Over the next five years, the company expects to boost its dividend to at least $11 per share. This would imply 68% growth compared to the current dividend.

As wild as this may sound, it’s reasonable.

• 68% growth over five years implies an 11% annual compounding growth rate.
• The current payout ratio is just 24%.
• The company is guiding for at least 10% annual EPS growth.

As a reference, an $11 future dividend indicates a 2.1% yield on cost for investors buying PH at current prices.

While 2.1% is still not a high number, we can assume the next five years will come with a lot of capital gains if the company’s growth plans are successful.

Based on that context, we have very fertile ground for potentially elevated total returns in the future.

Bear in mind that a total return is based on:

Capital gains are based on:

• EPS growth
• Valuation multiple

In other words, a company that grows its EPS by 10% per year and comes with a 1.2% dividend can return 11.2% per year if the valuation remains unchanged.

So far, so good.

The problem is that PH trades at a blended P/E ratio of 21.2x, which is a few points above the long-term average of 16.0x.

Since January 2015, the company has returned 16.8% annually, fueled by its successful growth measures and favorable economic growth.

Using the FactSet data in the chart above, analysts expect EPS growth of 15% in 2024, potentially followed by 7% and 10% in 2025 and 2026, respectively.

If the company is able to maintain at least 10% annual growth – as stated in its growth plan – I expect that a 20x multiple is warranted, which would give the stock a fair price target of $580, 11% above the current price.

In other words, as bullish as I am on the future of Parker-Hannifin, if I were looking for exposure, I would prefer to see a 10-15% correction first, which is a risky strategy as it could mean investors miss more gains.

The reason I’m not putting PH on my watchlist is too much correlation, as I own aerospace, machinery, and building product companies.

Takeaway

Parker-Hannifin is a powerhouse in the industrial sector with a significant aerospace footprint and diversified industrial products.

The company’s growth is impressive, driven by successful strategies and favorable market trends in aerospace, clean technology, and electrification.

With very ambitious targets for revenue, margins, and free cash flow, PH is poised for substantial growth on a long-term basis.

However, the stock’s current valuation suggests a cautious approach.

Nonetheless, because of its favorable tailwinds and growth measures, I apply a Buy rating.

Pros & Cons

Pros:

• Significant Aerospace Exposure: With a large footprint in aerospace, PH benefits from both commercial and defense tailwinds.
• Diversified Industrial Portfolio: PH’s diverse product range reminds me of an industrial ETF, especially with regard to its diverse end markets.
• Impressive Growth: The company has shown solid growth, with a 7% revenue CAGR and doubling free cash flow over the past five years.
• Long-Term Secular Trends: PH is well-positioned to capitalize on megatrends like clean technology, electrification, and digitalization.
• Solid Dividend Growth: The company has a history of strong dividend growth, forecasting a 68% increase over the next five years.

Cons:

• Valuation Concerns: Trading at a P/E ratio of 21.2x, PH is trading above its long-term average, which means there’s no room for error when it comes to future EPS growth.
• Economic Sensitivity: As with many industrial stocks, PH’s performance is closely tied to broader economic conditions, which can be unpredictable and tend to be very cyclical. PH will remain cyclical, even if it increasingly focuses on secular growth markets.