Parker-Hannifin Stock: Pullbacks Offer Buying Opportunities In 2023 (NYSE:PH)

Parker-Hannifin (NYSE:PH) is coming off a good quarter, but it’s going to get difficult to maintain momentum over the next year or so because of lack of clarity on how much impact the high interest rate and strong U.S. dollar environment will have on the company throughout 2023.

For the type of company, it has been trading very volatile, with its share price moving from a 52-week low of $230.44 to a 52-week high of $340.00. Recently it has been trading at lower lows and lower highs, and with an occasional short-term move above and below recent levels, I think it’s going to continue to do so.

As for fundamentals for the company, I see them remaining solid for the long term, but in the near term ongoing macro-economic weaknesses are likely to remain a headwind for the company, with the strong probability of getting worse in the first half of 2023 and depending on the length and depth of the recession, it could extend into the second half of the year, and possibly into 2024.

If it plays out that way, I see the next quarters as being a great time to consider taking a position in, or adding to a position in the company, as once the economic headwinds subside, we’re unlikely to see prices at this level again for a long time.

In this article we’ll look at some of its recent numbers, what to look for in its share price movement, the impact of macro-economic factors on the performance of the company, and how to think about its future.

Some of the numbers

Revenue in the first fiscal quarter of 2023 was $4.2 billion, up 12 percent from the $3.8 million in revenue generated in the first fiscal quarter of 2022. Organic revenue growth in the reporting period was up 14 percent.

Adjusted operating margins in the quarter were 22.7 percent, an increase of 70 basis points year-over-year. Adjusted EBITDA margins in the quarter were 23.3 percent, up 120 basis points from the first fiscal quarter of 2022.

Adjusted earnings in the reporting period was a quarterly record of $616 million, or $4.74 per share, up $0.48 year-over-year.

With the acquisition of UK-based Meggitt, it’s going to add to the interest expense of PH, which as of the last earnings report stood at a headwind of $0.35. Taking that into consideration, adjusted earnings in the first fiscal quarter was impressive.

Net income on the other hand was $388 million or $2.98 per diluted share, down from net income of $451 million or $3.45 per diluted share in the first fiscal quarter of 2021.

Cash and cash equivalents at the end of the first fiscal quarter of 2023 was $502 million, with long-term debt of $12.2 billion. With interest rates continuing to climb, debt could become an issue going forward.

At the end of the first fiscal quarter of 2023 gross debt to adjusted EBITDA was at 3.8 percent, with net debt of 3.6 percent. That didn’t include any contribution from the Meggitt acquisition.

As far as the impact of Meggitt on the first fiscal quarter results, it was a key contributor to the outperformance of its Aerospace Systems segment, where sales were up 26 percent to $746 million. Approximately $150 million of the increase came from Meggitt, where about 82 percent of revenue is applied to the Aerospace unit, accounting for about 19.5 percent of the boost in sales in the reporting period. Organic growth wasn’t bad either, coming in at 7.4 percent increase.

Concerning its divestiture of Aircraft Wheel and Brake in the reporting period, it added another 4 percent to overall sales.

The Meggitt acquisition

The Meggitt acquisition is projected to have about $300 million worth of synergies in full-year 2026, which would bring the adjusted EBITDA for the company to approximately 30 percent, so over time that should add profitability to the company.

New CEO Jennifer Parmentier said the key focus of the company at this time will be to successfully integrate Meggitt into the company and reaching the synergies the company has committed itself to.

The cost of the acquisition had an immediate effect on PH, with free cash flow having a 450-basis point impact from the deal. That is expected to moderate over the next year or so. Even with that, management guides for free cash flow to be in the mid-teens for the year. While the long-term benefits from the acquisition are easy to see, in the near term it could put some pressure on PH from the ongoing increase in interest which is accompanied by the rising strength of the U.S. dollar.

The combination of paying higher debt payments and FX headwinds will decrease the performance of the company until macro-economic headwinds subside. Once that period of time is over, Meggitt will have a significant impact on the performance of PH over the long haul.

With that in mind, the company is being cautious in its outlook for fiscal 2023, especially in regard to the second calendar half of the year where there is less visibility and more uncertainty.

One strong significant benefit from the Meggitt deal is it adds another $2 billion-plus to the backlog of the company, bringing the total to over $10 billion in backlog.

Management said so far it hasn’t seen any cancellations, but it’s quite possible that could happen if the economy goes south for a prolonged period of time. On the other hand, the backlog does offer some support for sales and earnings in the quarters ahead, even if some of the backlog is cancelled.

Share price considerations

Even though PH is a traditional industrial company, and expectations are for modest, incremental growth over time, from the beginning of 2016, when the company was trading at approximately $84.00 per share, it has soared to a high of $340.00 on February 3, 2022, before pulling back to its 52-week low of $230.44 per share on June 17, 2022. At its 2022 high, it represented more than a 4x move from 2016, an excellent performance by any measure. Since falling to about $93.00 per share on March 16, 2022, in response to the impact of COVID-19 policies, it then soared to above $300 per share before pulling back.

Since early January 2022 when it traded at around $320 per share, it has dropped to its aforementioned 52-week low of $230.44 per share, and from then on has been trading volatile, moving in a range of about $238 per share to close to $309.00 per share. For the type of company PH is, that’s some wide swings in share price.

Summarizing the share price movement, I think, when taking into consideration the fundamentals of PH aren’t changing, and its consistent acquisitions and divestiture of companies that improve its long-term performance, these big swings in its share price to the low side are great buying opportunities that are unlikely to be there again once economic conditions improve.

I believe buying during these deep drops in its share price are an excellent way to get in at a cost basis that will result in not only share price growth, but also an improved dividend yield. As of the last quarter the company raised its dividend for the 66th year in a row and has paid a dividend for 290 consecutive quarters.

The point is, if investors can get in at an attractive entry point, the company offers growth and income in the quarters and years ahead. That’s achievable under the current conditions the company is operating in.

Conclusion

Parker-Hannifin is coming off a solid quarter where some of its numbers were records for the company. In the near term I doubt it’ll be able to repeat that performance, and with interest rates continuing to rise, a heavy debt load, macro-economic weakness and headwinds from the strength of the U.S. dollar, it’s probably going to get worse for the company before it gets better.

But if the economy does better than expected, it’s positioned to perform very well in the quarters and years ahead.

I don’t see the company being able to match the performance it has had since early 2016, where its share price reached over 4x at its 2022 highs, it does have the potential to grow incrementally over a prolonged period of time.

Again, for those getting in at a good entry point with an attractive cost basis, they will be rewarded with growth and income going forward. For existing shareholders, when its share price drops in a big way it offers the opportunity to lower cost basis and improve average dividend yield.