Normally, looking at lists of stocks on the value screeners doesn’t give us much in the way of dividends. Mostly, we see potential capital gains, with perhaps a smallish dividend thrown in. I’ve profiled more than three dozen Buffett-Munger and Undervalued Predictable stocks over the past 10 months, and I don’t recall anything that would excite me if I were a dividend investor.
Yet, here is Parker-Hannifin Corporation (PH), which not only pays dividends, but has increased its dividend every year for the past 58 years. That makes it a Dividend Champion, and if the rules were slightly different, it would be a Dividend Aristocrat as well (an article at Seeking Alpha explains the technicalities).
PH is an industrial conglomerate: a designer, manufacturer, and distributor of motion and control technologies and systems. It got its start in 1918, making innovative bus and truck brakes, with pneumatics/compressed air systems.
Photo source: Parker-Hannifin company history
PH can be found on the Buffett-Munger screener at GuruFocus.com, where it’s shown as fairly valued and enjoying a 4.5-Star Predictability rating (that rating is currently on watch).
Here’s how it’s managed to grow its earnings per share (blue line) and revenue (green line) over the past two decades (note that on the right side of chart we see analysts’ projections for fiscal 2015 and 2016, with year-ends on June 30th):
History
1918: Engineer and inventor Art Parker starts The Parker Appliance Company, which specializes in pneumatic controls and air compressors.
1918: Parker introduces a pneumatic brake booster for trucks and buses.
1920s: Enters the aviation industry, with hydraulic and braking products.
1953: Makes its first acquisition: the Synthetic Rubber Products Company in Los Angeles.
1957: Buys Hannifin Corporation and gets access to new cylinder and valve products; name change to Parker-Hannifin Corporation.
1960: Opens its International Division.
1964: Begins trading on the New York Stock Exchange, with the symbol PH.
1977: First dividend payment.
2006: Since its first acquisition in 1953, it has bought a total of 210 companies.
2014: Reaches $13 billion in sales, and a workforce of 57,000.
2015: Between 2001 and 2015, it has spent $5 billion on 102 acquisitions.
History based on information at the company website, Wikipedia.org, and FundingUniverse.com.
Comments: A company born at the right time and place, and with the right idea, to tap into the burgeoning auto and aircraft industries. It has made an exceptional number of strategic acquisitions to help fuel growth and diversification.
Parker-Hannifin’s Business
The company specializes in motion and control technologies and systems. It provides precision engineered solutions for a wide variety of mobile, industrial and aerospace markets. Its technology platform includes:
- Motion systems
- Flow and process control
- Filtration and engineered materials
- Aerospace systems
Segments & Revenue
Operations involve two segments, Diversified Industrial and Aerospace Systems. The following chart, from a presentation at the BAML Global Industrials Conference London on March 18, 2015, shows Diversified Industrial broken out by regional divisions:
And this table from the 10-K for 2014 shows revenues in dollars for the past three years, by segment:
Competition
The company reports that it operates in highly competitive markets and industries. It also notes it has 142 divisions in 50 countries, meaning competition exists at many different levels and in many different areas.
In the Diversified Industrial Segment, it says competition comes down to product quality and innovation, customer service, manufacturing and distribution capability, and price competitiveness. (10-K)
For the Aerospace Systems Segment, it says it has developed “...alliances with key customers based on the Company’s advanced technological and engineering capabilities, superior performance in quality, delivery and service, and price competitiveness.”
Yahoo! Finance lists its competitors as Eaton Corporation plc (ETN, Financial), Emerson Electric Co. (EMR, Financial), and Honeywell International Inc. (HON, Financial). Of these companies in the Industrial Equipment & Components industry, PH is the smallest.
GuruFocus compares it with United Technologies Corp (UTX, Financial), 3M Co (MMM, Financial), Airgas Inc (ARG, Financial), and Ampco-Pittsburgh Corp (AP).
Other
The company is incorporated in Ohio, and headquartered in Cleveland, Ohio.
Comments: Parker-Hannifin is at the center of all the objects and industries that move people and things from one place to another. It is a big player, with $13 billion in revenues last year, although not the biggest in a competitive field.
Opportunities, Risks, & Growth
Opportunities
As part of its 10-K for 2014, Parker-Hannifin reports it has many opportunities for growth. Initiatives include:
- Maintaining and fostering customer service, as well as developing products, systems, and services that add value for the customer.
- Finding efficiencies by implementing lean management principles.
- Organizing its resources to target specific markets, technologies, and regions.
- Making acquisitions that are a strategic fit, as well allowing the company to maintain its financial strength.
The company also notes it will focus on opportunities related to energy, water, food, environment, defense, life sciences, infrastructure and transportation.
Risks
The 10-K for 2014 also reports on a number risk factors, issues that could negatively affect the company:
- Economic conditions, obviously, pose a risk, both at home and in all the countries it serves. When an economy slows, fewer wheels turn and fewer materials flow through process lines.
- Being a technology company, it depends on information systems to not only for reporting, but also for creating and developing new products and services. Failure of IT could lead to many types of problems.
- Product liability comes hand in hand with the company’s business of developing, manufacturing, and distributing products that move people and materials.
- Sales outside the United States accounted for about 44% of sales in 2014; this may lead to currency exchange issues, as well as regulatory/legislative exposure, and other potential problems.
- Parker-Hannifin calls its intellectual property, “...critical to its innovation efforts.” It must protect its own patents and copyrights, as well as avoid infringing on the intellectual property of other organizations.
Growth
The following chart shows PH’s revenue (blue line), Earnings Per Share (red line) and stock price (green line) over the past 10 years (and projects into 2016):
Among the analysts followed by Yahoo! Finance, the average estimate for 2015 (fiscal year ending June 30), comes in at $8.07 (compared to $6.87 for fiscal 2014). And, they project an average of $8.76 for fiscal 2016.
Its growth strategy includes the following five elements, as shown in an investor presentation:
Comments: The chart shows good growth after allowing for the downturn in the wake of the 2008 financial crisis; in the short term, analysts expect solid growth in the next year and a half, while the company has articulated plans to continue growth over the longer term.
Management
Chief Executive Officer: Thomas L. Williams, age 56, has held this position since February of this year. He joined the company in 2003, and became a senior operating officer in 2006. Previously, he held senior positions in General Electric.
Executive Vice President – Finance and Administration and Chief Financial Officer: Jon P. Marten, age 58, joined Parker-Hannifin in 1987 as a financial analyst.
Chairman of the Board: Donald E. Washkewicz, age 64, joined Parker in 1972; he became CEO in 2001. He served as Chairman of the Board since 2004 and President since 2006.
Board of Directors: A board of 14 including three related members: Chairman Washkewicz, CEO Williams, and President/COO Lee C. Banks. Independent members hold senior positions in a number of different industries.
ISS Governance QuickScore: a score of 10, which indicates higher governance risk (a score of 1 indicates lower risk, a score of 10 indicates higher risk). PH receives five red flags, for: Takeover Defenses, Meeting and Voting Related Issues, Equity Risk Mitigation, Termination, and Audit and Accounting Controversies. It receives no green stars.
Management and information from the company website: management - board of directors; and Reteurs.com.
Comments: The leadership team comprises well-seasoned managers, and their ages would suggest they could remain in place for at least several more years. We note the company receives a very poor score on the ISS Governance QuickScore, and would recommend potential investors investigate these issues before buying.
Parker-Hannifin by the Numbers
Comments: As we’ve noted, this is a dividend company, currently yielding just over 2% and with a payout of 29% there should be no question about its sustainability; it is buying back shares, but not aggressively; and its capitalization is just over $17 billion.
Financial Strength
The GuruFocus automated system generates a 7/10 score for Parker-Hannifin’s Financial Strength, and an 8/10 for Profitability & Growth:
To start this review of PH’s financial condition, let’s look at a chart of long-term debt over the past 20 years:
To that, let’s add free cash flow (blue line):
Finally, we will give some attention to the Equity to Asset ratio, since the red icon indicates some weakness in a historical context. This metric reflects the balance between the equity (owned by shareholders) and debt used by a company. The greater the debt, or leverage, generally speaking, the greater the risk the company might not be able to pay its bills. The following chart provides a wider perspective on this ratio:
Comments: The charts for long-term debt and the Equity to Asset ratio show bumpy times, and that perhaps that explains why this Dividend Champion receives only a 7/10 rating for Financial Strength. Overall, the company seems strong, and that’s backed up by mostly green icons across Financial Strength and Profitability & Growth.
Valuation
Parker-Hannifin currently (April 7, 2015) sports a PEG ratio of 1.25 indicating fair-valuation, and a predictability rating of 4.5 out 5 (although that rating is currently under watch, as indicated by the red box around the stars). The GuruFocus system for this rating shows stocks with a PEG ratio below 1.0 as under-valued, 1.0 to 2.0 as fair-valued, and stocks with a ratio of more than 2.0 as over-valued.
As those who have followed the stock’s PEG ratio will have noticed, this ratio can vary from day to day or even hour to hour. For example, the ratio at the close of trading on April 2, the ratio stood at 1.21. Why the difference from day to day?
The difference arises out of the price changes of the stock. The formula for PEG, or PEPG as it’s also known, starts with the P/E ratio, Price divided by Earnings of the last 12 months. While the Earnings piece of the P/E ratio changes only once a quarter, the share price changes more or less continuously. If the share price goes up, then the PEG ratio must also go up, and vice-versa; it’s a simple arithmetical relationship. To illustrate, here’s a chart showing the price (green line) and P/E ratio (blue line) over the past five years:
The PEG ratio is calculated by dividing the P/E by the average growth of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) over the past five years. So, the elements of P/E ratio remain, but now longer-term earnings matter more than earnings of the past 12 months.
Earnings also come into play when assessing predictability. The GuruFocus system rewards companies that consistently increase their earnings, giving them one to five stars, according to their performance. Those with low consistency get one or two stars; those with high consistency get four, four and a half, or five stars.
PH, as we’ve noted, currently has four and a half, but is under watch. This means the recent rate of growth has not kept up with earlier rates. Take a look at the EBITDA line (blue) in the chart below, and note how price (green line) has been affected:
Comments: The chart immediately above offers a telling story about the value of PH shares. Which leaves us with important questions: will EBITDA recover, and when? And the most compelling question: Is this a good time to buy?
Conclusions
Is it time to buy? Is Parker-Hannifin a value stock, or is it a falling knife?
For the fiscal year ending June 30, 2012, PH hit a new EPS (diluted) high of $7.45; the following year that dropped off to $6.26 per share, and at June 30, 2014 it recovered to $6.87 per share. Now, analysts expect (on average) $8.07 a share when fiscal 2015 ends this coming June 30th. That would be a gain of more than 17%, year over year.
No doubt a 17% jump in EBITDA, all else being equal, could boost the share price. As noted, analysts expect, on average, $8.77 for fiscal 2016, so again a good increase.
We note as well, Parker-Hannifin’s dividend record, so while the dividend is modest, it undoubtedly will grow, so this is a case where you will get paid to wait. But, we also note the number of reservations in the ISS Governance QuickScore; careful investors will want more research on those issues.
Overall, though, Parker-Hannifin looks like a good company at a fair valuation.
