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Morningstar | Parker Hannifin Turns in a Solid Performance During Its Fiscal 2Q

Narrow-moat-rated Parker Hannifin turned in a very solid performance today and is performing broadly in line with our expectations, even as the market paradoxically reacted negatively to its most recent results. We don’t expect to materially change our fair value estimate of $175. We also maintain our narrow moat, medium uncertainty, and Standard stewardship ratings. While sales increased 3% in the fiscal second quarter year over year, organic growth was actually up 6% offset by a 3% currency headwind. Total segment profit margins, moreover, rose about 220 basis points on a reported basis to 16.4% (or about 170 basis points on an adjusted basis). On the heels of this strong performance, Parker increased adjusted EPS guidance for full-year fiscal year 2019 to $11.60 at the midpoint versus $11.40 at the midpoint, primarily based on the firm’s strong operating performance.

As for Parker’s individual segments, like many of its counterparts this quarter, aerospace saw some strong growth this quarter, with sales up 12.1% year over year compared with the prior-year period. We believe the company’s Win strategy continue to reap benefits from the company. All three of the firm’s segments saw greater than 90 basis points of segment margin improvements on an adjusted basis (margin gains were higher on a reported basis), with aerospace specifically improving 370 basis points in the quarter from the prior year period. Backlog continues to be strong, which is an indicator we like given the long-cycle nature of the aerospace business.

Several business lines within aerospace including commercial OEM, military OEM and commercial MRO and military MRO were up either high-single-digit to double digits year over year. The market appears to be reacting to moderating growth, but we think of this as a normal effect of a market cycle that should already be baked into intrinsic valuation estimates. Decremental margins during a recession, moreover, have also abated to 20% to 30% from 60% nearly 20 years ago during prior economic slowdowns, a key component of current thesis for the stock (along with the strength of the company’s distribution network).

On the positive side of the ledger, management reports that its distributor base is still really bullish when it comes to the North America region. Also, the firm appears to be making good progress on the footprint consolidation front as it continues these reduction efforts from the acquisition of Clarcor that was completed in early 2017. CEO Tom Williams hinted at some undervaluation currently in the shares with his remarks that he thought it was a great time to buy Parker during the fiscal second quarter. While he often repeats this mantra, we thought it was interesting that he called out the specific time period as shares traded as low as a 20% discount to our fair value estimate toward the end of December.