Author Topic: PH - Parker-Hannifin Corp.  (Read 9617 times)

Cigarbutt

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Re: PH - Parker-Hannifin Corp.
« Reply #20 on: November 21, 2020, 12:00:12 PM »
i’ve been cleaning up old files and came up with a newspaper clip from 2012 and a summary that had taken me 5 minutes to make then concerning PH, recently decided to do a deeper dive and, before putting away for later, checked this site to see if the company had been discussed. There were several learning gains on my part so I decided to share in case this is helpful for anybody.
First, kudos to Palantir who presented this idea nicely in 2012. Also, apologies for the critical (constructive) comments that benefit from hindsight.
The following is spread over two Acts. The first Act covers the period from September 2012 to June 30th 2019. The second Act covers what happened after. There are multiple analytical reasons to do this but, for the purpose of this post, I assume Palantir bought around September 2012 and sold around June 2019.

First Act
Those interested about the company fundamentals can read for hours but they are basically a leading global industrial manufacturer with a wide distribution network. From the perspective of the initial 2012 presenting post, Palantir expected further growth in sales (CAGR about 7% per year) and improving margins with expected net income growth (CAGR about 7-10%) and tagged an IV that evolved significantly over a short period (around 115-120 when last mentioned) with shares trading in September 2012 around 80 (PE about 11).
The opening poster reports that he was stunned by before market price movements due to the company not meeting the expected quarterly numbers which, as usual long after, looks like incredibly insignificant noise from a long term perspective.

Going to June 30th 2019, the investment thesis, in terms of outcome, turned out to be confirmed but not for the reasons that Palantir mentioned (more on that later) and holding this investment after 2012 required some patience as the business fundamentals (and share price) did not make any significant progress until 2016. Overall, the company applied a ‘strategy’ that has worked for many which involved various cost initiatives, relatively low capex essentially to maintain existing capacity, increasing financial leverage to fund acquisitions and increased capital ‘returned’ to shareholders through dividends and buybacks. The following analysis takes the perspective of a reasonable value investor who would have bought this in September 2012, would have been patient and would have sold around June 2019 when intrinsic value was reached. From hindsight and forgetting what happened after for now, choosing June 2019 is tricky because numbers (profitability measures) looked significantly better than the years before and could have meant either an unusual and non-enduring bump or an early manifestation of new profitable trends, let’s look at some numbers.

The NPM went from 8.8% to 10.6% (difference=+1.8%). Decomposed, the NPM, of the 1.8%, major components: 1.0% came from COGS, 0.8% came from SGA, 0.3% came from taxes. Interest expense % increased from 0.7% to 1.3% (a difference of 0.6%), more on that below.

During that period (2012-2019), PH’s share price compounded at about 11.8% per year and the dividend yield hovered around 2%. Assumption: shares sold at around 175.08.
The CAGR 11.8% can be decomposed ( 1.2+2.7+4.8+3.1=11.8 ):
From growth in sales: 1.2%
From growth in NPM: 2.7%
From growth in PE: 4.8%
From reduction in share count: 3.1%

Growth in sales over the period was relatively low and was mostly due to a significant acquisition made in 2017. Growth in the net profit margin was concentrated mainly in the 2019 year (some in 2018 also but unusual tax movements hid the NPM improvement). It is interesting to note that PH paid (income statement) about the same absolute amount in taxes in 2012 compared to 2019 (421.2m vs 420.5) even if revenues increased 8.9% and pre-tax income increased by 22.9%. Interest expense increased as a % of sales (x1.9) but debt increased more, proportionately. Debt levels in 2019 increased ++ but are not representative as the company was gearing up for major acquisitions. Normalized debt for 2018 and 2019 suggests that debt levels were multiplied by about 3 over the period which, by itself, is not a bad thing.
A major part of the compound return (unlike what Palantir had expected) came from multiple expansion (more on that below) and from a decrease in share count. The effect of decreasing share count as well as dividends reinvested needs to be analyzed from a longer term perspective and using intrinsic value as a guideline but increasing prices over a specific period help to boost returns, whether the increase is fundamental or sentimental. Taking the IV value framework put in place by Palantir in 2012, the buyback of shares made in 2016 was below trend line. Of course, the IV value trajectory over time may change, both up and down as new info is integrated. A humbling aspect is that, for the same period, the S&P 500 total return (CAGR with div. reinvested) comes to about 13.5%, and the CAGR of PE expansion for the index comes to about 4.0%, implying that it’s not PH that ‘re-rated’ compared to the market but more that the multiple re-rate simply followed general trends. Before somebody shouts that interest rates work like gravity please note that the 10-yr Tr. yield was at about 1.65% around September 2012 and at about 2.0% around July 2019.

An aspect which is interesting for valuation, if interested in the value of book value (tangible or not), is that the strategy of buying competitors for growth results in a recognition of value which is absent compared to conventional capex for expansion, which is somewhat equivalent to the IFRS (compared to GAAP) allowing revaluation according to fair value. I think this is just something to be aware of, for example, when assessing return on capital measures (also debt to equity measures).

In this case, in 2019, return on capital measures improved, compared to the previous few years but remained at interesting levels compared to what they were in 2012, when the NPM was lower, implying that PH is paying up for growth (and is using debt to do so).
In 2012:   ROA(avg)=10.4%     In 2019:   ROA(avg)=9.2%
In 2012:   ROE(avg)=22.4%     In 2019:   ROE(avg)=25.6%

-----)Learning gains
-It’s hard to predict the future but you may end up with a reasonable result if changes in key assumptions cancel each other.
-Patience may be required and timing remains a difficult task.
-It’s hard to beat the market.
-Thank you Palantir (if you still exist) for the deep (at least for me) thought process that you triggered.

-----

Second Act
Of course what is even more interesting is what came after June 2019. The company completed two major acquisitions in the fall of 2019 and Covid came. Enthusiasm remained until February 2020 when shares hit about 215. Towards the end of March, it was possible to buy below 100. Like much of the rest, there’s been a V-type rebound and the last trade on Friday was at 267.12. I didn’t perform a deep enough analysis of the last two major acquisitions but, assuming more of the same, the company is trading at an about 20-22 “normalized” PE. Opinion (given the time spent lately): i would say the company is likely to disappoint from a return point of view going forward as return to the mean forces may play out. Looking back to the March period, i wonder (if this would have been on a watchlist) if i’d have bought. i think not and wonder if this is wrong.


Spekulatius

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Re: PH - Parker-Hannifin Corp.
« Reply #21 on: November 22, 2020, 09:37:03 AM »
Thanks for taking the time to write a post Morten. I have also followed PH (didn’t invest though) and it is interesting to look at how things panned out vs the expectations years ago.
For me the most striking point is that PH has performed well, despite very subpar organic growth and some badly (in retrospect) timed acquisitions. This is a company that came from a history of mediocre profitability, but a CEO a decade or so ago took measure on pricing and getting closer to the customer to boost margins, as I recall and this has contributed significantly to its outperformance. I don’t really see a similar tailwind going forward unless there is another transformation that led it boost its financial performance even more so.
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Cigarbutt

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Re: PH - Parker-Hannifin Corp.
« Reply #22 on: November 22, 2020, 04:01:06 PM »
^At this point (based on today's valuation), expectations of 'high' returns require a special set of (optimistic) assumptions. There's also been recently more emphasis on financial engineering.
However, PH has a very long history with some intrinsic cycles and quite consistent over-performance compared to the S&P500 over most previous longer term periods. Even 1.5-2% excess performance does add up if held long term (i'm presently thinking to invest in a small basket of stocks in my children's accounts to be held for 30 years or something and TRV, JNJ and now PH are candidates).
Of course, the fun is to try to build upon that by introducing some kind of trading decisions. The buying decision is easier than the sell decision. For PH, investing after general economic downturn has shown to be good idea even if it's impossible to invest at the exact bottom.
This time around, more leverage is involved and there may be less flexibility if ever a real downturn occurs.
In retrospect, a great time to invest was in around 2002 when PH was going both through a general downturn and through an intrinsic cycle with a new CEO about to help return the operations to their longer term potential (Mr. Don Washkewicz).