Earnings Call Transcript - PH Q4 2023

Operator, Operator

Hello and welcome to the Parker Hannifin Corporation’s Fiscal 2023 Fourth Quarter and Full Year Earnings Conference Call and Webcast. At this time, all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Leombruno, Chief Financial Officer. Thank you. Please go ahead.

Todd Leombruno, CFO

Thank you so much, Donna. And good morning, everyone, and thank you for joining Parker Hannifin’s fiscal year ‘23 fourth quarter and full year earnings release webcast. As Donna said, this is Todd Leombruno, Chief Financial Officer speaking. And with me today for the webcast is Jenny Parmentier, our Chief Executive Officer; and Lee Banks, our Vice Chairman and President. I think everyone knows we released our results and all of these slide materials this morning. Our comments today will address forward projections and non-GAAP financial measures. On slide 2 of this presentation, you will find specific details to the disclosures that we are making in respect to both, non-GAAP financial measures and forward projections. And just as a reminder, actual results could vary from what we speak about today in this presentation based on all of the items listed here in these disclosures. Our press release, this presentation and all reconciliations are available under the Investors section at parker.com, and those will remain available for one year. Today, we’re going to start with Jenny addressing some of the highlights of our strong fourth quarter and really what was a transformational fiscal year for Parker. She is also going to reiterate some reasons that show why Parker is so well positioned for the future. I’m going to follow up with just some color on how the quarter wrapped up and provide some details around our initial FY24 guidance that we released this morning. Jenny will wrap up the call with some key messages, and then we’re going to open up the lines for Q&A for Jenny, Lee or myself. So, now, I’ll ask you all to move to slide 3. And Jenny, I’ll hand it over to you.

Jenny Parmentier, CEO

Thank you, Todd. Good morning to everyone, and thank you for joining our call today. Q4 was a quarter of outstanding performance across all of Parker. Starting with safety. We remain in the top quartile with a 20% reduction in recordable incidents. Safety has been and will remain our top priority. We had record sales of $5.1 billion in the quarter, a 22% increase over prior year with organic growth of 6%. This is our second quarter above $5 billion in sales. We achieved record adjusted segment operating margin of 24%, a 110 basis-point increase over prior year. And as we discussed last quarter, our backlog coverage remains resilient at 55% and has increased 1% sequentially. The Win Strategy and portfolio changes have delivered a strong finish to a great year. A great and transformational year. On the right side of the page, you can see highlights from fiscal year ‘23. Again, it all starts with our team. Top-quartile safety and engagement delivers these results. We now have approximately 30% of the portfolio in aerospace and defense, and we couldn’t be happier with the progress of the Meggitt integration. The team is exceeding our expectations. And a record $3 billion operating cash flow, 22% higher than prior year, allowing us to make great progress in paying down debt.

Todd Leombruno, CFO

Thank you, Jenny. If everyone’s following, I’m going to start on slide 10. And I’m really proud to say once again, every Q4 number highlighted in this gold box is a record for the Company. It was really just an unbelievably strong finish to the fiscal year. I’m going to try to move quickly because Jenny already spoke to the 22% sales growth and the 24% segment operating margin. But in respect to sales, organic growth was 6%. When you take a look at the Meggitt acquisitions and the divestitures that we did in FY23, the net addition for the quarter was 16%. And the good news here is on currency, the headwinds have moderated. It’s now just a slight headwind of 0.4% in the quarter. One thing I do want to note is adjusted EBITDA margins at 24.4%, an increase of 130 basis points versus prior year. And if you continue down the page, both net income and adjusted earnings per share did increase by 18% versus the prior year. Our adjusted net income was $791 million or a 15.5% return on sales, and adjusted EPS was $6.08 in the quarter. That is an increase of $0.92 or 18% versus prior year. Internally, we always stress the importance of finishing strong. And really, these results are a testament to the resilience of our global team. So, thank you to everyone for a great Q4 and a great fiscal year ‘23.

Jenny Parmentier, CEO

So, as a reminder, living up to our purpose, top-quartile performance and being great generators and deployers of cash is what drives Parker. This slide provides an update on living up to our purpose, enabling engineering breakthroughs that lead to a better tomorrow. We are committed and on track to be carbon-neutral by 2040 and achieved a 20% carbon reduction in fiscal year ‘23. And we are proud to be in the first quartile of the Carbon Disclosure Project on climate change. Post pandemic, our teams were anxious to return to the communities where we work and volunteered over 10,000 hours in fiscal year ‘23 to help serve others. And again, our clean technologies are critical in helping our customers achieve their carbon-neutral goals. The combination of our growth drivers and living up to our purpose points to a very promising future for Parker. We are committed to our FY27 targets of growing EPS from $21.55 to $30 and achieving 25% adjusted segment operating margin. Growth from secular trends, continued transformation of the portfolio with Meggitt and continuing to accelerate our performance with Win Strategy 3.0 will drive top-quartile performance and organic growth of 4% to 6% over the cycle.

Todd Leombruno, CFO

Looking forward to next year, we expect to generate significant cash flow. We think we can reduce debt by an additional $2 billion in FY24. And we are targeting leverage of 2 times in early FY25. So, moving to guidance and putting FY23 to bed. Reported sales growth for the year is forecasted to be in the range of 3% to 6% or 4.5% at the midpoint. That equates to approximately $19.9 billion in total sales. If you look at the split, the first half is 49% and the second half is 51%. Speaking specifically to organic growth, for the full year, we expect it to be 1.5% at the midpoint. In respect to aerospace, we’re expecting high single-digit growth in aerospace, a little over 8%. North America organic, we expect that to still be positive at plus 1%. And international, we are forecasting slightly negative at 2.5%. Those are all full year numbers. The backlog that I just spoke of earlier does support our growth, so we feel confident in these numbers.

Jenny Parmentier, CEO

So obviously, aerospace is a real growth differentiator for Parker in fiscal year ‘24. We are projecting total aerospace growth at 17% with the acquisition sales from Meggitt and organic growth of 8%. We see strong mid-teens growth in commercial and mid-single-digit in military. Good story all the way around. We have now had two years in a row of double-digit growth for industrial. But having said that, as Todd mentioned, industrial orders have been negative for the past two quarters. However, in North America, backlog coverage is still above 30%, which is roughly double what it has been in the past, and it will support the growth we have in the first half.

Lee Banks, Vice Chairman and President

Destocking is mostly at the distribution level; it’s been going on for a couple of quarters. They were holding more inventory than usual. But I would tell you the sentiment is still strong. So, we’ve seen destocking across our European distributors and in North America. The biggest softness really is around the DACH region, which includes Germany, Austria, and Switzerland.

Todd Leombruno, CFO

If you remember a year ago, when we did the Meggitt post-close call, we felt Meggitt could add $0.80 of EPS on a full-year basis. We are ahead of that schedule. So that should give you some comfort too, that it is adding EPS to the bottom line as well.

Jenny Parmentier, CEO

We are seeing some activity in the mega projects and it’s early days, but Parker is winning and will continue to win in the future. We expect multiple years of solid growth in aerospace driven by both commercial and defense.

Operator, Operator

Today’s first question is coming from Julian Mitchell of Barclays.

Julian Mitchell, Analyst

Maybe just wanted to start off with the industrial businesses. Maybe give us a bit more color on the assumptions for international. It sounds like you’ve got a down first half organic sales and also down second half organic sales in the guide. So, are you sort of assuming heavy negative orders pressure there for the coming six months or so?

Jenny Parmentier, CEO

So first of all, your question on international, like I was talking about earlier, obviously, the backlog is still strong. It’s above 30%. But those customer shutdowns that I mentioned take weeks out of the schedule that we hadn’t seen previously. So, a return to that is one of the reasons. And then obviously, since the last time we talked, we’ve seen a slowing in Europe. We’ve seen the demand not be as strong in certain regions.

Lee Banks, Vice Chairman and President

The sentiment is still strong. So, we’ve seen destocking across our European distributors and in North America. Maybe too, just a little more color on Europe. The biggest softness really is around the DACH region. So, that would be Germany, Austria, Switzerland. I think it’s a couple of things. It’s the China export market is a big deal for them. And China has not rebounded like we all expected it would.

Todd Leombruno, CFO

We are forecasting international in total to be about 2.5% for the full year. And if I look across the year, there’s no real weighting there. It’s about an even split.

Joe Ritchie, Analyst

Thanks. Good morning, guys. And nice end to a year.

Jenny Parmentier, CEO

So in summary, this is our thinking right now: strong aerospace growth, strong backlog on the industrial side, some near-term uncertainties and tough comps, but the future growth drivers remain intact, and activity is at a high level.

Operator, Operator

The next question is coming from Joe O’Dea of Wells Fargo.

Joe O’Dea, Analyst

Todd, I wanted to circle back. You talked about Meggitt trending ahead of that $0.80 that you had given about a year ago. Just any sort of color on what you think the all-in Meggitt contribution is this year?

Todd Leombruno, CFO

I would say it’s slightly above that $0.80 that we really forecasted for the first full 12 months. So, we’ve only owned them 9.5 months, but it’s been a fantastic 9.5 months. We’ve talked about the synergies being ahead of schedule, but they are benefiting from the secular trend in aerospace.

Jenny Parmentier, CEO

We’re always working in the pipeline. We have long-standing relationships with people we talk to now as we have in the past. So that’s not something that we ever let go stale or dry. It’s a continuous pipeline.

Operator, Operator

This concludes our FY23 Q4 webcast. As always, we fully appreciate everyone’s interest in Parker. Thank you for joining.