This Company Could Become One of Buffett's Favorites (Part 5)

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Using StarMine models, Thomson Reuters senior analyst John Kozey has come up with 28 businesses that share similar characteristics to those that were purchased by Warren Buffett in the past. In previous articles, I have talked about several stocks on the list, including Mosaic, Johnson Controls, Sysco, Archer Daniels Midland, Coca-Cola Enterprises and The Hershey Company. In this article, I will dig deeper into another business in the list, Parker-Hannifin (NYSE: PH), to see whether or not investors should initiate a long position in this stock now.

Business snapshot

Parker-Hannifin, incorporated in 1938, is considered a global leading manufacturer of motion and control technologies and systems, such as electromechanical controls and fluid power systems, in around 47 countries, operating in three main segments: Industrial, Aerospace, and Climate & Industrial Controls. The company has a wide, diverse customer base of about 465,000 customers, and no single customer represented more than 3% of the company’s total sales.

The majority of its revenue, around $10 billion or 76.6% of total revenue, was generated from the Industrial segment. The Aerospace segment ranked second, with $2.1 billion in 2012 revenue, while the Climate & Industrial Controls segment contributed nearly $970 million in revenue. The Aerospace segment seems to be the most profitable segment, with the highest operating margin of 13.8%, while the operating margin of the Industrial segment and the Climate & Industrial Controls segment were 8.95% and 8.7%, respectively.

A consistent historical performance

Parker-Hannifin has demonstrated a great operating performance record in the past 10 years, with consistent growth in revenue, EPS, cash flow, and dividends.

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PH Revenue TTM data by YCharts

In the past 10 years, revenue has increased from $6.4 billion in 2003 to $13.15 billion in 2012, while EPS has grown 7 times from $1.12 to $7.45 in the same period. In 2012, it generated more than $1.3 billion in free cash flow, and paid $1.54 in dividend per share. Although the dividend has increased by nearly 240% over the past decade, Parker-Hannifin seems to be quite conservative in its dividend paying policy. Its payout ratio is currently quite low at 20.7%.

What interests me is that Parker-Hannifin has strong balance sheet. As of December 2012, it had $5.33 billion in total stockholders’ equity, $500 million in cash, nearly $2 billion in debt, and $1.7 billion in pension and other benefits. In the past five years, the company has been quite active in buying back its stock. Thus, the treasury stock amount has increased from $863 million in 2008 to $2.25 billion in 2012. 

Peer comparison

At the current trading price of around $98 per share, Parker-Hannifin is worth nearly $14.6 billion. The market is valuing the company at 8.52 times EV/EBITDA. Compared to its peers, including Emerson Electric (NYSE: EMR) and Honeywell International (NYSE: HON), Parker-Hannifin is the smallest company.

Emerson is trading at around $57 per share, with a total market cap of $41 billion. Emerson is a bit more expensive than Parker-Hannifin at 8.8 times EV/EBITDA. Honeywell is the biggest company among the three, with nearly $58 billion in total market cap. At the current trading price of around $74 per share, Honeywell has the most expensive valuation at 11.25 times EV/EBITDA.

Among the three, Emerson is the most profitable, with 17% operating margin, while the operating margins of Parker-Hannifin and Honeywell were 12% and 11%, respectively. Among the three, Parker-Hannifin is paying the lowest dividend with a yield of 1.8%. Emerson offers shareholders the highest dividend yield at 2.9%, while Honeywell’s dividend yield is 2.2%.

Foolish bottom line

Parker-Hannifin seems to be a decent stock for long-term investors. Among the three, I would prefer Emerson due to its highest operating margin, highest dividend yield, and reasonable valuation. However, investors need to dig deeper into Emerson’s business model to determine whether or not Emerson is suitable for their portfolios. 

hoangquocanh has no position in any stocks mentioned. The Motley Fool recommends Emerson Electric Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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