This Manufacturing Stock Could Pop
Sandeep is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Last month, Parker-Hannifin Corporation (NYSE: PH) announced a small divestiture. The company has agreed to sell the automotive air conditioning business to ContiTech AG of Germany. The divested business contributed approximately 1% of F12 revenue (14% of Climate and Industrial Controls segment revenue). I believe there is a further scope for such divestitures; in particular lower margin businesses. Looking forward, I see a number of levers that Parker Hannifin could pull to drive higher EPS and profit growth, including share repurchase, acquisitions, and more aggressive cost-cutting restructuring actions.
Expert on Acquisitions
I believe the company prefers small acquisitions which lie in the range of $100-200 million. Through small acquisitions, I expect that the company wants to remain focused on motion control with major areas of focus including aerospace, filtration and instrumentation. I believe these businesses offer a strong recurring/aftermarket revenue and therefore, the company should continue to acquire small businesses. Thus, in my view, the company’s increased focus on small acquisitions will add value to the portfolio in the near term.
Increasing Strength in Aftermarket
Impressive Aerospace margins in 4Q were driven by strength in aftermarket and less R&D spend. I expect aftermarket to continue to increase at a good pace and Parker’s distribution network to remain a huge competitive advantage as 90% of aftermarket is pulled through the Parker brand distribution network and has a higher margin. Going forward, I believe aerospace will be one of the higher growth markets given the $20 billion in announced contract wins. I am looking forward to see a high single digit CAGR over the next several years which will drive significant upside in earnings and valuation from current levels.
Share Buybacks and Dividend Growth
Parker’s dividend growth is among the most compelling. The company has been increasing its dividend for the last 56 years. Currently, the company is targeting a 25% payout ratio and there is ample room for further increases. Share repurchase activity is second on the priority list. I believe the acquisitions attributed to lower than announced (in 3Q) share repurchases in Q4. I am optimistic that the company will return back to its original cash deployment strategy in the coming quarters.
Stand Among Competitors
Parker-Hannifin does not have any direct competitor which competes in all of its segments. However, Parker's closest competitors are ITT Corporation (NYSE: ITT), Eaton Corporation (NYSE: ETN), and Honeywell International (NYSE: HON).
- ITT Corporation (ITT) - It largely competes with Parker as it provides systems and services to the aerospace, industrial, and transportation markets.
- Eaton (ETN) - Eaton is a global manufacturer of electrical power and control systems. Eaton also manufactures fluid power and hydraulic systems which put Parker into competition with it.
- Honeywell International (HON) -Honeywell is a worldwide technology and manufacturing company. I have taken this company as a competitor of Parker based on the fact that it is also aggressively trying to expand its international operations.
The following table summarizes the expected EPS growth, forward PE and dividend yield of ITT, Eaton, Honeywell and Parker:
|
Company |
Expected EPS growth (next year) |
Forward PE |
Dividend yield |
|
ITT |
10.78% |
11.52 |
1.71% |
|
Eaton |
10.88% |
9.98 |
3.18% |
|
Honeywell |
11.36% |
12.22 |
2.44% |
|
Parker |
9.18% |
10.43 |
1.92% |
Eaton seems relatively cheap given an impressive dividend yield and strong expected EPS growth. However, the company’s lack of visibility over the acquisition of Cooper Industries (NYSE: CBE) and assorted issues could not be neglected while comparing the stock. Parker Hannifin compares favorably to the other companies on growth and valuation metrics, and its dividend is impressive on absolute basis. I expect significant changes to Parker’s portfolio in the near term given more aggressive moves from other industrial companies including Eaton and Honeywell.
I believe end markets will be strong enough over the next few quarters to drive Parker’s EPS well above the current flattish guidance. Additionally, operating margins, free cash flow and returns are also supporting the secular growth story. I am confident that Parker Hannifin will be able to drive higher EPS and profit growth given the company’s increased focus on share repurchase, acquisitions, and more aggressive cost-cutting restructuring actions. Thus, I recommend buying it.
sandeep2gupta has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.
