Parker-Hannifin Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2023

There are 13 speakers on the call.

Operator

Hello, and welcome to the Parker Hannifin Corporation's Fiscal 2023 4th Quarter and Full Year Earnings Conference Call and Webcast. At this time, all participants are in 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 Lianbruno, Chief Financial Officer.

Operator

Thank you. Please go ahead.

Speaker 1

Thank you so much, Donna, and good morning, everyone, and thank you for joining Parker Hannifin's fiscal year 'twenty three Q4 and full year earnings release webcast. As Donna said, this is Todd Lee in Bruneau, Chief Financial Officer speaking. And with me today for the webcast is Jenny Barmatier, our Chief Executive Officer and Lee Banks, our Vice Chairman and President. I think everyone knows we released our results and all of the slide materials this morning. Our comments today will address forward projections and non GAAP financial measures.

Speaker 1

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 the 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 Our press release, this presentation and all reconciliations are available under the Investors sections at parker.com And those will remain available for 1 year. Today, we're going to start with Jenny addressing some of the highlights of our strong Q4 and really what was a transformational fiscal year 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 FY 'twenty four 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 and A for Jenny, Lee or myself.

Speaker 1

So now, I'll ask you all to move to Slide 3 and Jenny, I'll hand it over to you.

Speaker 2

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 Safety has been and will remain our top priority. We had record sales of $5,100,000,000 in the quarter, A 22% increase over prior year with organic growth of 6%.

Speaker 2

This is our 2nd quarter above $5,000,000,000 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. Next slide, please.

Speaker 2

A great and transformational year. On the right side of the page, you can see highlights from fiscal year 'twenty three. Again, it all starts with our team. Tapquartile 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.

Speaker 2

The team is exceeding our expectations and a record $3,000,000,000 operating cash flow, 22% higher than prior year, allowing us to make great progress in paying down debt. Todd will give you a few more details on this in his upcoming slides. Next slide, please. Many of you have seen this slide before. As you know, over the past 8 years, we have strategically reshaped the portfolio to double the size of aerospace, Filtration and Engineering Materials.

Speaker 2

I'd like to draw your attention to the middle of the page for the FY 'twenty three update. The dotted line represents where we originally forecasted our longer cycle and secular trends revenue to be at the end of the year. The combination of the portfolio changes and secular trends is all ready and will continue to create a profound shift in our revenue mix. We have high confidence that by FY 'twenty seven, we will have approximately 85% of the company in long cycle end markets And industrial aftermarket. This mix shift is further reason why we will grow differently in the future.

Speaker 2

Next slide, please. Diving a little deeper into our future sales growth drivers, the 5 buckets on this slide will allow us to achieve our FY 'twenty seven target of 4% to 6% organic growth over the cycle. The Win Strategy is our business system. It delivers growth and financial performance. Every tool in this system expands margins.

Speaker 2

CapEx reinvestment is addressing the last decade of underinvestment as well as investments to strengthen and develop the supply chain. This will result in increased equipment spend and higher levels of automation. And under innovation, our new product blueprinting tool and simple by design principles have increased our product vitality index. That is the percent of sales from new products. This enables faster growth in support of the secular trends.

Speaker 2

The acquisitions we have made are great companies with higher growth rates, aftermarket and accretive margins. We continue to benefit from the growth related to secular trends. We expect multiple years of solid growth in aerospace, driven by both commercials and defense. And we are enjoying an increased vehicles and continue to partner with our mobile customers on electrifying their equipment and helping them to achieve their carbon neutral goals. And today, 2 thirds of our portfolio enables these clean technologies.

Speaker 2

Again, all of this giving us high confidence 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 2,040 and achieved a 20% carbon reduction in fiscal year 'twenty three. And we are proud to be in the 1st quartile of the Carbon Disclosure Project on climate change. Post pandemic, Our teams were anxious to get back into the communities where we worked and volunteered over 10000 hours in fiscal year 'twenty three to help serve others.

Speaker 2

And again, our clean technologies are critical in helping our customers achieve their carbon neutral goals. Next slide please. 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 FY 'twenty seven 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.

Speaker 2

We have entered fiscal year 2024 on a solid foundation. The guidance that we are sharing with you today reflects continued progress to these FY 'twenty seven goals. Todd will go through the quarter and the guide, And then I will be back with more comments on our guide assumptions and why we are still very bullish about the future and the 4% to 6% organic growth over the cycle.

Speaker 3

Over to

Speaker 2

you, Chad.

Speaker 1

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 22% sales growth and the 24% segment operating margin. But in respect to sales, organic growth was 6%.

Speaker 1

When you take a look at the Meggitt acquisitions and the divestitures that we did in FY 'twenty three, the net addition for the quarter was 16%. And the good news here is on currency, the headwinds have moderated. It's now was just a slight headwind of 0.4% in the quarter. One thing I do want to note is adjusted EBITDA margins 24.4%. That's an increase of 130 basis points versus prior year.

Speaker 1

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 $791,000,000 or a 15.5 percent 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 how important it is to finish strong. And really these results are just really a testament to the resilience of our global team.

Speaker 1

So thank you to everyone for a great Q4 and a great fiscal year 2023. If you move to Slide 11, this is just a bridge on how we generated that $6.08 This is a $0.92 walk. And I'm proud to say again, you could see the biggest bar on this page is increased segment operating income. If you look at that, We increased our second operating dollars by $264,000,000 That's nearly 28% increase year over year. That added $1.63 of EPS to our total for the quarter.

Speaker 1

There were a few headwinds below the segment that are really no surprise. Obviously, that interest is 100% related to Meggitt. That's consistent with what we've seen in past quarters. And income tax was favorable this year In the quarter, even though we did finish favorable, it was a headwind of $0.19 compared to what we did last quarter. And if you think about that last quarter, we did have a few one time items that were related with the acquisition that were favorable and some Higher discretes last year.

Speaker 1

Those were obviously non repeating issues this year. So the story on the walk is just really strong operating execution and it's really across the board. If you move to Slide 12, just some details on the segment performance. Every segment delivered positive organic growth this quarter, But they also delivered positive margin expansion. You can see across the board here.

Speaker 1

Incrementals were very strong and all of these margins are records. And I'm also proud to say even with the challenging comparisons, orders did increase from last quarter to a +3 versus prior year And our backlog did increase 1% sequentially and did reach a record $11,000,000,000 So this is really The result of robust aerospace activity, but also the changes to the portfolio that we spoke to throughout the year. Just jumping into the North American businesses, sales were very strong, dollars 2,300,000,000 that was 5% organic. That's really right in line with our guide. Adjusted operating margins did increase 60 basis points to 23.5 percent, really just driven by excellent execution across those North American businesses.

Speaker 1

Incrementals also did improve sequentially and that helped drive our margin expansion. One thing to note, orders did turn negative Up to 8%, but that really still is against tough comps. We still have strong backlog coverage, that we believe will continue to support growth And customer sentiment overall remains positive in North America. So all in all, a great quarter and a great finish by our North American team members. If you look at the international businesses, sales were $1,500,000,000 organic growth nearly 4%.

Speaker 1

Organic growth did remain positive in all of our international Regions really led by Asia Pacific 8.5%, almost 8.6%, Excuse me, Latin America was 2.5% positive and even EMEA, which we've seen some softness in, did Post a 1% positive organic growth. Even with all that said, margins did increase 90 basis points, Finished at 23.3 percent versus prior year and really still continue to reflect consistent performance, Productivity improvement, good cost controls and that increase in distribution mix that we've talked about periodically. Orders in the international business did improve from last quarter. They are still negative 1%, but it is a nice improvement from last quarter. And again, from our international team members, great consistent performance and glad to see these results.

Speaker 1

If you move to Aerospace, this is really the story of the quarter, really a standout, Just fantastic results all around. Sales are $1,300,000,000 16 percent organic. Total sales are a 90% Increase versus prior year. That's really obviously benefiting from the Meggitt acquisition. But if you look at the business, Commercial OEM and MRO continue to be very strong.

Speaker 1

Both of those businesses are growing at plus 20% versus prior in the quarter. The military OEM business did return to growth this quarter with high single digits organic performance that was really nice to see. And operating margins, a new record high, really increasing an impressive 160 basis points to 25.8%. Those strong margins reflect that growth in the commercial aftermarket businesses and really notably a nice favorable mix Of spares versus repairs. So you can also see the addition of Meggitt has also increased our aftermarket exposure.

Speaker 1

That was one of the compelling aspects of that acquisition. We're glad to see that materialize in the results. The aerospace team is really doing a phenomenal job, Obviously dealing with growth. The integration is ahead of schedule and on track and these results are really fantastic to see. It's really Truth that Parker and Meggitt are really better together.

Speaker 1

If you look at aerospace order rates, plus 28 continues to be Robust and then obviously it's helping our backlog. Great performance across the segments. If I jump to Slide 13, I just want to highlight our We finished the year with extremely strong cash flow. It was a record in FY 'twenty three. We increased cash flow from operations 22 Percent, we reached a record $3,000,000,000 of cash flow from operations.

Speaker 1

That's 15.6 percent of sales. Free cash flow also very strong, dollars 2,600,000,000 or 13.6 percent of sales. Our CapEx came in right where we were forecasting 2%. And just as a note, because this was the closing of Meggitt, we did have some transaction related expenses that were a drag To cash flow, that was about 1% of sales. So those obviously aren't going to repeat next year.

Speaker 1

And we have set ourselves up extremely well To be great generators of cash. If you look at conversion, free cash flow conversion for the year, 125%. And I just really want to thank our teams for the great work on working capital. We strive to be great generators, great deployers of cash and reaching this $3,000,000,000 milestone It is really the result of significant effort from our team across the globe.

Speaker 3

If you go

Speaker 1

to Slide 14, You can see what we did with all that cash. We reduced debt by $850,000,000 in the quarter. Since we I closed Meggitt just this fiscal year in September, we have reduced our debt by 1 point 4 Since announcing Meggitt way back in August of 2021, we have already paid down approximately 35% Of the total consideration of nearly $10,000,000,000 So very impressive work across the board by our team. If you look at leverage, Gross debt to adjusted EBITDA finished the year at 2.8 percent and net debt to adjusted EBITDA finished the year at 2.7 Excuse me, 2.7 times. We've spoken about our great track record of how we are so dedicated to quickly deleveraging After the deals and since closing the transaction in September, we have already reduced leverage by one full turn.

Speaker 1

So we're proud of that. Looking forward to next year, we expect to generate significant cash flow. We think we can reduce Debt by an additional $2,000,000,000 in FY 'twenty four and we are targeting leverage of 2 times in early FY 'twenty five. Okay. So moving to guidance and putting FY 'twenty three to bed, you could see what we are looking at here is Slide 15.

Speaker 1

And I'll start with the top line. Reported sales

Speaker 4

growth for

Speaker 1

the year is forecasted to be in the range of 3% to 6% or 4.5% at the midpoint. That equates to approximately $19,900,000,000 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%.

Speaker 1

North America organic, we expect that to still be positive at +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. And if you look at the breakdown, the guidance does assume acquisition sales, roughly $500,000,000 from Meggitt, Offset by $400,000,000 of the divestitures that we did complete in FY 'twenty three.

Speaker 1

So the net impact is $460,000,000 or about 2.5% of our total sales. I mentioned currency earlier based on spot rates as of June 30, we do expect currency to be a slight tailwind of 0.5 percent or roughly $100,000,000 So, that is based on currency rates as of June 30. We still see margin expansion this year, 30 basis points is what we're forecasting for FY 'twenty four. That is all based on continuing to accelerate Our performance across all of our businesses using the Win Strategy and of course delivering on mega synergies that we have communicated. If you look at adjusted segment operating margin, our guidance is 23.2% at the midpoint and there is a range of 20 basis points on either side Of that midpoint.

Speaker 1

If you look at operating income dollars, segment operating income dollars, the split is 47% first half, 53% second half. And for the full year, we are forecasting incremental margins of 30%. Few other items in respect to guidance. Corporate G and A is $240,000,000 that's a full year number. Interest expense is $525,000,000 That is a $40,000,000 reduction from where we finished in FY2023, really just based on our strong debt pay down.

Speaker 1

And other expense is $25,000,000 Full tax rate, we're guiding at 23.5%. That is without any discrete items. That is really our continuing Rate from operations 23.5 percent. And finally, we expect full year as reported EPS of $18.55 Or on an adjusted basis, dollars 22.40 The range those are both midpoint numbers. The range on either side of those is $0.50 Plus or minus and the splits, 46% first half, 54% second half.

Speaker 1

And just specifically for Q1 of FY 'twenty four, We are forecasting adjusted EPS to be $5.10 at the midpoint. Looking at cash flow, full year free cash flow is expected to be between 2 $600,000,000 $3,000,000,000 So we'll be mid teens free cash flow and our conversion will be over 100%. Also included in the appendix is some segment guidance details and some other specifics that you might find helpful. If I move to Slide 16, this is just a bridge and really highlights as follow. Again, very similar to what's happened throughout this fiscal year.

Speaker 1

The organic growth, the acquisition sales, margin expansion and the $75,000,000 of incremental MIGA Synergies For the year translates to an increase in segment operating income of $1.47 We will have less interest expense next year Based on that debt reduction that we've done, but and that will add $0.23 to EPS. Our forecasted tax rate of 23.5 percent It is a headwind of $0.26 but you remember we had a lot of favorable items in FY 'twenty three, we're not forecasting those to continue. We also had lower interest income. If you remember, we prefunded those the mega transaction in June of last year. So We had interest income in the Q1 of last year that was about $35,000,000 Just to note, that is reported in the other Expenseincome line on the business segment statement, that was a one off benefit that obviously will not repeat in FY 'twenty three.

Speaker 1

That's a $0.21 headwind. The rest is just forecasted $0.20 unfavorable to EPS. So there's just some really some non repeating items in there. And obviously share count is also a $0.10 headwind that we hope to make up. So that's the walk from FY 'twenty three to FY 'twenty four.

Speaker 1

EPS at the midpoint is forecasted to be $22.40 So with that, Jenny, I'll hand it back to you and ask everyone to move to Slide 17.

Speaker 2

Thank you, Ted. Just a few key messages to close this out. So FY 'twenty three was a tremendous year with record performance. We have top quartile safety and engagement and that continues to drive results in our business. We truly have a great team.

Speaker 2

We have a proven track record and we're going to continue to accelerate our performance with The Win Strategy 3.0. The transformation of the portfolio is And continue to be great generators and deployers of cash. So before we go into Q and A, I'd like to give you a few of our assumptions and comments on the guide. So obviously, aerospace is a real growth differentiator for Parker in fiscal year 'twenty four. We are projecting total aerospace growth at 17% with the acquisition sales from Meggitt and organic growth of 8%.

Speaker 2

We see strong mid teens growth in commercial and mid single digit Military. Good story all the way around. We have now had 2 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.

Speaker 2

We do expect some destocking to continue, But overall sentiment from our customers is positive about steady demand and future growth. Obviously, there's more macroeconomic uncertainty for the second half And we'll update you on that in future calls. While we did see an improvement in international orders from Q3 to Q4, This does include a benefit coming from some of those multi period longer cycle orders and an easier comp from last year's China COVID shutdown. Again, the backlog coverage remains above 30%. But as Todd said, we are forecasting negative growth for the first half and full year.

Speaker 2

Since the last time we talked, we've seen some signs of Europe slowing. Customers are returning to those seasonal shutdowns where they do maintenance in their facilities And we're starting to see some softness in some of the end and geographic markets as well as some weakening macroeconomic indicators. And although China had stronger growth in Q4 than Q3, recovery is slower than anticipated and then we will face a tough comp in Q1 against prior year China COVID rebound. 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 that I went through on the earlier slide remain intact and activity is at a high level.

Speaker 2

We are still very bullish about the future and our 4% to 6% organic growth target over the cycle. So now I'll hand it back to Donna for Q and A.

Operator

Thank you. The floor is now open for questions. In order to allow as many individuals as possible the opportunity to ask a question, we do ask you to please limit yourself to one question and one follow-up. Today's first question is coming from Julian Mitchell of Barclays. Please go ahead.

Speaker 5

Thanks and good morning. 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 The down first half organic sales and also down second half organic sales in the guide. So you sort of assuming heavy negative orders pressure there for the coming 6 months or so.

Speaker 5

Just wanted to check that. And broadly on destocking any regions or markets to call out in particular where that's most severe?

Speaker 2

Good morning, Julien. So, first of all, to your question on international, like I was talking about earlier, obviously, the backlog is still strong. It's About 30%. But, those customer shutdowns that I mentioned, that takes weeks out of the schedule that we hadn't seen previously. So a return to that is one

Speaker 6

of the

Speaker 2

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. And then, the China recovery is We haven't seen the rebound from the stimulus that had been previously anticipated. So that is all weighing in there as well.

Speaker 5

I see. And maybe just following up on the sort of the destocking comments you'd made, any more color On markets or geographies most affected?

Speaker 2

Well, we did see destocking happen in Q4 and we just I'll let Lee comment a little bit on the specifics of some regions and markets.

Speaker 4

Yes, Julien. It's Lee. Good morning. I think destocking mostly at the distribution level, there's 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.

Speaker 4

So we've seen destocking across our European distributors and in North America. Maybe too, just a little more color on Europe, as Jenny was talking about. The biggest softness really is around the dock 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.

Speaker 4

China It's not rebounded like we all expected it would. And then I think when you pivot to Asia, with China, the property woes We continue to weigh heavily on the business community there. So all the stimulus we read about Really hasn't trickled down to any significant economic activity. I'm still expecting that to change going forward, but Those are the plus signs as we move forward.

Speaker 1

Hey, Julien, this is Todd. I would just add, We don't have this really first half, second half weighted. 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 waiting there. It's about an even split.

Speaker 5

That's great. Thank you.

Operator

Thank you. The next question is coming from Joe Ritchie of Goldman Sachs. Please go ahead.

Speaker 6

Thanks. Good morning, guys, and nice end to your year. Maybe just Hey, just wanted to maybe talk a little bit more about North America. Obviously, you've got This little order deceleration, the destocking commentary. Just maybe talk a little bit more about what your expectation is For orders going forward or any comments you can make about how this fiscal Q1 is trending, that would be helpful.

Speaker 2

Yes. Thank you, Joe. So, obviously, we've already talked a bit about what we expect to see a continuing destocking and And just kind of a softening in orders despite a very positive sentiment from the customers. So in the first half In North America, we're projecting 2% growth, and overall for the year, 1%. So, We think that there's some macroeconomic uncertainty in the second half.

Speaker 2

But in the first half, We fully believe that this strong backlog is going to support what we have in the guidance. So, the backlog, again, Above 30%, a little bit down, about 2% down from last quarter, but very strong. And in talking with our customers, we continue to constantly pressure test this and analyze it and We're not really seeing any major push outs or cancellations. So we feel good about the guide we have out there.

Speaker 6

Okay, great. And then maybe just focusing to ARO, I guess it's funny like you're expecting 8% growth, good But why is 8% the right number? It feels like it could be better than that. And then particularly with military inflecting. And then also, we'd love to get any color around where the integration is going better than expected with Meggitt?

Speaker 2

Sure. Sure. So the first half for Arrow is 12%. So obviously, we're going to see some nice growth here in the first half. And In the second half, we have 5% and the comps get pretty tough in the second half.

Speaker 2

So We feel good about that 8% organic number right now. So obviously, we're seeing really nice growth in commercial OEM. We We see those narrow body rates increasing. Wide bodies are starting to recover, but really it's a story about narrow body rate increases. And then MRO, as Todd mentioned earlier, the Meggitt acquisition has really increased our aftermarket exposure And it's been really strong with the air traffic recovery, especially with those narrow bodies.

Speaker 2

And we're pleased to see military OEM return. Obviously, The military budget increase is going to drive mid- and long term growth. F-thirty five is nearing peak delivery, so all good news there. And then, same thing with military MRO. I mean, there's a focus on retrofits and upgrades as the fleet ages.

Speaker 2

So really, Really good, outlook for all of Aerospace going forward. So you questioned about, Meggitt integration. I mentioned in the slides, we couldn't be happier with the progress of that integration. We're forecasting another $75,000,000 in synergies in FY 'twenty four. Team did a great job in FY 'twenty three of pulling some actions ahead and allowing us to increase those synergies by 15,000,000 So really just a positive outlook for Aerospace.

Speaker 6

Sounds good. Thank you.

Speaker 1

Hey, Joe. This is Todd. Just one thing I would add. If you remember a year ago when we did the Meggitt post close call, we said that We felt Meggitt could add $0.80 of EPS on a full year basis. We are ahead of that schedule.

Speaker 1

So that should give you some comfort too that it is adding EPS to bottom line

Operator

Thank you. The next question is coming from Andrew Obin of Bank of America. Please go ahead.

Speaker 7

Hi, guys. Good morning.

Speaker 2

Good morning, Andrew.

Speaker 7

Good morning, Janet, Todd Lee. Good to hear from you guys. Yes, just a question on price and cost. Companies are starting to talk about disinflation, maybe some deflation. What's the view on the company's pricing power into next year And also ability to actually extract price concessions from your supply chain.

Speaker 4

So we've Andrew, you've covered us a long time. I mean, the one thing I think we've got a good handle on inside the company is kind of price cost And the ability to push cost in the price. Every one of our facilities is embedded in our win strategy. We look at cost constantly and we look at price. I would say pricing has become much more normal now.

Speaker 4

We're not in that rapid inflationary period. But our goal is always to keep things margin neutral and we're working that. And we're working the cost side and the supply chain side too. So I'm comfortable that kind of the price cost scenario We have is baked into our margin forecast.

Speaker 7

Excellent. And then the other question, you sort of talked about Europe slowdown, specifically Germany and the DACH region. If you read the newspapers, Economist, Politico, A lot of articles about sort of structural slowdown in Germany, right, because exports to China, cheap energy from Russia. Could you use the slowdown as an opportunity to sort of reconfigure your manufacturing footprint and supply chains in Central, I would call it Central Europe or just Western Europe in general. What are your thoughts?

Speaker 7

And is it too early to say?

Speaker 4

Well, so first off, we've been reconfiguring our supply chains and our manufacturing footprint in Europe for the last 8 or 10 years. I mean, You remember when Tom and I took our roles, we had a big initiative?

Speaker 7

I absolutely do. Absolutely do.

Speaker 4

So and I I would just tell you that that is always ongoing. So we never stop with that and we take every opportunity we can To just continue to be better and we're doing that today.

Speaker 2

Yes. We don't wait for an event, Andrew. It's something we're always working on.

Speaker 1

Andrew, this is Todd as well. I think Lee brings up a good point. We've been working that initiative for a long time. And if you look at The margins that I just ran through for Q4 and really what we're guiding for FY 'twenty four, you'll see that those international margins Are similar to every other piece of our business. So that has been a great success.

Speaker 4

Great European team with great leadership doing great things. They really are.

Speaker 7

No, I appreciate you. You shouldn't have been doing something right. Thanks a lot.

Speaker 2

Thank you. Thanks, Andrew.

Operator

Thank you. The next question is coming from Nathan Jones of Stifel. Please go ahead.

Speaker 8

Good morning, everyone. Question on the margin guidance in Aerospace. Jenny, you just mentioned $75,000,000 of additional synergies for Meggitt in 24, which I think is about 150 basis points. And the margin guidance is up about 60 basis points. So maybe just some commentary On the core, I guess, margin decline in 2024, is that really just a function of increasing commercial OEM as part of the mix or something else in

Speaker 2

You just answered the question, right? We expect those narrow body rates to go up and it's definitely a matter of mix.

Speaker 8

Okay, fair enough. That's helpful. And then I guess just on the M and A outlook now, I mean you guys have obviously Done a sensational job paying down debt post Meggitt, back towards 2 by the end of the fiscal year, early in 'twenty five. What are kind of your criteria for getting more materially back into the M and A market? And the Shape of the pipeline, I know you guys continue to cultivate that even when you're out of the market.

Speaker 8

Just commentary on plans there?

Speaker 2

Yes. So, we're committed first to pay down our debt. That is our number one priority and our focus. We're always working the pipeline. We have long Ending relationships with people we talk to now as we have in the past.

Speaker 2

So that's not something that we ever let go stale or dry. It's a continuous So, for now, we're focused on paying down debt and, we expect to get In the range of about 2 times by fiscal year 2025, and I'm sure we'll talk about it in the future.

Speaker 8

Fair enough. Thanks for taking my questions.

Speaker 2

Thanks, Damon.

Operator

Thank you. The next question is coming from Jeff Sprague of Vertical Research Partners. Please go ahead.

Speaker 9

Hey, thank you. Good morning, everyone.

Speaker 10

Hi, Chad.

Speaker 9

Hey, good morning. I have to touch base with all of you. Just wanted to follow-up on Lee your comments on price cost margin neutral. I believe you Got yourself the price cost margin accretive through this period. Kind of correct me if I'm wrong on that, but Should we kind of expect that trend back to neutral to occur here in 2024?

Speaker 9

Or can you actually maintain some kind of positive spread?

Speaker 4

Well, I think, Jeff, again, you followed us. We've always maintained some kind of positive spread. We're always looking at the portfolio. We're sunsetting products. We've Got different strategic pricing initiatives.

Speaker 4

But I would tell you, we deal with a lot of Core tough customers and pricing is very competitive. It's really what we do with the balance of the portfolio that helps us out. And as we talked about in the past, one of the great strengths of this company is the distribution base we have, which gives us A great opportunity to kind of price into that market.

Speaker 9

Understood. And then, Jenny, just back to aero. Can you be a little bit more explicit about what your aero commercial aftermarket assumption is inside the guide? And is the growth similar at legacy Parker, Arrow and Meggitt on those metrics?

Speaker 2

Yes, I would say, 1st of all, that it is very similar, but obviously the Meggitt acquisition, as we've mentioned, has meaningfully increased Our aftermarket exposure. So it's mid teens is what we're projecting right now. And again, that air traffic recovery, especially with the narrow bodies, With this high domestic traffic, is that really what's going to help that into the fiscal year?

Speaker 9

Great. Thank you very much.

Speaker 1

You're welcome.

Operator

Thank you. The next question is coming from David Raso of Evercore ISI. Please go ahead.

Speaker 11

Hi. Thank you for the time. On the margins industrially that you had them up despite in aggregate your industrial organic Sales are down. Just want to make sure I understand the destocking that you're referring to, I think that probably is distribution, which Be a challenging mix if that's your destock. Are you also referencing though maybe a more balanced destock?

Speaker 11

It's at OEs as well. I'm just trying to get a sense of The ability to have margins up when you're destocking distributions a heavy lift. So I'm just curious if you could color on that. And maybe the what's in the backlog? It sounds like the backlog will help carry the 1st part of the fiscal year.

Speaker 11

Are the margins Particularly positive what will be coming out of the backlog. Just trying to get a sense of the margin progression and how to have margins up If organic is down industrially for top line.

Speaker 2

Yes. So, David, primarily when we talk about destocking, we are talking about But we're just seeing a kind of a moderation of growth across all of our customers. So Don't worry about margin degradation. We're not going to allow that. We have all the right things in place to make sure that we hit our margin targets.

Speaker 2

So really, it's about we're just continuing to see the benefit of this transformed portfolio, right? We're continuing to The power of the acquisitions that we've done over the last several years.

Speaker 1

Hey, David, this is Todd. I would just add to that. Jenny is absolutely right. We do believe that we can expand margins both in the North American businesses and the international businesses. It really is a testament to the power of the Win Strategy.

Speaker 1

But if I'm looking at the numbers here, it really is a smooth glide path, very similar to what we've done Historically with our normal seasonality. So it's not weighted in any one way or the other. I gave a little color on the splits of 7 operating income, but The margin expansion is a nice glide throughout the year.

Speaker 11

And maybe I missed it, just a clarification. The Q1 in North America particularly has a hard comp. Are we saying margins could be up every quarter in North America? Or is it just for the full year and the first quarter is down and Then it's up from there.

Speaker 1

No. We see margin expansion in every quarter of this fiscal year.

Speaker 11

Okay. Alright. Thank you so much.

Speaker 1

Thanks David.

Speaker 2

Thanks David.

Operator

Thank you. The next question is coming from Josh Pokrzywinski of Morgan Stanley. Please go ahead.

Speaker 10

Hi, good morning, all.

Speaker 2

Good morning.

Speaker 10

So, Jenny, you've referenced the backlog here a few times. I I think for most folks, they don't really think about backlog when they think about the industrial pieces of Parker. Clearly, that's changing, but Maybe some more kind of breakdown of how long does that backlog extend out? Is there A particular set of end markets or channel mix, like I would assume more OEM, maybe more project activity. Just Any kind of color you can give us on the nature of that backlog and really the duration over which it ships?

Speaker 10

Is it kind of 1 to 2 quarters, 3, 4 or something like that?

Speaker 2

So the backlog, as I've said, is at 55% right now and it went up 1% sequentially. So We talk about that backlog being so strong and especially, obviously, aerospace is in there, but in industrial being above 30%, It's roughly double what it was in the past. So we were sitting around 15% to 17% coverage in the past, and now we have 30%. So that's really coming from the acquisitions we've done, the higher aftermarket, the longer cycle. So we're seeing A more resilient and longer, I call it the demand horizon, a longer horizon on that backlog.

Speaker 2

So we feel Very strongly about it. Now, we know from the past that backlog isn't bulletproof, but we are constantly pressure testing Talking to our customers, which is really a great benefit of us being so decentralized because our divisions can have Real time conversations to make sure that that backlog is strong. So, I wouldn't I won't be able to break out all the detail that you were just asking about between the channel and the OEM, but I would tell you that Over 30% coverage in industrial is a good place to be right now. And that's why we feel good about it covering the growth we have in the first half.

Speaker 10

Got it. That's helpful. And then yes, please go ahead.

Speaker 3

Josh, this is Todd. I was just going to

Speaker 1

add to that. The other thing to keep in mind is When we talk about the company having 30% aerospace exposure, 5% of that exposure does come from our industrial business. So that is also a plus there as well.

Speaker 10

Understood. That's helpful. And then just pivoting to something I've heard a lot of your peers talk about, This quarter on U. S. Mega projects or I guess North America mega projects and near shoring.

Speaker 10

Obviously, you folks play in All stages of that, I guess, new products that are being developed here as well as the construction of maybe some of these facilities themselves. Open ended question, but That's something that in Parker's, I guess, more kind of component in subsystem type business You're actually seeing it or is it just a little too early, maybe we see that more kind of later in 2024?

Speaker 2

We are seeing some of it through our customers and our distributor partners. And you're right, there's just been a massive amount of announced CapEx, I mean, some industry sources are citing over $500,000,000,000 Some key examples of that where we will get Into the game is the semi fabs and the electric vehicle battery plants that are now breaking ground. So we win Parker wins when the job site is prepped, when the factory is built and when the machines go into the factory. So It's early days, but Parker is winning and will continue to win in the future.

Speaker 10

Great. Appreciate it. Best of luck for the rest of the year.

Speaker 1

Thanks, Josh.

Operator

Thank you. The next question is coming from Joe O'Dea of Wells Fargo.

Speaker 12

Todd, 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 megatre contribution is this year?

Speaker 1

Yes, 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 has been a fantastic 9.5 months. We've talked about the synergies being ahead of schedule, but the other thing is they're benefiting from The secular trend in aerospace, so their growth has exceeded expectations every quarter since the close. We feel really good about that. I'm really happy we got the deal done.

Speaker 12

Got it. And then, Jenny, I wanted to circle back the macro CapEx investment sort of drivers that you talked about, kind of the 3 main buckets with underinvestment, supply chain, mega projects. Can you just talk about sort of within those buckets, sort of if you can rank order, what you're seeing is sort of like the biggest growth Drivers for you, but also just what you're seeing in terms of kind of the evolution of them, maybe where things are accelerating, where things have played out a little bit more?

Speaker 2

Well, I don't know that I can rank them right now, but I would tell you that I see activity in obviously all three of them. If you start off just thinking about the CapEx investment because of the reinvestment over the last 10 years, We're seeing some just some upgrading of factories, a lot of work being done to Really developed the supply chain and increased capacity. So that ties into the investment, A lot of machinery and a lot to help really that supply chain development. A lot of folks that Yes, burns during the pandemic are going to dual sources, so that drives a lot of investment. And as I mentioned just a few minutes ago, the mega projects, we're starting to see some of that.

Speaker 2

We're hearing about involvement in that from some of our distribution partners. And it's still early days, but there's a lot out there for us to go win.

Speaker 12

Thank you.

Operator

The next question is coming from Jamie Cook of Credit Suisse. Please go ahead.

Speaker 3

Hi, good morning. Congrats on a nice quarter. I guess most of my questions have been asked, but I guess just to, you wouldn't know this from looking at your results, but in 2023 Or 2022, is there any way you can handicap the inefficiencies running through your earnings, whether it's related to Supply chain, employees not being back, etcetera. And I'm just wondering, freight, if Any of this is an opportunity for 2024 potential tailwind that's not implied in your guide? And then my second question, Lee, I don't think you said this yet.

Speaker 3

I know you walked Some end market color, but last quarter you told us like the percent of the portfolio that was growing versus not growing. I think last quarter 90% of the portfolio was still in growth mode. Can you give us an update, just on your portfolio percent flat versus growing versus negative? Thank you.

Speaker 4

So Jamie, it's Lee. I guess I'll start on a couple of things. One, in terms of We're always striving for productivity and continuous improvement. So certainly things coming out of COVID were chaotic. Some of that chaos is settling down.

Speaker 4

So those are opportunities for us, but productivity is increasing. You see it in our numbers And kind of the inefficiencies that work going on are getting better. It's not perfect. There still are supply chain issues out there, but it's A far cry from what it was before. I would say when we look at our markets from the backlog we have, all our markets Are still growing at different levels.

Speaker 4

I mean, it's kind of interesting. Nobody talks about oil and gas anymore, but that's been incredibly strong. Land based oil and gas here and even offshore here and in Europe. Everything in aerospace is great. And forestry and automotive is still Great.

Speaker 4

North America, anything around electric vehicles is doing really well and we share a lot of content in those areas. And then construction equipment is still steady Throughout all that as is Ag. I think some of the areas that have softened and you've seen it with public announcements is the whole area HVAC is down. I think that's short term. That will come back.

Speaker 4

And semicon is soft and life sciences really just tough comps coming out of COVID. Things are We're really going there. The sentiment is it's just tough comps. So it's getting better as we kind of cycle through the comps.

Speaker 3

Hey, Jamie, this is Todd.

Speaker 1

I would just add to that on your 90% question. If you look at our total orders, last quarter they were plus 2%, they did move to plus 3%. So So, there really hasn't been a material change in that percentage of end markets that continue to grow.

Operator

Thank you. Thank you. The next question

Speaker 1

Hey, Donna, this is sorry to interrupt you. This is Todd.

Speaker 3

I think we have time

Speaker 1

for one more question. So whoever you have next in the queue, that'll be our last call.

Operator

The next question is coming from Jeffrey Hammond of KeyBanc Capital Markets. Please go ahead.

Speaker 1

Hey, good morning, everyone. Just a couple of quick questions. Supply chain in aero has kind of been a problem point. Just wondering what you're seeing there and how that Kind of informs, kind of the growth rate and how much it's maybe holding the

Speaker 2

growth back. Yes. So it's interesting. I've been talking to a lot of people about supply chain as always. And the aerospace supply chain is really experiencing What the industrial side of the business did 18 to 24 months ago.

Speaker 2

So, just, it's a little bit tough. There's constraints responding To the high rate increases in demand. But I would tell you that outside of chips and electronics, We're starting to see some lead times moderating, but overall, I would say it's still a constraint for Aerospace. So, again, we work closely with our suppliers. We're investing in developing suppliers, especially in aerospace Because obviously with it being a third of our portfolio, it's very important to us that we can deliver these orders.

Speaker 1

Okay, great. And then, I think as was the case with LORD Exotic, the deleveraging process is Pretty swift here and seems maybe a little bit ahead. Just level set us on when we start to shift away from debt pay down? Hey, Jeff. This is Todd.

Speaker 1

Obviously, Jenny mentioned it earlier. We are fully committed to debt pay down. So if you look at what I mentioned earlier, we expect to pay down another $2,000,000,000 of debt in this fiscal year of FY 'twenty four. We don't expect to get to 2.0 times till early FY 'twenty five. So we talked about the portfolio.

Speaker 1

We never stop looking at it So from an addition and a subtraction standpoint, but our main focus really is still for FY2023 is to continue that debt pay down Okay. This concludes our FY 'twenty three Q4 webcast. As always, we fully appreciate everyone's interest in Parker. Jeff Miller, our VP of Investor Relations and Yan Hua, our Director of Investor Relations are available. If anyone needs any further clarifications or has any questions on any of the materials we covered this morning.

Speaker 1

I want to really thank everyone for joining. We appreciate your support. Thanks.

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Earnings Conference Call
Parker-Hannifin Q4 2023
00:00 / 00:00