Parker-Hannifin Corp. (NYSE:PH)

The financial performance, as measured by economic profit, demonstrates a consistent pattern of negative value creation over the analyzed period. While net operating profit after taxes (NOPAT) fluctuates, it has not been sufficient to cover the cost of capital employed. Invested capital has generally increased, contributing to the widening economic loss.

Net Operating Profit After Taxes (NOPAT)

NOPAT increased from US$1,132,702 thousand in 2017 to US$1,184,764 thousand in 2018, then experienced substantial growth to US$1,718,681 thousand in 2019. A decline was observed in 2020 to US$1,466,070 thousand, followed by a recovery to US$1,895,230 thousand in 2021. However, NOPAT decreased significantly in 2022 to US$1,166,223 thousand.

Cost of Capital

The cost of capital exhibited volatility throughout the period. It rose from 19.41% in 2017 to 20.43% in 2018, decreased to 18.64% in 2019, and slightly increased to 18.96% in 2020. A notable increase occurred in 2021, reaching 21.01%, before decreasing to 19.46% in 2022. These fluctuations likely reflect changes in market conditions and the company’s risk profile.

Invested Capital

Invested capital generally trended upward. It decreased slightly from US$13,507,821 thousand in 2017 to US$13,016,451 thousand in 2018, then increased to US$15,269,283 thousand in 2019 and further to US$17,529,292 thousand in 2020. A decrease to US$16,926,500 thousand was seen in 2021, but a substantial increase occurred in 2022, reaching US$21,994,132 thousand. This growth in invested capital, without a corresponding increase in NOPAT sufficient to offset the cost of capital, contributed to the negative economic profit.

Economic Profit

Economic profit remained negative throughout the entire period. The economic loss was approximately US$1,489,172 thousand in 2017 and US$1,474,725 thousand in 2018. It improved slightly to US$1,127,634 thousand in 2019, but worsened to US$1,858,234 thousand in 2020 and US$1,661,071 thousand in 2021. The economic loss reached its highest point in 2022, at US$3,113,387 thousand. This consistent negative economic profit indicates that the company is not generating returns exceeding its cost of capital.

The widening gap between invested capital and NOPAT, coupled with fluctuations in the cost of capital, resulted in a progressively larger economic loss, particularly evident in the final year of the analyzed period. Further investigation into the drivers of NOPAT and the efficiency of capital allocation is warranted.

Net Income Attributable to Common Shareholders

The net income attributable to common shareholders demonstrates a generally positive trend from June 30, 2017, to June 30, 2021, increasing from approximately 983 million US dollars to over 1.74 billion US dollars. This represents a significant growth over this four-year period, highlighting strong profitability. However, there is a notable decline in the year ending June 30, 2022, where net income falls to roughly 1.32 billion US dollars, which suggests some challenges or increased expenses affecting profitability in the most recent period.

Net Operating Profit After Taxes (NOPAT)

NOPAT follows a similar upward trajectory from June 30, 2017, through June 30, 2021, rising from about 1.13 billion US dollars to approximately 1.90 billion US dollars. This consistent increase reflects improving operating efficiency and effective tax management during this period. However, there is a significant reduction in NOPAT in the year ending June 30, 2022, falling to nearly 1.17 billion US dollars, indicating a considerable drop in operating profitability or increased tax expenses most recently.

Summary of Trends

Both net income and NOPAT demonstrate strong growth over the initial five-year period, suggesting favorable operational performance and profitability enhancements. The peak values recorded in the year ending June 30, 2021, indicate the company's highest profitability during the timeframe examined. The sharp declines in both metrics for the year ending June 30, 2022, signal a reversal of this trend and may imply emerging financial challenges or external factors impacting profitability. The divergence in the magnitude of decrease between net income and NOPAT in 2022 could also point to changes in non-operating items or tax effects during that period.

Income Taxes

The income taxes show a fluctuating trend over the six-year period. Beginning at 344,797 thousand US dollars in 2017, the figure notably increased to 640,962 thousand US dollars in 2018. After this peak, there was a decline in 2019, with the value dropping to 420,494 thousand US dollars. The downward trajectory continued into 2020, reaching a low of 305,924 thousand US dollars. However, a substantial recovery occurred in 2021, rising again to 500,096 thousand US dollars. In 2022, income taxes decreased to 298,040 thousand US dollars, marking one of the lower points across the given years.

Cash Operating Taxes

Cash operating taxes exhibit more volatility and a generally increasing trend throughout the same period. Starting at 367,985 thousand US dollars in 2017, values soared to a high of 745,009 thousand US dollars in 2018, the largest increase observed. In 2019, these taxes declined to 429,023 thousand US dollars but remained higher than the 2017 baseline. The downward movement persisted into 2020, registering 357,562 thousand US dollars. However, in contrast to income taxes, cash operating taxes surged significantly in 2021, reaching 604,610 thousand US dollars, and escalated further to 703,301 thousand US dollars in 2022.

General Observations

There is a noticeable divergence in the trends of income taxes and cash operating taxes, particularly evident in the later years. While income taxes fell sharply in 2022 relative to the prior year, cash operating taxes continued to experience substantial growth. This discrepancy may indicate differences in accounting treatment, timing of tax payments, or underlying operational cash flow changes. The initial spike for both tax measures in 2018 suggests extraordinary activities or tax events occurred in that year, followed by varying recoveries and declines in subsequent periods. Overall, the analysis reveals a dynamic tax expense environment with significant annual fluctuations.

Total reported debt & leases

The total reported debt and leases fluctuated significantly over the period analyzed. It initially decreased from approximately 6.08 billion USD in mid-2017 to about 5.16 billion USD in mid-2018. Subsequently, it experienced a sharp increase to roughly 7.23 billion USD in mid-2019, continuing to rise to around 8.60 billion USD in mid-2020. A notable decline occurred in mid-2021, dropping to approximately 6.72 billion USD, followed by a substantial increase to nearly 11.62 billion USD by mid-2022. This trend indicates considerable volatility and an overall increasing debt load in recent years, particularly the marked increase between mid-2021 and mid-2022.

Shareholders’ equity

Shareholders' equity showed a consistent upward trend throughout the analyzed period. Starting at around 5.26 billion USD in mid-2017, it steadily increased each year, reaching approximately 5.86 billion USD in mid-2018, 5.96 billion USD in mid-2019, and 6.11 billion USD in mid-2020. A significant rise occurred between mid-2020 and mid-2021, where equity increased sharply to about 8.40 billion USD. The growth continued at a slower pace, reaching approximately 8.85 billion USD by mid-2022. This steady increase suggests strengthening equity capital and potentially retained earnings accumulated over the years.

Invested capital

Invested capital, representing the aggregate of debt and equity financing, exhibited considerable growth. Beginning at approximately 13.51 billion USD in mid-2017, it slightly declined to roughly 13.02 billion USD in mid-2018. Thereafter, a consistent upward trajectory is evident: rising to about 15.27 billion USD in mid-2019, followed by 17.53 billion USD in mid-2020. A marginal decrease to approximately 16.93 billion USD was noted in mid-2021, but invested capital surged substantially to nearly 22.0 billion USD by mid-2022. The data indicate increased resource deployment backed by both debt and equity, with particularly robust growth in the most recent year.

The economic spread ratio exhibited a fluctuating, generally downward trend over the observed period. While there were periods of relative stability, the latter years demonstrate a marked decline in this metric. Economic profit consistently remained negative throughout the period, contributing to the negative economic spread ratios.

Economic Spread Ratio

The economic spread ratio, representing the difference between the return on invested capital and the cost of capital, began at -11.02% in 2017. It improved to -7.38% in 2019, indicating a narrowing gap between returns and capital costs. However, this improvement was short-lived, as the ratio deteriorated to -10.60% in 2020 and -9.81% in 2021. The most significant decline occurred in 2022, with the ratio reaching -14.16%, signifying a substantial underperformance relative to the cost of capital.

Invested capital generally increased over the period, rising from US$13,507,821 thousand in 2017 to US$21,994,132 thousand in 2022. This increase in invested capital, coupled with consistently negative economic profit, likely contributed to the worsening economic spread ratio in the later years.

Economic Profit

Economic profit remained negative throughout the entire period, ranging from -US$1,474,725 thousand to -US$3,113,387 thousand. The magnitude of the negative economic profit increased significantly in 2020 and continued to worsen through 2022. This consistent negative economic profit directly drives the negative economic spread ratio, indicating that the company is not generating returns sufficient to cover its cost of capital.

The observed trend suggests a growing challenge in generating adequate returns on invested capital. The increasing invested capital base, combined with persistent negative economic profit, is exacerbating the negative economic spread, potentially signaling a need for strategic adjustments to improve profitability and capital allocation.

The economic profit margin exhibited considerable fluctuation over the observed period. Initially negative, the margin demonstrated improvement before declining significantly in the later years. A consistent pattern of economic loss is apparent throughout the entire timeframe.

Economic Profit Margin Trend

The economic profit margin began at -12.38% in 2017. A relative improvement was noted in 2018, with the margin increasing to -10.31%. This positive trend continued into 2019, reaching -7.87%, representing the least negative margin during the period. However, 2020 saw a substantial deterioration, with the margin falling to -13.57%. This downward trend persisted in 2021, with a margin of -11.58%, before reaching its most negative point at -19.63% in 2022.

Net sales generally increased over the period, but this increase did not translate into improved economic profitability. While net sales rose from US$12,029,312 thousand in 2017 to US$15,861,608 thousand in 2022, the economic profit remained consistently negative and, in fact, increased in absolute value. This suggests that the cost of capital, or other factors impacting economic profit calculation, are increasing at a faster rate than revenue growth.

Relationship between Net Sales and Economic Profit Margin

Despite a general upward trend in net sales, the economic profit margin consistently declined, particularly from 2019 onwards. This indicates that increases in sales revenue were insufficient to offset increases in costs or the cost of capital, resulting in a widening economic loss. The most significant decline in the margin occurred in 2022, coinciding with the highest level of net sales, further emphasizing this disconnect.

The increasing negative trend in economic profit margin from 2019 to 2022 warrants further investigation. A detailed analysis of the components of economic profit – net operating profit after tax and the cost of capital – is recommended to identify the specific drivers of this decline.