Fitch Affirms Parker-Hannifin's Ratings at 'A/F1'; Outlook Stable

Fitch Ratings has affirmed Parker-Hannifin Corp.'s (NYSE: PH) ratings including its long-term Issuer Default Rating (IDR) at 'A' and short-term IDR at 'F1'. A full list of rating actions is shown below. The ratings affect approximately $3.3 billion of total debt as of Sept. 30, 2015. The Rating Outlook is Stable.

KEY RATING DRIVERS

The ratings and Outlook take into account PH's strong market positions in diversified end markets and solid operating performance over time. Ongoing restructuring and organizational simplification efforts should support margins and result in the continuation of healthy free cash flow (FCF). The ratings also consider the current weakness in PH's results due to macroeconomic headwinds, particularly in natural resource markets, and the company's recently more aggressive share repurchase activity. While leverage has moved higher, Fitch expects PH will maintain mid-cycle leverage (total debt to operating EBITDA) below 1.5 times (x) over the long term.

The 'F1' short-term IDR reflects solid liquidity resources, including a $2 billion credit facility that more than fully backs the $1.85 billion commercial paper (CP) program.

PH's results began to soften in the second half of fiscal 2015 (ending June), and this softness is expected to continue over the near term. For fiscal year 2015, reported sales were down 3.8%, and organic sales (ex. currency and acquisitions) were up 0.2%. In the first quarter of fiscal 2016, reported sales were down 12.3% and organic sales were down 7%. Fitch expects full-year fiscal 2016 sales will decline by around 10%. Over the long term, Fitch anticipates low- to mid-single digit organic revenue growth, driven by product innovation, expanding the distribution footprint, and growth in the aerospace business and services.

Despite sales weakness, Fitch expects only a modest narrowing of PH's consolidated operating margin in fiscal 2016 as a result of business realignments made in recent years. Fitch expects EBIT margins will be down around 60 basis points (bps) in fiscal 2016 to around 12% before recovering toward 12.5% over fiscal 2017-2018. Ongoing restructuring and organizational simplification should yield some upward movement in margins in successive cycles.

Healthy margins together with manageable capex of around 2% of sales and a dividend payout of around 30% yields strong FCF that has ranged from 5%-8% of sales in recent years. Fitch expects annual FCF of $600 million to $700 million (before voluntary pension payments) over the next few years. This FCF will be used for share repurchases and, beginning in fiscal 2017, some debt reduction.

PH accelerated its share repurchases in fiscal 2015, repurchasing $1.4 billion of its shares toward a two year goal of $2 billion-$3 billion. Approximately half of these repurchases were debt-financed, causing debt/EBITDA to increase in fiscal 2015 from 1.3x to 1.5x. Share repurchases are expected to moderate, but leverage is expected to increase further in fiscal 2016 to a level closer to 2x due primarily to lower EBITDA but also modestly higher debt levels as share repurchases continue in excess of FCF.

Credit metrics are expected to recover over fiscal 2017-2018, with leverage improving toward 1.5x and interest coverage toward 15x from 13.6x currently, as EBITDA recovers and debt levels are reduced. Acquisition spending remains uneven and Fitch anticipates smaller technology platform enabling deals rather than larger market share driven transactions. Pension contributions will be manageable over the intermediate term following a $200 million voluntary contribution made in the first quarter of fiscal 2016.

The ratings are supported by:

--Leading manufacturer of motion and control technology resulting in significant customer, product and end market diversification, reducing operating volatility through the cycle;

--Long-standing customer relationships and research and development (R&D) investments support profit margins and share by fostering ongoing design collaboration;

--Solid annual FCF of $600 million to $700 million over the next few years.

Credit concerns include:

--Accelerated share repurchases leading to higher financial leverage;

--The potential that the current revenue downturn could extend into fiscal 2017;

--Subdued long-term organic revenue growth rates for the majority of revenues in North America and Europe with less exposure to faster growing developing economies;

--Need for a steady stream of new product introductions to offset profit erosion for seasoned products.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--Revenues decline 10% in fiscal 2016, approximately 3% of the decline due to currencies, and then grow at low single digit pace thereafter.

--EBIT margins narrow by around 60bps to 12% in fiscal 2016, and then recover toward 12.5% over 2017-2018.

--FCF (before voluntary pension payments) of $600 million-$700 million annually will be used for capex of around $230 million-$240 million (2% of sales), acquisitions of $100 million annually, and debt reduction.

--Debt/EBITDA increases toward 2x in fiscal 2016, and then improves to 1.5x by fiscal 2018 through a combination of EBITDA growth and debt reduction.

RATING SENSITIVITIES

Factors that, individually or collectively, could lead to a negative rating action are as follows:

--Debt/EBITDA above 1.75x or funds from operations (FFO) adjusted leverage above 3.0x for a sustained period of time due to an extended downturn, a leveraged acquisition or additional share repurchases. Debt/EBITDA would be expected to track at or under 1.5x on a mid-cycle basis.

--Operating margin (EBIT) structurally below 10%, driven by lower new product introduction (NPI) sales levels or sustained pricing pressures, suggesting reduced competitiveness.

--FCF margin below 5%.

Fitch does not anticipate a positive rating action in the absence of a commitment from management to structurally reduce financial leverage.

LIQUIDITY

Fitch believes PH's liquidity is solid. As of Sept. 30, 2015, liquidity consisted of:

--$1.79 billion of cash and marketable securities, of which $1.76 billion was located overseas and $25 million in the U.S.;

--$1.6 billion of availability under the company's $2 billion RCF, net of $407 million of CP outstanding as of Sept. 30, 2015. The revolver more than fully backs PH's $1.85 billion CP program.

FULL LIST OF RATING ACTIONS

Fitch affirms PH as follows:

Parker-Hannifin Corporation

--Long-term IDR at 'A';

--Senior unsecured credit facilities at 'A';

--Senior unsecured notes at 'A';

--Short-term IDR at 'F1';

--Commercial paper at 'F1'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994221

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