S&P Lowers Outlook on Parker-Hannifin (PH) to Negative Amid CLARCOR (CLC) Deal

December 1, 2016 10:47 AM EST

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S&P Global Ratings said that it has revised its outlook on Parker-Hannifin Corp. (NYSE: PH) to negative from stable and affirmed all of its ratings on the company, including our 'A' corporate credit rating.

"Parker-Hannifin's debt balance will increase meaningfully following the close of its acquisition of CLARCOR because it will issue about $3.0 billion of new debt to partly fund the transaction, which we expect will leave the company with weak credit measures for the current rating over the next two years," said S&P Global credit analyst Carissa Schreck. We expect the acquisition to close at the beginning of the company's fiscal-year 2018 (ending June 30) and anticipate that its debt-to-EBITDA metric will reach the high-2x area at the end of that same fiscal year. We believe that Parker-Hannifin's management will further reduce the company's leverage through planned debt repayment, leading its debt-to-EBITDA to improve modestly to the low- to mid-2x area by the end of fiscal-year 2019 before improving below 2x by the end of fiscal-year 2020. After the transaction closes, we expect Parker-Hannifin to generate annual free operating cash flow in excess of $1 billion and anticipate that management will use the bulk of this free cash flow to reduce the company's debt. Although the company's credit measures will remain weak in fiscal-years 2018 and 2019, we believe that it has a credible plan--and is committed--to reduce its debt leverage to pre-acquisition levels (below 2x on an S&P Global adjusted basis). The forecast incorporates our expectation that Parker-Hannifin's management will make financial policy decisions related to share repurchases and future acquisitions such that the company will be able to reduce the leverage on its balance sheet below 2x and maintain this level on a sustained basis by fiscal-year 2020.

The negative outlook on Parker-Hannifin reflects that we could lower our rating on the company over the next two years if weaker-than-expected operating conditions, unexpected integration issues, or more aggressive financial policies limit its ability to improve its elevated credit measures relative to our expectations. The company's credit measures will be weak pro forma for the CLARCOR acquisition; however, we believe that Parker-Hannifin has a credible plan--and is committed--to restore its credit metrics to pre-acquisition levels in the 24 months following the completion of the acquisition given its strong free cash flow generation.

We could lower our rating on Parker-Hannifin if the company's credit measures stagnate or deteriorate over the two-year period following the close of the acquisition. In particular, the risk of a downgrade would be heightened if the company fails to improve its debt-to-EBITDA to the high-2x area in fiscal-year 2018 and the low- to mid-2x area in fiscal-year 2019 as it integrates CLARCOR. This could occur if the economy weakens or if there are integration missteps that cause the company's operating profits to decline relative to our expectations. We could also lower the ratings if management deviates from our expectations regarding its financial policies and decides to undertake additional acquisitions or share repurchases that increase the company's debt or limit its debt repayment.

While not likely in the next year, we could revise our outlook on Parker-Hannifin to stable if we believe that the integration of CLARCOR is on track and the company has demonstrated a willingness to repay its debt over the 12-24 months following the close of the acquisition, resulting in a debt-to-EBITDA metric of less than 2x on a sustained basis. The stable outlook would also incorporate our belief that there is limited risk of the company's debt leverage increasing above 2x due to more aggressive shareholder returns or additional acquisitions.

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