March 17, 2015 Flowserve Corporation Current Recommendation Prior Recommendation Underperform Date of Last Change 12/18/2014 Current Price (03/16/15) $56.96 Target Price $60.00 NEUTRAL (FLS-NYSE) SUMMARY Flowserve s fourth-quarter 2014 earnings beat the Zacks Consensus Estimate, as its competent business model and strategic investment initiatives were growth drivers. The company has been gaining from its customer-centric approach, coupled with prudent cost-saving initiatives and operational excellence. Moreover, it approved a 12.5% hike in its quarterly dividend payout. However, several major concerns remain for Flowserve, including unfavorable global macroeconomic conditions, the strengthening U.S. dollar and uncertainty in the oil and gas markets. Additionally, the company expects its 2015 financials to face challenges due to tough year-over-year comparisons. SUMMARY DATA 52-Week High $79.49 52-Week Low $53.29 One-Year Return (%) -23.94 Beta 1.95 Average Daily Volume (sh) 1,713,708 Shares Outstanding (mil) 135 Market Capitalization ($mil) $7,690 Short Interest Ratio (days) 1.92 Institutional Ownership (%) 93 Insider Ownership (%) 1 Annual Cash Dividend $0.64 Dividend Yield (%) 1.12 5-Yr. Historical Growth Rates Sales (%) 4.6 Earnings Per Share (%) 11.9 Dividend (%) 13.1 using TTM EPS 15.1 using 2015 Estimate 15.4 using 2016 Estimate 14.1 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Average, Type of Stock Large-Growth Industry Mach-Genl Indl Zacks Industry Rank * 236 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 1,097 A 1,240 A 1,229 A 1,389 A 4,955 A 2014 1,068 A 1,224 A 1,204 A 1,381 A 4,877 A 2015 1,074 E 1,236 E 1,234 E 1,445 E 4,989 E 2016 5,154 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.67 A $0.84 A $0.90 A $1.10 A $3.51 A 2014 $0.78 A $0.90 A $0.93 A $1.16 A $3.77 A 2015 $0.71 E $0.90 E $0.93 E $1.17 E $3.71 E 2016 $4.05 E Projected EPS Growth - Next 5 Years % 8 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Founded in 1912 and headquartered at Irving, TX, Flowserve Corporation is a leading manufacturer and aftermarket service provider of comprehensive flow control systems, globally. The company develops and manufactures precision-engineered flow control equipment, such as pumps, valves and seals, for critical service applications that require high reliability. Flowserve uses its manufacturing platform to offer a broad array of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. The company uses a footprint of Quick Response Centers (QRCs) around the globe to deliver these aftermarket services. The company sells products and services to more than 10,000 companies across more than 50 countries in North America, Europe, the Middle East, Africa, the Asia Pacific and Latin America. Flowserve currently has three reportable segments: FSG Engineered Product Division (EPD): The segment s operations include the longer lead-time, highly engineered pump product operations of the former Flowserve Pump Division and substantially all of the mechanical seal operations of the former Flow Solutions Division. This is the largest of all the three business segments and is engaged in manufacturing of products and provision of services. EPD products division is engaged in the manufacturing of more than 40 different active types of pumps and approximately 185 different models of mechanical seals and sealing systems. Similarly, the EPD service division provides engineered aftermarket services through the global network of 126 QRCs. FSG Industrial Product Division (IPD): The segment s operations include the more standardized, general purpose pump product operations of the former Flowserve Pump Division. The IPD product division manufactures approximately 40 different active types of pumps and the IPD service division is concerned with marketing the manufactured products through worldwide sales force team. Flow Control Division (FCD): The segment includes industrial valve and related automation products and solutions. FCD Products division is engaged in manufacturing of valve, automation and controls product and solutions and FCD service division provides service personnel for comprehensive equipment maintenance services used in flow control systems. REASONS TO BUY Flowserve follows the One Flowserve Culture through which it has put in place a strong and collaborative management team, with focus on the top line driven by disciplined strategic prioritization and investment process. Flowserve has been able to achieve strong market share, cost control, high operational excellence and increased earnings leverage. This culture is customer centric that aims at providing what is important to the customer and exceeding their expectations by on-time delivery and quality. Flowserve holds a diversified mix of products, end markets and geographies and remains highly optimistic about investment projects that will be conducted on global platform. Strong prospects of the U.S. chemical market business in 2015, led by the ethylene expansion in the Gulf Coast, are likely to be the key growth driver. Also, strong investment prospects in Asian and European markets are expected to add to the bliss. In particular, India s nuclear agreement with the U.S., emergence of fossil-based projects in China, Europe and Russia are expected to fuel the growth momentum of Flowserve going forward. Finally, business in the Middle East will likely receive a boost from surging investments in solar and Equity Research FLS Page 2
conventional power. Hence, we believe such opportunistic investments globally promises strong top line growth prospects. Additionally, Flowserve is expected to benefit from the strong synergies generated by the acquisition of the Netherland-based SIHI Group B.V, which was completed in January, 2015.This acquired engineered vacuum and fluid pumps provider company offers Flowserve scope for opportunistic investments and product-offering expansions in the long term. SIHI s strong foothold in the vacuum and fluid pump market is likely to augment Flowserve s prowess in chemical pump, along with engineering and manufacturing services. This apart, the buyout will also enhance the company s top-line growth and support its costsaving initiatives. Hence, encouraged by this SIHI buyout, we project bright growth prospects for Flowserve. Flowserve has a strong balance sheet with ample liquidity. As of Dec 31, 2014, the company s cash and cash equivalents stood at $450.3 million, higher than $363.8 million in 2013. In addition, Flowserve s long-term debt declined to $1.10 billion in 2014, from $1.13 billion in prior year. Going forward, management expects the enhanced capital structure to aid strategic mergers and acquisitions and pave way for profit maximization. Moreover, Flowserve has consistently returned capital to its shareholders in the form of share repurchases and dividend. In 2014, the company returned $332 million to shareholders through share repurchases and dividends, which signifies 64% of its net income. Also, during the reported quarter, the company announced a sequential increase of 12.5% in its quarterly dividend. Such activities enhance investors confidence on the stock. REASONS TO SELL Flowserve s business, being spread across the globe, remains vulnerable to unfavorable currency translations. Uncertainty in the broader political macro environment is also expected to hurt the profitability of the company. Flowserve anticipates the currency headwinds, fueled by the strengthening of U.S. dollar, to continue in the upcoming quarters, weighing on its business profitability. Uncertainty in the oil and gas markets continues to pose challenges for national oil companies, thereby, adding to the woes of Flowserve. The current volatility in the Oil and Gas market, with oversupply continuing to pressure the prices and spending levels, will affect the company s projects and orders. Further, management expects the existing price levels to reduce demand for upstream oil and gas projects, thus, increasing its risk. Flowserve s business depends on capital investment and maintenance expenditure from customers, which, in turn, are impacted by numerous factors, including the state of domestic and global economies, global energy demand, the cyclical nature of their markets, their liquidity and condition of global credit and capital markets. Flowserve sells its products in highly competitive markets, which puts pressure on profit margins and limits its ability to maintain or increase the market share of its products. The company may be unable to deliver significant backlog on time, which could affect its revenues, future sales, profitability and relationships with customers. Equity Research FLS Page 3
RECENT NEWS Flowserve Prices Senior Notes to Boost Liquidity Position Mar 10, 2015 In order to reduce its debt level, Flowserve disclosed the pricing of its 1.250% senior notes worth 500 million. In particular, this fluid motion and control products & services provider has priced these notes at 99.336% of the aggregate principal amount. Flowserve expects to reap net proceeds of 491.8 million from this latest offering, after deducting related fees & expenses as well as discounts to underwriters. Aiming toward a buoyant financial health, management has decided to use the net proceeds diligently for repaying the current balance on the revolving credit facility. The remaining funds will be used for financing future strategic acquisitions and other corporate needs. Flowserve Tops Q4 Earnings, Hikes Dividend by 12.5% Feb 17, 2015 Flowserve reported fourth-quarter 2014 earnings per share of $1.16, surpassing the Zacks Consensus Estimate of $1.13. The bottom line marked an increase of 14.9% over the year-ago quarter. Flowserve s diverse business model and investment strategies have been major drivers of the quarterly earnings uptrend. Healthy performance of its operating platform has also contributed to the earnings growth. Other positive factors include the company s effective backlog mechanism, unperturbed aftermarket performance and strong financial health. For full-year 2014, the company's earnings per share came in at $3.76, beating the Zacks Consensus Estimate of $3.73. Moreover, the figure was 10.3% higher than $3.41 per share earned in 2013. Quarter in Detail Revenues totaled $1,381.4 million, edging down 0.6% year over year. On a constant currency basis, revenues experienced a modest 5.6% increase year over year. Nevertheless, the top line missed the Zacks Consensus Estimate of $1,399 million. Growth in the quarter was driven by the company s enduser aftermarket strategies. However, strengthening of dollar, coupled with unfavorable crude oil price movements, proved to be a drag on the revenues. Additionally, uncertain macroeconomic factors and reduced transparency of markets worsened the fall. Full-year 2014 revenues totaled $4,877.9, down 0.6% year over year. The company s bookings stood at $1.32 billion for the fourth quarter of 2014, reflecting a 5.6% increase after considering currency impact, and 8% without the impact. Bookings growth for the quarter was mainly driven by strong aftermarket sales, which grew 6.8% without considering currency impacts. Segment Results EPD revenues for the quarter increased 1.1% year over year to $728.8 million. Bookings were up 8.3% $684.9 million compared with the prior-year quarter. Equity Research FLS Page 4
IPD segment experienced a decline in both sales and bookings. While sales declined 9.4% year over year to $251.6 million, bookings fell 9.2% year over year to $224.6 million. FCD sales climbed 3.1% year over year to $439.4 million. Bookings of the segment rose 8.7% year over year to $448.3 million. Margins Flowserve s gross margin grew 130 basis points (bps) to 35.2% in the fourth quarter of 2014. Gross margin of EPD stood at 33.8%, same as the prior-year value. Gross margin of IPD segment increased 410 bps to 30.5%, while that of the FCD segment rose 160 bps to 37.0%. Operating margin in the fourth quarter was 17.3%, up 200 bps year over year. Operating margin for full-year 2014 rose 90 bps to 16.2%. Segment results were attributable to the performance of aftermarket and chemical business, upstream activities in oil and gas mining and impressive growth in emerging markets. Balance Sheet and Cash Flow The company ended the quarter with cash and cash equivalents of $450.3 million compared with $363.8 million as of Dec 31, 2013. Long-term debt stood at $1.10 billion as of Dec 31, 2014, compared with $1.13 billion as of Dec 31, 2013. Flowserve s net cash flow from operating activities was $ 571.0 million for the twelve months ended Dec 31, 2014, compared with $ 487.8 million in the prior-year period. Quarterly Dividend The company decided to increase its quarterly dividend by 12.5% sequentially to 18 cents per share from 16 cents paid earlier. The dividend is payable on Apr 10, 2015 to shareholders on record as of Mar 27. Outlook Management reiterated 2015 adjusted EPS in the range of $3.60 to $4.00 and projects revenues to be down 1% to up 3% on a year-over-year basis. The outlook is based on expectation of higher year-overyear comparable challenges in the first half of 2015. The tough comparison factors comprises FX differential, profits from 2014 Naval sale and differences in markets view on commodity prices in last year. VALUATION Flowserve s current trailing 12-month earnings multiple is 15.1x, compared with the 27.0x average for the peer group and 17.9x for the S&P 500. Over the last five years, shares have traded in a range of 9.8x to 23.1x trailing 12-month earnings. We have maintained our Neutral recommendation on Flowserve as we expect it to perform in line with the broader market. Our $60.00 target price, 16.2X 2015 EPS, reflects this view. Equity Research FLS Page 5
Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Flowserve Corp. (FLS) 15.4 14.1 8.0 12.2 15.1 23.1 9.8 Industry Average 17.4 15.8 13.2 38.3 27.0 51.7 10.7 S&P 500 16.3 15.2 10.7 14.5 17.9 18.4 12.0 Dover Corporation (DOV) 15.0 14.1 10.2 11.0 15.3 22.5 11.0 Ingersoll-Rand Plc (IR) 17.7 15.1 12.4 14.3 20.1 20.5 10.6 Metso Corporation (MXCYY) 16.8 4.9 13.8 18.1 27.7 9.5 Colfax Corporation (CFX) 22.6 20.0 7.8 12.8 22.0 36.7 13.0 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Flowserve Corp. (FLS) 4.4 6.0 1.8 27.1 0.6 1.12 9.1 Industry Average 2.9 2.9 2.9 21.1 0.4 0.8 7.1 S&P 500 6.2 9.8 3.2 25.4 2.0 Equity Research FLS Page 6
Earnings Surprise and Estimate Revision History Equity Research FLS Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of FLS. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1130 companies covered: Outperform - 15.5%, Neutral - 74.7%, Underperform 9.0%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research FLS Page 8