Flowserve (FLS) designs, manufactures, and markets fluid-handling equipment, such as pumps and valves, for industries that handle corrosive fluids. The company is well diversified with 55% of 2013 sales coming from developed markets, like Europe and the United States, and the remaining 45% from emerging markets. The equipment designer serves a wide variety of industries including oil & gas, water management companies, power generators, and mining, to name a few. The client base is also quite diverse, with engineering & construction companies, original equipment operators, distributors, and end users accounting for the majority of business.
The flow control market is both sizable and competitive, with the market estimated at $130 billion. Of that, emerging markets now account for 60% of industry sales. Roughly 80% of Flowserve’s revenue is recurring, while the aftermarket business accounts for approximately 40% of total sales. What’s more, the aftermarket business is of particular importance, due to the higher margins compared to new equipment.
We believe the company is well positioned for near-term growth. It ought to capitalize on the rising demand for flow control equipment in the coming years. In addition, Flowserve is making progress lowering its cost structure by building new facilities in emerging markets like Brazil, China, and India. Similarly, the company has over 170 Quick Response Centers (QRC) that offer aftermarket equipment services, including installation, maintenance, and retrofitting. The QRCs also provide emergency capacity and localized manufacturing capabilities, while carrying inventory that has certain local-content requirements. The equipment designer believes that the quick delivery of engineering and manufacturing gives it an advantage over the competition.
The largest segment, the Engineered Products division, manufactures customary pumps and pump systems, mechanical seals, auxiliary systems, and replacement parts. The company markets its products through a global salesforce and distributors, offering 40 kinds of pumps and over 185 different types of seals. Flowserve has 29 manufacturing facilities with the majority located in North America and Europe. Backlog for the unit is $1.4 billion and over 80% is expected to be shipped by the end of 2014.
The Industrial Products unit manufactures and sells pre-configured engineered pumps and pump systems, mechanical seals, and replacement parts. Flowserve sells over 40 products from motors to pumps, while providing aftermarket parts and services. The division has 13 manufacturing plants and 19 QRCs worldwide. The company’s backlog is approximately $555 million on June 30, 2014, with 83% expected to be delivered this year.
Lastly, its Flow Control division designs and manufactures industrial valves and automation solutions. The unit also produces energy management products, including steam traps, boiler controls, and energy recovery systems. In addition, this business provides project management services to the chemical, power generation, and oil & gas industries, to name a few. Flow Control has 27 manufacturing facilities with the majority being located in Europe, while also operating 33 QRCs globally. Backlog for this unit is roughly $810 million on June 30, 2014, with 87% expected to be shipped in 2014.
We believe an acceleration in the global energy infrastructure buildout will drive a majority of new equipment orders in the coming years. The offshore drilling market should provide a number of opportunities, as national oil companies and E&Ps look to extract oil & gas from newly discovered underwater fields. Additionally, the rapid growth in unconventional drilling in the North American shale plays is fueling a rise in the creation chemical and petrochemicals facilities. Finally, the development of the Canadian oil sands and the emerging LNG export market appear ripe for solid growth over the next decade.
Capital Allocation Strategy
Flowserve currently plans on returning 40% to 50% of the average net earnings to shareholders over the next five years in the form of dividends and stock buybacks. The company has a good history of generating free cash flow, generating $1.4 billion over the 2009 to 2013 period. We expect stronger aftermarket orders, coupled with expense-reduction plans, to help accelerate free cash growth. In fact, the manufacturer will likely generate over $2 billion over the next five years in free cash flow, which would be a nice return for investors.
The company has struggled to book orders in the first half of the year, due to project deferrals on a number of oil & gas fields and the inclement weather. That said, Flowserve expects order to rebound in the back half of the year and reiterated its forecast of 3%-6% new bookings growth in 2014. Management also reaffirmed the full-year bottom-line guidance range of $3.65 and $4.00 a share (increasing at an upper- single—mid-teen clip from the 2013 figure). We believe the company will continue to grow earnings at a double-digit clip in the next couple of years, thanks to an acceleration of new orders, cost-cutting initiatives, and stock buybacks.
Nevertheless, the stock is trading near its all-time high and investors would probably be best served by waiting for a pullback before jumping in. For more information regarding FLS’ near- and long-term prospects, subscribers are encouraged to check out our full-page report in The Value Line Investment Survey.