Investment Recommendation
Hold
Pricing
Closing Price (9/18/08) $97.82
52 Wk High (9/19/08) $110.74
52 Wk Low (11/20/08) $37.18
Ave Vol (10 day)
1.1M
Valuation
P/E
Current Ratio (mrq)
Quick ratio (mrq)
Debt/Equity (mrq)
ROA (ttm)
ROE (ttm)
ROI (ttm)
12.8
1.65
0.99
0.36
11.2%
28.1%
17.1%
Margins
Gross Margin (ttm)
Oper Margin (ttm)
Net Prof Margin (ttm)
35.8%
14.2%
9.8%
“Flowserve Corporation (Flowserve) is a manufacturer
and aftermarket service provider of comprehensive flow
control systems. The Company is engaged in
developing and manufacturing precision-engineered
flow control equipment, such as pumps, valves and
seals, for critical service applications. Through the
manufacturing platform, the Company offers a range of
aftermarket equipment services, such as installation,
advanced diagnostics, repair and retrofitting. The
Company operates in three business segments:
Flowserve pump division (FPD) for engineered pumps,
industrial pumps and related services; flow control
division (FCD) for engineered and industrial valves,
control valves, actuators and controls and related
services, and flow solutions division (FSD) for precision
mechanical seals and related products and services.”
(WSJ)
Flowserve operates in 56 countries worldwide and
employs around 15,000 people. The company serves
various industries including oil and gas, power
generation (nuclear and solar), chemical processing,
water resources, and general industry. Although about
60% of the company’s revenue is from the oil and gas
and chemicals industry, they are establishing a
presence in the clean and renewable energy field as
well. The company recently booked orders from the
solar power generation industry totaling $31.5 million.
They also received orders from Westinghouse for valves
to be used in nuclear power generators. (Reuters)
Flowserve’s presence in many different industries, as
well as competing sectors in the energy field makes it
well positioned for the future. They have grown net
income as well as EPS each of the last 5 years. In fact,
EPS is up 1,579% since the end of fiscal year 2004.
While this is impressive, the important thing to focus on
is continued growth for this mid-cap company.
Analyst: Jesse Bunse
Jhbcx5@mail.missouri.edu
One can see by the chart above that Flowserve has consistently performed better than
its competitors as well as the S&P 500 over the past 5 years. While past performance
of a security is no guarantee of future performance, it is apparent that Flowserve’s
business model over the past half-decade is quite strong. The large dip in stock price
apparent at the end of 2008 coincides with the market crash, but more importantly the
quick drop in the price of crude oil, a major source of revenue for the oil and gas
industry that it serves. As more and more rigs and pipelines have become profitable
again, the stock price has risen accordingly.
Relative Valuation and Margins
Flowserve Corporation’s largest competitors by market capitalization are ITT
Corporation (ITT), IDEX Corporation (IEX), and Gardner Denver, Inc. (GDI). While
these companies compete with Flowserve in at least one specific industry, many are
diversified across other industries that Flowserve does not engage in. Therefore, any
relative valuation should be applied with a grain of salt. Below is how each company
stacks up with relation to one another.
Company
P/E
EPS (ttm)
FLS
ITT
GDI
IEX
12.6
11.4
10.4
14.5
$7.64
$4.20
$(3.04)
$1.16
EPS Growth
(ttm)
19.1%
11.6%
(175.3)%
(40.7)%
Debt/Equity
Current Ratio
0.36
0.52
0.48
0.42
1.65
1.49
2.29
2.42
As far as EPS and EPS growth, FLS is ahead of the competition. A September 14,
2009 S&P report projected EPS for 2009 at $8.15 (after $0.50 realignment charge) and
$9.65 in 2010.
Company
Gross Margin
Oper Margin
FLS
ITT
GDI
IEX
35.8%
27.6%
30.5%
39.0%
14.2%
9.9%
(6.3)%
11.3%
Net Profit
Margin
9.8%
6.9%
(8.2)%
6.8%
Sales Growth
(5 yr)
14.7%
17.8%
35.6%
13.3%
As margins are concerned, FLS shows signs of a healthy company compared to its
competitors. With a high rate of revenue growth, more of these dollars will reach the
bottom line. In the same report referenced earlier, analyst expectations were that FLS
gross margin would increase to 36.0% in 2009 from 35.3% in 2008. This trend is
observable from in the gross margin for the most recent quarter above. Margins tell a
lot about management of a company, and FLS has shown itself to be very efficient in
funneling cash from revenues to profit.
Balance Sheet Snapshot
On the balance sheet, the company looks fairly strong. The current ratio of 1.65 and the
quick ratio of .99 mean that they have the capabilities of meeting short term debt
obligations well. Also, they are well positioned to take advantage of new opportunities
with a high cash balance and a relatively low LT debt to equity ratio of 0.34. This figure
is only 77.83% compared to the industry as a whole, meaning that the company could
lever up if needed. Their total debt is valued at $570.98 million. Total debt to equity is
0.36, and this figure has been steadily decreasing since 2004, when it was at nearly
0.81. (Balance sheet data from WSJ) Very good news came out on September 18th, as
S&P upgraded its rating of Flowserve debt to BB+, one step away from investment
grade. This means that new debt can be issued at much lower rates, especially if
investment grade is achieved. (Dow Jones Newswires)
Income Statement Snapshot
Looking at the income statement (mrq) with relation to debt, the interest coverage ratio
for FLS is quite high (very attractive) at 16.02, another indicator that the company is not
burdened by debt, and is in a good position to lever up if needed. Since 2004, total
revenue is up 77.34% (as of last fiscal year), and net income after taxes is up an
astonishing 1,539%. This is from increased revenues compounded by a healthy 3.07%
average annual growth rate for the gross margin. These figures provide a basis for the
large appreciation in stock price since 2005. This company has shown high rates of
growth in the past few years, but analysts doubt we will see such impressive figures in
the near future. (Income statement data from WSJ)
Capital Expenditures
Capex for the future is hard to project, and for a company in a period of high growth like
FLS past data may not tell the whole picture. The 5 year average used in my DCF
evaluation below has a range from $45 million in 2004 to nearly $127 million in 2008.
Yet, the company projects that capex will be down to $100 million for 2009.
Future Oil Outlook
It has been established that the company is well positioned for the future, but it is
important to look at the economic conditions surrounding the end users of Flowserve’s
products and services. The following is a forward curve for crude oil futures reaching
out past June 2016.
It shows that the market sees crude reaching above $80.00 again by 2013. The most
important piece of information to get out of this graph is that the market currently does
not see crude oil reaching last year’s highs of near $150.00/barrel. While this may be
discouraging for the oil and gas industry, there is still healthy, sustainable growth on the
horizon. This, of course, is based on the assumption that the global recession is
nearing an end, and a period of expansion has begun. (Bloomberg) While OECD
countries will see virtually no growth in liquid fuel consumption from 2009-2010, nonOECD countries (such as the BRIC nations) will see an increase in consumption. More
specifically, world oil consumption (weighted GDP) will increase 2.4% in 2010.
(eia.doe.gov) It is safe to say that world oil consumption will increase in the near future,
and that as this happens more and more rigs will need to be built and maintained.
Sales by
Market 2008
6%
15%
Oil and Gas
General Industrial
39%
Chemical
17%
Power Generation
Water Treatment
23%
% of Bookings
YTD
18%
35%
Oil and Gas
Water
Power Generation
19%
Chemical
7%
General
21%
Revenue by
Region 2008
8%
35%
18%
North America
Europe
Middle East/Africa
Asia Pacific
11%
Latin America
28%
Source: Standard and Poor’s
Revenues
Information about the company’s 2008 revenues shows a dependence on the oil and
gas market. Also, 63% of revenues come from North America and Europe, showing a
concentration on more developed markets. Data from Flowserve’s Q2 2009 earnings
report shows sales growth in the Europe, Middle East and Africa region increasing to
44% of total sales, while North American sales decreased to 31%. I believe that there is
significant room for expansion in more developing markets where margins may be
higher, and the company’s healthy debt positions makes this a possibility. A statement
from S&P made on 9/14/2009 supports this conclusion. “What we see as FLS's strong
balance sheet and financial flexibility should aid results, while operating margins likely
expand on a better mix and plant realignments.”
Revenues-Future Developments
While little data on the previous two quarter’s revenue distribution is available, recent
bookings in solar power generation mentioned earlier show an uptick in demand (or
perhaps better marketing by FLS). Also, the Westinghouse order for its nuclear plants
indicates that for 2009 and beyond, power generation may be a larger part of revenues.
This bodes well for the company, as while nuclear and solar plants are much costlier
than their gas and coal powered counterparts, recent political and social developments
signal renewed interest in these forms of energy generation. New “Generation III”
nuclear plants may come on line as early as 2012. (WSJ) As engineers find ways to
make these plants safer, more cost-effective, and less wasteful, the future of nuclear
energy (which uses a lot of the components and services offered by FLS) will get
brighter. Yet, oil will not go away anytime soon, and the company’s core competence in
this industry will provide the bulk of revenues for years to come.
DCF Valuation
I chose to use the Warren Buffet Style DCF valuation. I used a beta of 1.428 from
Bloomberg, which was comparable to the average of betas from sites such as Yahoo!
Finance and CNBC. With a risk free rate of .13 and a historical market return of 11%,
the CAPM equation is as follows:
.13+1.428(11-.13)=15.65
I felt that this discount rate was slightly high, even for a mid-cap company like
Flowserve. I chose a more appropriate 13%. The growth rate for 2010 corresponds to
analyst coverage that that oil demand will not pick up fully until 2011. After this, used a
growth rate of 12% per year, which is conservative in that it is still well below previous
growth rates. Thereafter I used a 7% growth rate that corresponds to analyst
consensus. A 3% growth rate into perpetuity was used, while I think that a higher rate
may have been reasonable due to the company’s current potential. This led to an
intrinsic value per share of $94.51, which is just below what the stock is currently trading
at. With a lower discount rate of 12%, this becomes $105.36, slightly above the current
trading price. The inherent conservatism of my estimate is apparent in the high rates of
growth the company has seen in recent years. The reason for this decision was that
rates like previously seen cannot continue forever, yet when growth will slow down is
still somewhat in the air.
The table below shows the effects of different discount and first stage growth rates.
Sensitivity
12%
13%
14%
15%
Discount Rate
5%
$85.80
$77.61
$70.95
$66.43
7.5%
$101.76
$91.56
$83.26
$76.40
10%
$120.89
$108.20
$97.91
$89.42
11%
$129.56
$115.73
$104.53
$95.29
12%
$138.86
$123.80
$111.61
$101.56
Management
Flowserve selected Mark A. Blinn as the company’s next president and CEO. It should
be a smooth transition, as former CEO Lewis Kling has planned a retirement for
February for some time. Kling will remain with the company as a member of the Board
of Directors. The company has a Non-executive Chairman of the Board, which is good
in that it separates leadership and oversight.
Company Structure
Flowserve has three divisions, the pump division, flow control division (valves), and the
flow solutions division (seals). Each division includes original equipment sales as well
as aftermarket service. An increase in sales can translate into multiplied future
revenues due to the service function. The Q2 2009 earnings report showed little
change from Q2 2008, when original equipment sales made up 65% and aftermarket
services made up 35% of total sales. Being able to service its own equipment provides
future revenue, but also a good opportunity to see firsthand how to improve products.
FLS as a whole is a relatively simple organization which is good for transparency in
reporting. Another component of the company’s structure that has been of importance
to date is their large global presence and the negative foreign currency effect this has
had lately. A weakening dollar in the future would be good news for any company
repatriating funds into the United States. As our economic committee projected this
happening, FLS stands to benefit in the future if they can mitigate risk in foreign
currency transactions outside the US.
Concluding Remarks
In recent years, Flowserve has proven itself a very exciting company. A quick glance at
a 5 year history of stock prices shows that a lot of money has been made (and lost) with
the company. While I do not believe the security will reach previous highs of over
$120/share anytime soon, there is definite potential to reach this milestone again. The
appeal of the company is its concentration on its core competencies (pumps, valves,
and seals) coupled with its presence in all major markets that use these components.
They are present globally, and achieve less than 40% of their revenues from North
America. Flowserve is a well positioned company, but I through my DCF valuation I
believe that they are a little on the pricy side currently. While they are an excellent
company, I would hesitate to increase our holdings too much at the current share price.
I think we need to keep an eye on the company, and revisit increasing our holdings at a
later date. Currently, we hold 525 shares of FLS valued at $51,355.50. This is around
5% of the total portfolio. Depending on the risk appetite of the group, increasing
holdings would not be out of the question, but I feel the prudent move would be to sit on
what we currently have.
Sources
Wall Street Journal Online
www.Flowserve.com
www.yahoofinance.com
www.google.com/finance
www.scottrade.com (used to obtain S&P and Reuters Reports)
eia.doe.gov
Bloomberg