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Flowserve Corp.: More Than Half a Billion in Purchase Obligations

November 22, 2012 | About:
Flowserve Corp. (FLS) is one of the world's leading providers of fluid motion and control products and services. Operating in more than 55 countries, FLS produces engineered and industrial pumps, seals and valves as well as a range of related flow management services.

Valuation

FLS is currently trading at a trailing twelve months P/E of 17.44, a 30% premium over its five year average P/E of 13.44. FLS is also valued at 10.17x trailing twelve months EV/EBITDA. FLS has delivered a five year average ROE of 23.6% and five year book value per share CAGR of 18.2%.

Financial And Business Risks

FLS is moderately geared with a debt-to-equity ratio of 46% and a net gearing of 35%. This is partly mitigated by an interest coverage ratio of 35.5 and a current ratio of 1.9. FLS' target leverage is gross debt to EBITDA of 1 to 2 times. This does not include $601 million of inventory-related purchase obligations.

Competitive environments for original equipment orders have been inherently more influenced by pricing. In addition, some of FLS' customers have been attempting to reduce the number of vendors, in order to reduce the size and diversity of its inventory.

The markets for FLS products and services are geographically diverse and highly competitive. Competitors include multi-nationals, low-cost replicators of spare parts and in-house maintenance departments of its end user customers.

FLS purchases substantially all electric power and other raw materials in the manufacturing of products from outside sources. In recent years, the prices for energy, metal alloys, and nickel have been volatile and they are influenced by factors beyond FLS' control.

Business Quality and Capital Allocation

FLS has pursued a strategy of industry diversity and geographic breadth to mitigate the impact of economic downturns in any one of the industries or in any particular part of the world on its business. FLS sells to a wide variety of customers globally including leading engineering, procurement and construction firms, original equipment manufacturers, distributors and end users in several distinct industries: oil and gas, chemical, power generation and water management. No individual customer accounted for more than 10% of its 2011 revenues.

FLS has been actively engaged in reducing working capital. At the end of third quarter of 2012, receivable days are at 85 days and management is targeting to lower receivable days into the mid-60s range over the next nine to 15 months. Inventory turnover stands at 2.7x in the third quarter, with FLS targeting a range of between 4.0x to 4.5x within the next 15 to 21 months.

FLS has paid out dividends every year since 2007 and has a dividend yield of 1.04% with a corresponding dividend payout ratio of 16.9%. Dividends are paid out quarterly. Since 2006, $1.35 billion has been spent on share repurchases and dividends of $1.35 billion, while $692 million and $287 million have been used for capital expenditures and acquisitions respectively. FLS has repurchased $534 million worth of shares year-to-

date and plans to complete the remaining $524 million of the $1 billion share repurchase program in 2013. Shares outstanding for FLS have decreased by 10% since 2006.

Conclusion

If we were to include the $601 million purchase obligations, the adjusted debt-to-equity ratio will be closer to 1x. I would prefer a stronger balance sheet.

Disclosure

The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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