FLS - Flowserve: Inflection Point?

Summary

• Flowserve has seen a very poor fundamental and share price performance since the shale oil peak in 2014.
• The company is showing signs of life again in recent times.
• This and a recent interesting bolt-on deal look interesting here.
• Too early to have conviction on the turnaround, I recognise that we might find ourselves at an inflection point.

It has been a very long time since I last covered Flowserve ( FLS ). In 2014, Flowserve made a bolt-on deal for SIHI, yet shares looked fully valued to me at the time. I am glad that I ended up at that conclusion as the peak in US shale oil (investments) happened at the time, creating a painful near decade period thereafter.

A Quick Reap

Back in 2014, Flowserve was a huge player with operations in the energy infrastructure and industrial sector. Despite diversified operations in terms of end-markets and geographical regions, it was a full valuation following strong performance which made me cautious at the time, even as a $372 million deal for Dutch-based SIHI looked okay.

Flowserve posted $4.9 billion in sales ahead of the deal, as the purchase of SIHI would increase this number to about $5.2 billion. Standalone EBITDA of $870 million would improve to over $900 million, as pro forma net debt came in around $1.4 billion. The 137 million shares outstanding were trading at $66, valuing Flowserve at $9.0 billion (equity that is), equivalent to about 18 times earnings as the business has doubled in terms of sales in the decade leading up to 2014, while having bought back some shares as well.

With shares trading at $65 at the time, the valuations looked quite full to me.

Caution Saves The Day

As it turned out, shares of Flowserve peaked in 2014 as this coincided with the peak of US shale production, at least the peak enthusiasm and capital spending for the sector. Shares traded around the $40 mark in the years thereafter and since the outbreak of the pandemic they have generally traded in a $30-$40 range.

Structural headwinds, relating to less capital spending into oil and gas (predominantly) hurt the business as 2022 sales were down to $3.6 billion, a massive decline from the $5.2 billion number in 2014. In fact, this marks a 30% revenue decline, even ahead of the impact to inflation, over an eight-year time period. The share count has been reduced in a much more modest fashion to 131 million shares, with approximately 5% fewer shares outstanding here.

Reported operating earnings in 2022 fell to $197 million, with margin pressure observed for years now. The company posted higher earnings on the back of a tax refund, with adjusted earnings posted at $144 million, equal to $1.10 per share. While 2022 sales numbers rose 2%, there was a silver lining in some parts of the operations as booking rose 18% on a reported basis to $4.4 billion, resulting in a book-to-bill ratio far above the 1 mark, with the backlog up 36% to $2.7 billion.

Net debt was reported at $838 million by year end, down in nominal terms, but still relatively large, as EBITDA comes in around $300 million according to my math.

The increase in bookings was already seen in the fourth quarter results with revenues up 13% to $1.04 billion, with some margin expansion reported as well, as quarterly adjusted earnings of $0.63 per share were responsible for the majority of all of 2022s earnings.

This momentum is seen in the 2023 guidance as well, a year in which sales are seen up 9-11%, with adjusted earnings seen between $1.50-$1.75 per share. With the market valuing these shares at $4.6 billion at $35 per share, the enterprise value of $5.4 billion works down to about a 1.4 times sales multiple and about 20–23 times adjusted earnings multiple, based on forward estimates as the track record has been quite troublesome of course.

A Bolt-On Deal

Just ahead of the release of the 2022 results, Flowserve announced the purchase of Velan in a $245 million deal. The purchase of the highly engineered industrial valves manufacturers adds about 1,650 people to the payroll. These valves and solutions are being applied to nuclear, defense and cryogenic markets.

Velan posts revenues of $380 million a year and $21 million in EBITDA which shows that a 0.6 times sales multiple looks cheap, albeit that EBITDA margins are quite low at 5-6%, trailing those of Flowserve by a margin. This is the case even as Flowserve's own margins are not too impressive as well. Flowserve furthermore expects $20 million in annual synergies, as those alone could justify the purchase price of course.

On the back of this deal, shares of Flowserve rallied about 10% on the announcement, adding nearly half a billion in shareholder value, as this deal look very interesting indeed. $20 million in synergies alone have the potential to add more than $0.10 per share in earnings per share, that is before the acquired earnings power (although this will likely be in part offset by additional interest expense).

What Now?

Right now I am a bit in doubt. Flowserve has seen terrible years, but is showing signs of life in terms of sales and earnings growth, an increase in the backlog, and it has announced an interesting bolt-on deal. This looks quite promising, but on the other hand, the long term positioning is a bit challenged and the track record since 2014 has been dismal.

Weighing it all together, a small opportunistic purchase, banking on a multi-year turnaround story on the back of energy insecurity, could be interesting, yet I fail to have conviction to potentially initiate a position in size here.

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