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Flowserve Gains From End-Market Prospects Despite High Costs

Zacks Equity Research

We have issued an updated research report on Flowserve Corporation FLS on Mar 4.
 
The company, with a market capitalization of $6.1 billion, currently carries a Zacks Rank #3 (Hold).

Certain growth drivers and headwinds that might influence Flowserve have been discussed below.

Factors Favoring Flowserve

End Market Prospects: Flowserve anticipates gaining from rising MRO spending across the globe due to an increased focus on maintenance and efficiency in the oil and gas market. Also, higher demand for cleaner fuels and pickup in liquefied natural gas-related activities in North America will be beneficial.

In addition, the company will gain from improving demand, spurring investments in ethylene and derivative facilities in the chemical market. Also, business in North America, the Middle East and some emerging markets are likely to flourish. Further, the company will gain from the increasing need for technical services driven by the strengthening thermal solar market. In the general industries, higher distribution and mining activities induced by growing global economy increased growth prospects for the company.

Projections for 2019 & Shareholder-Friendly Policy: For 2019, Flowserve anticipates adjusted earnings per share of $1.95-$2.15, higher than $1.75 recorded in 2018. Revenues are predicted to grow 4-6%. Further, in the year, the company intends to pay $100 million in dividends to shareholders and use $90-$100 million in cash for capital expenditure.

Long-Term Targets: From 2019 till 2022, Flowserve anticipates revenue growth of roughly 200 basis points above the industry’s growth rate. Operating margin is predicted to be 15-17% in 2022 while after-tax return on invested capital is likely to be 15-20% and free cash flow is expected to be above 100% of net income. In addition, the company intends on using its funds for enhancing organic growth, investing in Flowserve 2.0, acquisitions and returning higher values to shareholders.

It is worth noting here that Flowserve 2.0 is a multiyear program that is designed to enhance the company’s ability to effectively support customers and create a better workplace for employees. It will also help drive significant long-term value for Flowserve’s shareholders.

Factors Working Against Flowserve

Share Price Performances, Poor Valuation and Earnings ESP: Flowserve delivered earnings surprise of 0% and a negative sales surprise of 7.68% in the fourth quarter of 2018. The company’s share price declined 5.8% following the release of results on Feb 20, 2019. This performance was weaker than the industry’s growth of 0.7%.



Since Feb 20, on a price-to-earnings (P/E) basis, the company’s stock appears overvalued compared with the industry. Its P/E is at 30.41x, up compared with the industry’s multiple of 20.16x.

Further, the company’s Earnings ESP is -3.34% for 2019 and -1.90% for 2020. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

High Costs: Although it is likely to benefit in the long term, Flowserve’s transformational realignment program is fueling costs for now. The company’s realignment costs adversely impacted earnings per share by 6 cents in the fourth quarter and by 31 cents in 2018. Further, transformation and realignment expenses adversely impacted its fourth-quarter earnings by 13 cents. For 2019, Flowserve’s transformation and realignment expenses are predicted to be roughly $55 million.

Highly Leveraged Balance Sheet & Other Woes: In the last five years (2014-2018), Flowserve’s long-term debts increased 5.1% (CAGR) while its debt/total equity ratio increased from 59.5% in 2014 to 89.3% in 2018. Notably, the company’s long-term debt was at $1.4 billion at the end of 2018. We believe that a highly leveraged balance sheet can increase financial obligations and be detrimental to Flowserve's profitability.

For 2019, Flowserve predicts divested businesses and forex woes to have adverse 2% impact on sales.
 
Stocks to Consider

Some better-ranked stocks in the industry are Atlas Copco AB ATLKY, Roper Technologies, Inc. ROP and Dover Corporation DOV. While Atlas Copco sports a Zacks Rank #1 (Strong Buy), both Roper and Dover carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

In the past 60 days, earnings estimates for 2019 improved for Atlas, Roper and Dover. Further, earnings surprise in the last reported quarter was a positive 42.42% for Atlas, 2.88% for Roper and 10.85% for Dover.

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