Flowserve: Despite Long-Term Potential, Shares Likely Offer Limited Upside

seekingalpha04-30

Flowserve Corporation's stock has risen 42.8% since January 2023, outperforming the broader market.The company reported strong financial performance in Q1 2024, with revenue exceeding analysts' ...

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Even if you acknowledge that your stance on the matter has not played out according to plan, jumping in and buying stock because that stock has risen nicely can lead to some pain down the road. Although such pain has not developed yet, I do think that investors of Flowserve Corporation (NYSE:FLS) should be wary about expecting additional upside from here. You see, back in January of 2023, I wrote an article that delved into the investment prospects of the producer of flow control systems. Examples of these products include pumps, valves, seals, automation and aftermarket services, and more. Even though it's the type of business that I like and I believed that it is a solid business in the long run, shares did not look cheap enough to warrant any more optimistic than a ‘hold’ rating. But since then, the picture has changed quite a bit. Due to improved financial performance in 2023 and continued improvements so far for 2024, the stock has risen higher, with shares up 42.8% since the time that article was published. That dwarfs the 27.3% rise seen by the broader market over the same window of time. This increase, combined with performance just announced that covers the first quarter of the 2024 fiscal year and that exceeded analysts’ forecasts across the board, might encourage investors to try and capture additional upside from here. However, the way shares are priced, I think that most, if not all, of justifiable upside has already been had. A solid quarter Fundamentally speaking, the first quarter of the 2024 fiscal year was a pretty good time for Flowserve. Revenue, for instance, came in at $1.09 billion. That's 10.9% above the $980.3 million generated the same time one year earlier. It also happens to be $50 million more than what analysts expected. According to management, this was driven by strength across the board. Original equipment sales, for instance, grew by 14.1%, or $65.2 million, year over year. Aftermarket sales, meanwhile, popped up 8.1%, or $42 million, compared to what was seen in the first quarter of 2023. Author - SEC EDGAR Data Clearly, the revenue picture for the company remains quite impressive. And in all likelihood, that trend is probably going to continue. You see, from 2021 through 2023, Flowserve saw revenue climb from $3.54 billion to $4.32 billion. And when it comes to the 2024 fiscal year, management is expecting revenue growth of between 4% and 6%. At the midpoint, that would imply sales of $4.54 billion. Author - SEC EDGAR Data This doesn't mean that everything was great from a top line perspective. During the first quarter, bookings for original equipment came in at only $462 million. That's actually 8.9% lower than the $507 million reported one year earlier. On the other hand, aftermarket bookings popped up 4.7% from $550 million to $576 million. At this point in time, the company has exposure to a variety of industries that should perform well in the long run. For instance, management stated that high refining utilization rates are driving significant maintenance, repair, and operations expenditures, including when it comes to the aftermarket space. LNG demand continues to grow and there is a wave of decarbonization and investment across the planet. It just so happens that, during the first quarter, 37% of the company's bookings involved these industries. Another 22% involved the chemical space, which is expected to see some improvement this year. And when it comes to power, which accounts for 12% of bookings, the firm should benefit from growing electricity demand thanks in part to new data centers aimed at supporting AI endeavors. The growth of renewable energy sources and nuclear power should also help on this front. On the bottom line, the picture was even better. Earnings per share came in at $0.56. That's up from the $0.20 per share reported one year earlier and it happened to be $0.11 per share greater than what analysts forecasted. This resulted in net profits nearly tripling from $26.8 million to $74.2 million. Net profits weren't the only thing to improve during this window of time. Operating cash flow nearly tripled from $26.6 million to $62.3 million. If we adjust for changes in working capital, we would get a near doubling from $58.8 million to $107.7 million. And lastly, EBITDA for the company expanded from $78.8 million to $134.7 million. If all goes according to plan, earnings per share this year should be between $2.25 and $2.45. That would translate, at the midpoint, to net income of about $311.1 million. That compares to the $272.7 million in adjusted profits seen in 2023. Interestingly, when we look at management's guidance, we actually get EBITDA falling slightly from $483.1 million last year to $451.3 million this year. And that should mean a decline in adjusted operating cash flow from around $299.4 million to $279.7 million. Author - SEC EDGAR Data With these results, valuing the company becomes a simple process. In the chart above, you can see precisely what I mean. In that chart, I valued the company using results from 2023 and estimates for 2024. On a forward basis, shares do look more expensive relative to cash flows. But the opposite is true when it comes to earnings. These are trading multiples that I would consider to be at fair value or approaching some level above that. But shares aren't just pricey on their own. They are also expensive relative to similar firms. In the table below, I compared Flowserve to five similar entities. And using all three of the valuation metrics, I found that four of the five firms ended up being cheaper than it. This shows that the stock is expensive on a relative basis as well.   Company Price / Earnings Price / Operating Cash Flow EV / EBITDA   Flowserve Corporation 22.2 20.6 14.4   Mueller Industries (MLI) 11.6 9.0 6.1   Gates Industrial Corp (GTES) 20.8 10.2 10.1   Franklin Electric Co (FELE) 25.1 15.4 15.5   John Bean Technologies (JBT) 4.8 39.1 10.9   Hillenbrand (HI) 6.4 18.4 12.3   Click to enlarge An appropriate question is the extent to which these firms make for solid comparables. I based this list off of a couple of factors. First and foremost, they all fall under the Industrial Machinery & Supplies & Components industry of the Industrials sector as defined by the filtering on Seeking Alpha. For the most part, they are also similarly sized. As of this writing, Flowserve boasts a market capitalization of $6.16 billion. These firms range between $2.87 billion and $6.60 billion in size. And even if we remove the smallest one, which would be John Bean Technologies, this narrows to between $3.47 billion and $6.60 billion. In the near term, the stock does look pricey compared to similar firms and more or less fairly valued on an absolute basis. And because of this, I cannot bring myself to be optimistic from an investment perspective. But this doesn't mean that I believe that its potential for the long haul is bad. The fact of the matter is that the company has plenty of opportunities. In fact, while the firm should generate around $4.54 billion in revenue this year, it's expected to grow sales to $5 billion per year by 2027. There are multiple initiatives that can help it reach that level. For instance, management is looking to focus even more on improving its structure and capturing growth from specific markets. One of the projects involves an award for flow control equipment that the company won in order to help an unnamed chemical company construct what it calls a ‘smart plant of the future’. This particular facility will include automated packaging activities, high tech control systems, and vehicles that are controlled autonomously. Management has pointed out decarbonization opportunities as a source of potential growth as well. The pumps and valves that it produces are being used to help with carbon capture and storage projects, including a new carbon capture and storage facility in Europe that should be completed by 2026. That particular project will have the capacity to store 2.5 million tons of carbon dioxide each year. In addition to this, the firm is also investing in providing monitoring solutions for electric actuators that are used for offshore wind projects, including one in Norway. Other opportunities likely exist across the globe. After all, while about 40% of the company's revenue comes from North America, 19% comes from Europe while 17% comes from the Asia Pacific region. Another 17% comes from the Middle East and Africa combined, with the remaining 7% attributable to Latin America. So as customers and other parts of the world embark on projects that could utilize the products and other solutions that Flowserve offers, there's an opportunity for additional expansion. Flowserve Corporation In all likelihood, this revenue growth will bring with it higher profits as well. In fact, in 2023, the company had an adjusted operating margin of 9.5%. This year, that number is expected to be more than 11%. And by 2027, management is forecasting margins of between 14% and 16%. This is expected to help adjusted profits per share rise to more than $4. That compares to the $2.60 per share anticipated for this year. It might be helpful for me to provide some sort of guidance as to what I think upside potential for the company might be. Oftentimes, it can be helpful to compare the trading multiples of one company to similar firms as I already did above. Based on management's own projections for adjusted earnings per share for 2027, net profits should be somewhere around $478.6 million per year by that time. If we assume that other profitability metrics will rise at the same rate, adjusted operating cash flow would be around $430.3 million, while EBITDA would come in somewhere around $694.3 million. From the firm's current price today, we are looking at a forward price to earnings multiple of 12.9, a forward price to adjusted operating cash flow multiple of 14.3, and a forward EV to EBITDA multiple of 10.   Author - SEC EDGAR Data By comparison, if we average out the multiples of the comparable firms, we would get a price to earnings multiple of 13.7, a price to adjusted operating cash flow multiple of 18.4, and an EV to EBITDA multiple of 11. Applying these same multiples to the forward profit and cash flow metrics for the company would imply, between now and the end of 2027, annualized upside of between 1.7% and 7.1%. Historically speaking, the S&P 500 appreciates by around 11% or 12%. And this is without factoring in the kind of margin of safety that I typically prefer. Ignoring the margin of safety issue, we would be looking at a share price by the end of 2027 of between $50.23 and $60.72. If we want to discount that back to the present day, it depends on what discount rate we use. But the bottom line is that, in none of these cases do we see shares experience any meaningful upside even if management achieves their targets. Naturally, this says nothing about whether or not these targets are even achievable. In many instances, the management teams at firms make projections but fail to deliver. But the good news in this case is that management has a pretty good history of delivering on better-than-expected forecasts. At the end of the 2022 fiscal year, the company claimed that revenue in 2023 would rise by between 9% and 11%. It actually ended up growing by 19.5%. Adjusted earnings per share were forecasted to be between $1.50 and $1.75. The company ended up delivering $2.10 per share. This does help to ease my concern about the lack of a margin of safety in my assessment. In fact, it gives credit for management potentially exceeding forecasts on their 2027 guidance. Takeaway  As much as I want to be bullish on a company like Flowserve, the price just is not right. It is a fine company that likely would do well for itself and its investors in the years to come. But shares look more or less fairly valued or close to being overvalued. What I mean by this is that the stock is unlikely to generate upside or downside that is materially different from what the broader market should see. This doesn't mean that upside doesn't exist. But it does mean that investors likely won't beat the broader market unless something changes for the better. So even though the company did quite well from an earnings and revenue perspective for the most recent quarter, I have to say that there are better opportunities that can be had. Because of that, I have decided to keep the business rated a ‘hold’ for now.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2431323582"}