Flowserve Corporation (FLS) Earnings Call Transcript & Summary

Okay. Next up, we have Flowserve. Flowserve is a leading manufacturer of pumps, valves and seals for the energy, chemical, power generation, water treatment and general industrial markets. The company has 130 million shares outstanding. The stock trades around $39, $5.1 billion market cap, $632 million of net debt, $5.7 billion in total enterprise value. Joining us today from Flowserve is CFO, Ms. Amy Schwetz. Amy joined the company in February of last year as CFO after previously serving as CFO of Peabody Energy, where she worked for a total of 14 years. Prior to Peabody, Amy spent 8 years at Ernst & Young, managing audit engagements with public and private companies, ranging from $300 million $10 billion of revenue. Amy also serves on the Board of Directors for Dril-Quip, and she is a certified public accountant. So Amy, thanks so much for joining us today.

Thanks a lot, Brett. We appreciate the Gabelli team for the opportunity to be with you virtually again today and for your clients' interest in Flowserve. We also value the support and ownership of the Mr. Gabelli and GAMCO Partners in our company over many years. For those of you who are new to the Flowserve story, I'm going to start with some background on our company as well as some of our key initiatives before we open it up to questions. Flowserve brands and relationships with our customers have a long heritage, reaching back more than 225 years. These relationships and products not only provide us with opportunities for original equipment sales, but also created a significant installed base for aftermarket opportunities, where we generally see larger margins than on original equipment. When our CEO, Scott Rowe joined Flowserve in 2017, he saw an opportunity to improve the financial results of the business through operational excellence initiatives to allow us to perform better through the cycle. And we refer to these initiatives generally as Flowserve 2.0. Those transformation activities served us well in 2020. We accelerated certain activities, particularly around SG&A savings, and this allowed us to weather the COVID storm relatively well. We're proud of our strong balance sheet. Over -- we had over $1.8 billion of liquidity at year-end and 2020 free cash flow over $250 million. Net debt is currently at its lowest level since 2012, and we currently enjoy investment-grade ratings from all 3 major agencies. With this strength, we are able to return $135 million to our shareholders in dividends and share repurchases in 2020. Flowserve operates in over 50 countries around the world. This includes our manufacturing facilities and also 163 quick response centers or QRCs. These QRCs allow us to be located close to our customers and to provide them with services on a just-in-time basis. From a geographic product and end-market perspective, we have balance in the portfolio. Over 60% of our sales come from outside North America. Our largest market is oil and gas, largely downstream. But we also serve the chemical, power and general industries, which includes our distributor channel and mining and water sectors. Our sales are balanced between aftermarket and original equipment. Flowserve is the only company in the Flow Control industry with a significant presence in pumps, valves and seals. This allows us to provide multiple innovative solutions to our customers and to more easily accommodate comprehensive enterprise frame agreements as well as life cycle advantage agreements. I touched on operational excellence as a component of the transformation process, just a few slides ago. But with significant improvement in the category of work that we consider to be fix the core, we are ready to focus on optimizing and growing the business in 2021. This work centers on strengthening the relationship with our customers, both through our service and product offerings in order to maximize revenue. To that end, in 2020, we had 21 commercial launches, including 3 new products, 6 products that completed our design-to-value process and the remaining launches were product extensions and feature updates or portfolio upgrades. Another example of this innovation is RedRaven, which is Flowserve's global IoT offering. RedRaven will provide a solution for our customers to optimize their Flow Control processes. We are uniquely positioned to provide our customers with our experience with pumps, valves and seals, combined with our proprietary analytics and embedded diagnostics. RedRaven provides our customers with the opportunity to improve productivity, avoid unplanned downtime and ultimately reduce the overall cost of their operations. We're still in early stages of the rollout. And while the current financial contribution from RedRaven is small, we expect that RedRaven will expand into a more meaningful revenue stream and pull through our complete suite of aftermarket services in the years ahead as customer adoption increases. As we talk about the transformation, we believe the size of the prize is a big one, as demonstrated by our long-term targets. We believe the company can continue to make significant strides in revenue growth, operating margin, free cash flow and ROIC through the cycle. Progress has been made in making these targets a reality. Although 2020 represented some setback. We're pleased to have delivered on our free cash flow conversion and to have achieved ROIC well above our weighted average cost of capital despite these challenges. As we see uncertainty around economic conditions clear, primarily driven by the pandemic, we plan to update the market around the timing of achieving our targets. And we firmly believe that these targets are the right one, both in categorization and in size. If 2020 has taught us anything, it's that how we do things as important as what we do. And to that end, we believe that we made significant strides over the last 12 months in ESG. We've committed to reducing our carbon emissions intensity by 40% by 2030. We have a focus on products that support clean technology. And despite the challenges that we saw in 2020, our safety performance was top decile, and we continue to focus on this element of our culture. We have reinvigorated our focus on diversity, equity and inclusion, particularly in the communities where we have associates that live and work. And finally, from a governance perspective, our Board maintains a continued focus on Board composition of skills and diversity and strong governance practices. And Brett, with that, I'm happy to answer any questions.

Great. Thank you, Amy. That was a great overview. So first, I want to ask if you could comment broadly on Flowserve's resilience through the most recent market downturn. It's certainly been different than past industrial and energy infrastructure downturns. And just what you've seen within the organization how folks have responded to the challenges as well as opportunities of the past year?

Sure. And I'd start by saying thank you to our associates who have worked so hard during what has been an extremely challenging year. I'm sitting in our office in -- outside of Dallas today, probably 1 of 5 people who are not -- and are not working from home with pandemic conditions. But realistically, the majority of our 16,000 associates still go to work at our locations around the world every day. And so the attention that they played during -- paid during this time to not just their own health and safety, but to those of our clients is really to be commended. As we think about the type of work that we did -- that we undertook during the start of the transformation process, it really positioned us well for 2020, although we certainly didn't -- we didn't see it coming. So in the second quarter of the year, as this became evident that this was a long-lasting event, we took pretty decisive actions with respect to our cost structure. And as a result, we really rightsized 2 components of our business, starting with our SG&A. And then over time, making adjustments to our manufacturing personnel as well as -- as we work down the backlog. And so we're able to hold our decrementals in 2020 to around 28%. But really, that was a tale of 2 halfs of the year. And in the second half of the year and in the fourth quarter, in particular, we were at around 14%. But I think it's important to note that those actions that we took were really in response to what we knew was going to be that backlog coming down pretty significantly in 2021. And our goal is to really hold that decremental through the cycle to kind of that mid- 20s range, which we feel like puts us in a very strong position as we start to return to growth somewhere in the back half of 2021.

Great. And maybe following on from that, with higher fuel prices recently, there's also some early positive indications on vaccines being rolled out. How do you all expect customer behavior to evolve in terms of addressing their equipment maintenance needs at facilities?

Yes. You really touched on a key point, which is that containment of the virus is realistically one of the key components that we see to normal activity resuming, oil prices being back in the $60s is a fantastic thing for us. The more money that our customers have in their pockets, the better positioned they are to make investment decisions in the future. And certainly, even on an emotional level, the increase in prices from what we saw in the early days of the pandemic is certainly a boost to everyone's psyche. Long term, we need travel habits to return something more close to normal to increase demand as well. But we certainly see these prices, one, encouraging customers to pick up industrial projects that might have been shelved or deferred early on in the crisis. And then I think from an aftermarket perspective, as we begin to see that demand pick up as well, we're going to start to see more normal operations resume in refineries and that need for aftermarket services begin to ramp up again.

And are you seeing the impact of higher commodity prices yet positively impact, I guess, the outlook for your mining end market as well as the potential for emerging market infrastructure spending more broadly?

Yes. We really like the mining sector. It's one that we've played in for some time, although, not in large scale. And certainly, those commodity prices continue to make it a really attractive market. And the one comment that I would make is as we think about energy transition, the mining industry is clearly going to play an important role in that. So we continue to try and focus our efforts in that general industries category, but mining, in particular, to see what sort of share that we can capture over time in that business.

Great. And I guess sticking with the energy transition. We've recently seen federal support for carbon capture projects in the way of tax increases -- sorry, tax credits increased and extended. Can you discuss the current and potential opportunities for Flowserve in that technology area?

Yes. So carbon capture storage is obviously an emerging, kind of emerging trend. It's one that Flowserve has actually been active -- pretty actively involved in for about 5 years now. So we certainly see more government support of this technology... [Technical Difficulty]