Flowserve Corporation (FLS) Earnings Call Transcript & Summary

Good morning, everyone. Thanks for joining us. Coming to you live from my lovely hotel room in Detroit here. We're really excited of my portion today with Scott Rowe. And I think Amy Schwetz is on the line too from Flowserve. Scott, we had a little bit of a technical difficulty with the cameras, but we have Scott on the line. If anyone has any questions, feel free to drop it into the chat functionality or you can e-mail me at [email protected]. So before we kick off Q&A, I'm going to turn it over to the team and let them give some prepared remarks, and then we'll jump on in. So Scott, Amy, if you're there, thank you very much for your time. We appreciate it and take it away.

Joe, thank you so much for having me. Sorry for the technical difficulties. I'm not sure what happened there with the link. But at least for an audio and very much looking forward to just walking through our ESG strategy and approach. So today, it's just me. So it's Scott Rowe, the CEO of Flowserve. I've been here for 5 years now. And like everything, we're on a journey in many aspects of the company, but certainly on the ESG journey, and we put a lot of focus and emphasis on this in the recent years. But I want to go back to almost the beginning. And so we were one of the first industrial to launch the sustainability report back in 2011. And so sustainability and doing the right things have been really important to Flowserve for many, many years. And then when I came in and took over as the CEO in 2017, we really wanted to drive purpose and values. And just as a reminder, for some that follow us or some that don't know, our purpose statement is really what drives everything we do. And so our purpose at Flowserve is together, we create extraordinary flow control solutions to make the world a better place. And so the important part of this is about making the world a better place and ESG certainly fits into that nicely. And so now as we've transitioned from sustainability to true ESG program, we're very much focused on making the world better based through our actions at Flowserve. But I look forward to sharing some of those things today on the call.

Okay. Well, I guess we'll get started at the beginning. So maybe talk a little bit about the process you use to develop and formulate the strategy. Like how is the current structure chosen? Who is involved in creating it? How is the Board involved, things like that?

Sure. Yes. So again, back in 2011, we've launched sustainability, and then we've transitioned over the years to true and proper ESG, and we launched our first ESG report last year. The process to do that is very -- well, it's just a very holistic process involving most of the organization. It obviously starts with our Board of Directors. They've been very involved in what does our ESG program look like and how do we measure and monitor it. And so that starts with our Corporate Governance and Nominating Committee. We provide updates to them twice a year in terms of what we're doing and how we're doing it. And then within my leadership team, we've created a committee, our General Counsel, Susan Hudson, is the leader of that committee, and she's driving the program. But each of the different components, right, the E, the S and the G, and then the sub strategies are all owned by somebody on the leadership team. And so from a process standpoint, we've really taken a long-term approach to this making sure that it addresses all the elements of a proper ESG program. And then just recently, last year -- or I'd say last year, at the end of last year, we brought in a third party to help us make sure that we were on the right path and that we are telling our story as well as we could. And so that happened last year, and we started with what we call materiality assessment. So making sure we really understood some of the things that we were doing and what our program should entail and how do we tie the ESG approach more to our long-term strategy as digitized. And I'd just say that our ESG vision and our ESG approach aligns very nicely with that strategy.

Yes. That's what I wanted to talk about next. So you developed the Sustainability Board, you have an ESG strategy and then with the launch of the 3D kind of extending that more fully into like an operational strategy. So maybe can you flush that out a little bit more and talk about what went into taking us what was a sustainability practice and kind of pushing that into the operating structure?

Yes. No, absolutely. So the sustainability really was around the environmental aspects and things that we can do to sustain the environment. And then again, last year, we went to a more comprehensive ESG approach. But I'd say it all starts with, again, with our purpose statement, so that's creating extraordinary flow control solutions to make the world a better place for everyone. And so that's kind of the driver. And our operational strategy falls from that and certainly our ESG strategy as well. And so what we're trying to do is figure out how can Flowserve through flow control technology truly make the world better? And fortunately, we've been providing flow control solutions now for over 200 years, and we have a lot of opportunities to do that. And so let me talk first about the 3D strategy and then I'll talk about how that fits nicely within the ESG vision and our approach there. So for us, the 3D approach is diversified, decarbonized and digitized. And on the diversification, what we're looking to do is get into long-term attractive markets. It doesn't mean we're walking away from some of our traditional markets. But what it does mean is really focusing our new product development, our M&A dollars and things like that on areas that we believe are going to be sustainable in flow control for the long run. So examples of this would be water, specialty chemical, other applications of flow control that we really think have enduring and long-term growth projections. And then on the decarbonization side, that's where we can really help our existing customers today, drive CO2 emissions down in their facilities. And this, quite frankly, is where we believe Flowserve can have the single biggest impact on the globe and making the world better. And so well, let's just take an example of a refinery. [Audio Gap] equipment and services and products and solutions to help that refinery minimize their CO2 reduction. We can do that through flare gas recovery and capturing emissions. We can do it through energy advantage in driving their energy costs down and driving energy input down also reduces their CO2. And we can do that through our pump technology and our valve technology, making their flow looks more efficient. And so there's lots of ways to do that on the decarbonization lane of helping in the existing assets. And then if we think to the future, whether it's hydrogen or concentrated solar power or other forms of clean energy, all of those things have a form of flow control, and we're working hard to make sure that our portfolio of services and products can fit that new world. And then finally, on the digitization side, we believe that through digitization, we can be more efficient in our internal operations as well as our external operations in helping our customers. And so a great example externally is back to this refinery. If we put our RedRaven IoT solution into the refinery and monitoring our pumps and valves, we're very confident that over time, we can help that operator make, therefore, look more efficient in the long run and more efficient full loop require less energy and then that substantially drive their CO2 reductions down. And so our approach on the 3D, diversified decarbonization and digitize, then aligns really nicely with what we're trying to do on the ESG vision in our approach there. And so it really does fit seamlessly and it works really well together. And I'd say, we launched our 3D strategy externally here at the beginning of the year. We did it internally late last year, but it's really resonating with all of our stakeholders. So our employees are excited about the approach. Our customers are very much aligned with what we're trying to do, and it's certainly resonating with the investment community as well. And so we think we've got the right strategic approach for the time and the external environment right now, and we're going to continue to push on all 3 lanes as we go forward.

And you drive accountability for a strategy like this. What are you tracking? What are the kind of the KPIs that the people are following at the employee level? How does it work its way into compensation, things like that?

Sure. Yes. So the 3D strategy is really about growth. And so most of our metrics around are really around how are we growing in each of those lanes. So diversified, decarbonize and digitize. And so we've got a great bookings tracking system. We use a CRM system to track the funnel but then also to track our bookings as well. And so that's what we're all measured on now. And that is in its full -- or fully implemented to our annual incentive plan this year and everybody has a measurement of 3D bookings growth. And so we feel really good that our strategy is being taken care of within the compensation plan and that we've got the visibility and the attention of all of our associates. Now in addition to that, we have it in our KPIs. And so part of our annual performance review process, that's in there. And then we also have executive sponsorship for each of the categories that we're pushing within the 3Ds. And so just back to the example of water, our water strategy is led by our pump's President. She's doing a great job of developing and implementing that approach across the enterprise. And so we've got good accountability. We're starting to measure these different programs and then certainly, at the bookings level, we can see how successful we are in growing this side of the business faster than our traditional business.

And are there any like either -- I'm sure they're internal, but are there like external targets that you've communicated that are more near term? I know in sustainability reports someone's got like 2030 or 2040, kind of overarching big goals, but what are you kind of driving towards on like an annual basis or something like that?

Yes, sure. So just I want to make it clear, my comments before were really about the 3D strategy and our growth targets. And so that's what we've got the whole organization aligned to you. We have not talked about publicly yet what the 3D goals and long-term goals are. This is the first year we have rolled it out. I would say, just generally on the 3D growth side, we believe that we can grow within these categories faster than the overall growth of the market and the rest of Flowserve. And so through cycle or over the long run, that's our expectation, and we'll start to define that more clearly externally in the coming quarters. On the ESG side, we're also doing a lot to measure and track the ESG performance. And so obviously, there's rating agencies out there that we look at for overall and holistic scores, but I would just say, with the -- our commitment to the ESG report last year and really a commitment to telling our story better than ever before. And just quite frankly, highlighting a lot of the good work that's been going on, our scores have improved dramatically across the top 3 rating agencies. And so MSCI, Sustainalytics and ISS, we came up in all 3 of those categories. And right now, Flowserve is either in like with sustained analytics, we're in the top decile within the Industrial group. And on MSCI, we're in the second quartile by just telling our story. And now with the materiality assessment and some of the other things that we're doing, we're confident that we can continue to move up. And then from an external kind of commitment, what we have said is that we're going to reduce our overall CO2 emissions by 40% by the year 2030. And so that's out there, we've made truly good progress already to that goal. We're about 60% of the way on our journey of reducing the CO2 emissions. And that's just within the 4 walls of the Flowserve organization. And so I feel very confident that we'll meet that goal. In fact, we're ahead of the curve now, and we'll need to publish something that's more aggressive in the coming years. But back to what I said earlier, the biggest impact that we can have is helping our customers reduce their CO2 emission. So that scope 2 and 3 is where we think we can make the biggest difference, and we call that the handprint and what we can do in the global environment. And so that's an area that we're incredibly focused on. As we kind of make some progress with our customers with the alignment of CO2 reduction, whether it's the carbon capture side or the energy efficiency side, we'll start to tell that story more and more as we go forward. And we'll make some significant commitment as to what we think we could do in the external environment.

So what do you think the actual perception of your company is in this whole type of conversation? It's funny. You can almost make an argument why a company like Flowserve can be like extremely attractive on an ESG kind of framework of making to your point of flow control to make the world better on an environmental basis or you could say it's not -- it's fundamentally bad to make energy, oil and gas more efficient because it prolongs how long we'll use it essentially. So you could I've heard both arguments like the most positive and the most negative related to you guys. So like...

So it's a great story, and that's what we wrestle with all the time. And I think before we started to really get serious about telling our story, I think you can easily go to the other side and say, well, their end markets are 40% in the oil and gas and maybe petrochemical and things like that. What I would say, though, is oil and gas isn't going away. Refineries aren't going away this year. And you think about who can help -- you'll try to clean up the existing assets and then who can be there for the future of concentrated solar power high hydrogen and all these other things. And Flowserve checks all of those boxes. And so I actually think we're better positioned than most companies to truly make an impact on the environment. And that's what we're trying to do. And we're doing it because it's the right thing to do, but we're also doing it because it's a great business for Flowserve. And so we're going to continue to help the customers that we have today. We think we've got a great offering to do that, both on the ability to capture carbon but also the ability to drive efficiencies and reductions. And then we're also participating now on big programs like CCUS, so carbon capture and underground storage. We're participating in hydrogen projects around the world. And so we've got a list of those that are going forward. We're the #1 flow control player in concentrated solar power right now. We put tons of valves and seals into that. And so we're very much a part of the green energy, and we're going to continue to do that. Another big area that we're participating in widely right now is the conversion to biodiesel and then also recyclable plastics and other types of bio-type processes. And so all of these things are incredibly green and are incredibly helpful to cleaning up the global footprint. And we're right in the middle of that, and we're evolving our portfolio to make sure that we can continue to support those type of processes.

Yes. It's an interesting date for sure. And I think you articulated it well, though, as to why you're doing what you're doing. I guess, some of the questions we get a lot are when can markets like hydrogen and carbon capture and these, like, what has to happen for this to be big enough a percentage of your revenues to really like dig into? Like I know it's going to grow faster than the rest of the portfolio, but when can it be like a material piece of dollars? When is that?

No, I think it's a good question, Joe. I mean all we can look at right now is projections and then different discussions we're having with some significant end users. But we do think the growth rate is high. It's obviously a very small percentage of our business today, but these contracts are getting bigger and bigger. And so like on the CCUS side, we've got a big project going on in Norway, and that was kind of $5 million to $10 million gross. We've got another project that we're working on in the United States that's going to capture CO2 from ethanol producers. And that's a meaningful project for us in kind of the $10 million to $20 million range. But again, those are 2 big projects that have launched, and we've got an outlook of maybe 15 others around the world. And that, quite frankly, is not enough to fully move the needle, but it's a great business for us, and we're in a proprietary position. I do think these will continue to move forward. I think carbon capture will be very much a part of any process industry as the world evolves and moves on. And so we can really lock in our technology for that side of the process. And if you think about all of the different installations that are emitting out there, there's a massive opportunity for us to put additional equipment around that emissions that will either capture that CO2 and reinjection into process or capture it and reinject it into some form of storage. And then on the hydrogen side, I just think we're in really, really early stages here. We're very much involved in gray and blue hydrogen. And so that's essentially taking an existing process on a refinery or petrochemical plant and creating hydrogen from that process. And so we've got the ability to do that through steam methane reforming and some of our different equipment. And so we're confident that we can make an impact there and that side of the business is growing very rapidly. But then also, when you think about green hydrogen, it really is a water process. And so we're really looking at all of our technology and trying to make sure that we're positioned nicely to support the fluid handling in the water side of hydrogen. This space is evolving quickly. We've done some projects at, what I'll call, very small scale on -- for hydrogen transportation. We're involved in some development right now on some of the larger scale hydrogen production. And I think it's really a matter of just proving these concepts and making sure that they work. And if they're successful in the early pilot stages, then I think we start to see some pretty significant investment in moving these type of projects forward. And if we do that, then the numbers start to come up in a meaningful way. But I don't want to pretend that this is a 2022 or 2023 thing. I think we'll see steady growth for a couple of years, but it won't be material for us for probably 3 or 4 years as these technologies start to gain traction.

So I think that lends itself into like a discussion about M&A. Like are there ways to accelerate this process with adding chunks of revenue? Are there things out there to buy? Or is it more a function of the market itself needs to develop?

Yes. I think on the really green things in the new technologies, our approach is being more on partnerships rather than acquisitions. I don't see anybody out there that's got a pump or a valve that fits this space incredibly well. What I will say is we are interested in getting a little bit more gassier with our portfolio. And so there would be things like that, that would support like LNG potentially on the hydrogen side and then more on the carbon side. And so that's part of some of the approach that we're looking at. But overall, from a technology standpoint, it's more making sure that we're collaborating and we're partnering with some of the thought leaders in the process side and then making sure that our flow control technology is part of that process and part of that solution as we go forward.

Makes sense. Now you guys also are bringing in a lot of stuff, right? You're buying castings, you're bringing a lot of equipment. So just curious about how you're thinking about -- how you're choosing suppliers? I mean it's a very diverse global list that you use, but how has that process had to change? And are you being viewed like -- or almost like bedded from your customers on like an ESG framework now to make sure that you are producing in a way that meets their standards?

Yes. Let me -- I'll do supply chain first and then I'll talk about our customers and what they expect from us. So on the supply chain side, there's the new concept of supplier country ESG risk scoring. We're just now beginning to use that risk assessment framework. We've started looking at it and we had our own supplier risk scorecard and kind of how do we think about suppliers. We're now incorporating that more formal country ESG risk score into that thought process. But I'll just say, generally, on supply chain, this has been the most challenging kind of 18 months in my career in the operational side. Those are unfortunately significantly leveraged to some low-cost countries in an extended supply chain, and we're being impacted pretty significantly, and we saw that in the Q4 and the Q1 results. We are seeing some signs of stability, and we're seeing some signs of things opening up. But as we go forward, resiliency has always been a part of our focus on supply chain strategy. I would say that, that is now an incredibly important part of how we think about our suppliers and making sure that they have surety of supply and that they are more vocal through our operations than ever before. And then on the customer side, it's interesting, we're not getting anything specific from an ESG standpoint, saying that we prefer Flowserve over somebody else because they have a better ESG score. We're not getting mandated to say you have to produce this way or we'd like to see your facilities do this. But what we are seeing -- certainly, in my discussions at a high level, we're seeing incredibly strong alignment with our end customers. And so think of the big customers, whether it's a national oil company or a refining company or even somebody that's focused on desalination in the water side, ESG is important to them. They're being measured on it that you were seeing the same thing -- the same thing with our customers that we're seeing here that their teams are now being incentivized on it. And their -- big part of their program is making sure that their supply chain is in compliance with their ESG program. And so while we're not being -- there's no requirements at this point, we're having different discussions than we've ever had before. And I think -- well, I think this could ultimately go with some of our bigger customers is preferential treatment for suppliers like Flowserve that are considering ESG and how they run their business. And so if we have a higher -- let's just say, they choose the MSCI towards, they might actually factor that into their supply chain philosophy. And if Flowserve has got a bigger MSCI or better MSCI for than others, then we would get some preference on providing equipment and services into their project or installation. So I do think that's coming. I don't think we're far off from that. But at this point, that's not getting widely factored in. It's more just discussions at the highest level.

So do you think that's realistic that companies could factor that in on like a -- when they're bidding? Or is it right now still like this is a nice discussion to have with me and with investors. But at the end of the day, it's a little bit wins a project?

Well, that is -- today's environment is -- this is a wonderful discussion, but on a project that's going through an EPC, it is -- if your product is fit for purpose, then it is absolutely lowest price. I do believe, though, as we go forward, you will get some sort of benefit from some companies if you are doing the right things on ESG. And I was just traveling in the Middle East, and I won't name, but I'm pretty confident that there's a large player in the Middle East that's going to incorporate this into how they think about their supply chain. And that will be a formalized process.

That's interesting. I guess we can't have this discussion about these markets without talking about what's happening right now with energy markets and what's going on in Europe and Russia. How have your conversations been forced to change in the last 100 days here?

Yes. I mean, it's an understatement to say the world has changed since the invasion in February of Ukraine. And it's just -- it's unfortunate that we're in the place that we're in, and there's just massive disruption, certainly for the people of Ukraine, but it's also impacting the global markets. And so for Flowserve, we've been very public about our stance on this and that we're supporting the people of Ukraine. We're also exiting our business and have exited our business in Russia. And so sadly, we had a nice operation there. We had a good team in Russia. We've been able to retain several of those or many of those employees in different parts of our country -- or different parts of the world. But sadly, we've stopped now all operations in Russia. And so that's an impact on Flowserve not a material impact, and we disclosed that in Q1, but it's a meaningful part of our business. And then as we think about what that's done to the energy market, obviously, the commodity prices are up. But the countries are now more and more focused on energy security. And so where their oil and natural gas come from is becoming more and more important and having reliable partners to get that is something that everybody is talking about. And so what we're seeing is more focused on liquid natural gas. We're seeing more focus on oil out of the Middle East and out of North America. And then we're also seeing more focus and an acceleration on some of the energy transition topics in some of these green energies. So I think energy transition only accelerates because of this. But I also see in parallel a significant investment in traditional parts of the energy economy. And so I think Flowserve benefits from this in both ways. We're very strong with the traditional energy sources. And then we're positioning ourselves nicely for the energy transition. And so for us, our -- this will only strengthen what we already thought was positive in markets, and we're seeing our outlook from a bookings perspective continues to get better and better.

So I'm curious what you're hearing with prices kind of spiking here both on the crude and nat gas side. Are you getting the sense that more of your customers are looking to advance projects? Or is there some sort of view that this is due to somewhat artificial means and are more nervous? Like how are people thinking -- how fundamental has this changed? Is it enough to commit long-term dollars to?

Yes. No, I truly think long-term dollars are going to be committed to production of energy. And it really is about security, right? And so countries in Europe are really interested in getting natural gas and oil from somebody that they can rely on, on a continuous basis. And so I think that's almost more important than the spike in pricing. And so if a country like Germany commits to somewhere else and say, we've got to have this natural gas for this amount of time, then there's going to be investment in activity that comes from that and Flowserve will benefit from that. Now what I will also say is there's been far more discipline in the operators in North America, right? And so those operators are now very much focused on shareholder returns rather than necessarily investing dramatically to improve their production rates and their capacity. And so I think it's an interesting dynamic. I don't see -- I think energy prices will settle, but I don't see them going down dramatically until something changes here. And so we feel very good about the different investments around the globe certainly around LNG. We feel good about oil investments and refining investments. And then we also feel good about other forms of energy like nuclear. And so we're seeing a resurgence in nuclear in Europe. We're seeing different discussions now in the United States around nuclear and Flowserve has got a real nice portfolio, both on the valve and the pump side to support the nuclear industry.

All right. I think we have to leave it there. We're a few minutes over. Scott, I really appreciate your time. Thanks very much for joining us.

Yes. Thank you, Joe. We appreciate Cowen and you hosting us today, and have a great conference.

Thank you.