Flowserve Corporation (FLS) Earnings Call Transcript & Summary

Good morning, everyone. Thanks for joining us today. I'm Joe Giordano. I cover diversified industrials, automation and robotics here at TD Cowen. Welcome to the sustainability week. My first session of the week, I'm excited to ask Scott Rowe, CEO of Flowserve with us today. If anyone has questions as we go along here, feel free to e-mail me. It's [email protected]. where you can submit through the dashboard length that you should have. Scott is going to start with some prepared remarks, and then we'll jump into the fireside chat. So Scott, thanks for joining us. Appreciate your time, and why don't you take us away.

Yes. Great. No, thank you, Joe. I appreciate you having us, and I want to say thank you to all of Cowen for hosting the sustainability week. And I've got just a few prepared slides and then happy to answer questions as we go forward. But let me just start on the ESG and sustainability side with a few prepared comments. This is an exciting day for us. We released our 2022 ESG report yesterday. So that's now out on our website. So flowserve.com. You can find the ESG report. So I encourage anyone to listen to pull that up. And what I would say, this year is, we've done some things to enhance our overall program. We refreshed our ESG vision. And then we've also made it just a little bit more relevant to our associates and to our customers and then basically all our stakeholders, our shareholders as well. And one of the big focus is really tying the ESG program to our purpose and our strategy and our operations. And I think we've done a really nice job articulating our story in the ESG report. And so let me first start by how we're now segmenting the ESG focus for us. And so our -- I'll start with our strategy, which is diversified, decarbonized and digitized. And now what we've done is encapsulated the ESG program within the 3D strategy. And the way we're doing that is with 3 Cs. So Climate, Culture and Core responsibility. On the Climate side, right, this is relatively intuitive, but it's how does Flowserve support the changing climate environment and how do we work through an energy transition and ultimately making the world a better place with reduced CO2 and better stewards of the natural resources. And so we'll talk a lot about this, and we're doing several initiatives. But what I would say here is we're excited about what we can do internally at Flowserve, but we're even more excited with what we can do at our customers' facilities. So I think large refining, petrochemical plants, steel mills where we've got big equipment, we're doing a lot to support our customers on their ESG journey and supporting the climate. On the culture side, this is something I've been passionate about since joining Flowserve, we started with a purpose statement and core values to really move our culture in the right direction. And essentially, the way I see this is just really energizing our associates. We've got [ 17,000 ] worldwide and making sure that we can take that collective energy and do good things for our customers and ultimately, the communities where we live and then our investors as well. And then finally, core responsibility is just how do we conduct our business ethically in accordance to the local laws and regulations. And again, this has been a big part of the Flowserve values, and I think we've made tremendous progress here. And so I really just want to close by sharing some of the examples from the 2022 progress. On the Climate side, we've reached 80% of our 2030 carbon emissions reduction goal. So the goal we put down was a 40% reduction in CO2 emissions intensity, and we're now 80% the way through that goal and obviously, we're in 2023. So we've got -- we've done a lot of good work here, and we're well ahead of our timeline. And so next year, we'll look at how do we enhance this target even further. On the energy transition bookings, so these are things that are supporting the climate with things like hydrogen or recyclables or other types of applications that are supporting energy transition and clean energy, we did over $140 million of bookings last year in that. And then we've made several strategic partnerships that we've announced throughout the year in terms of collaboration with new energy sources. So this is hydrogen fueling LNG, carbon capture and sequestration and then the recyclable side. On the culture side, again, this is what I'm super excited about and very proud of the progress we've made. Last year, we launched what we call Leadership in Motion, which we trained over 2,000 people leaders at Flowserve. And this is just really about how do we do our jobs better, how do we treat people properly and how do we learn and grow as an organization. So a great, great program really driving our culture. And then the other one is Flowserve Cares, and this is how we give back in our local communities. And so last year, we invested over $0.5 million back into the communities where our folks live and work and really trying to be good stewards of the -- not only the environment but the community, the education system and the folks around the world. And so our associates get behind these big time. While the dollars is important, what's really important is getting people out to volunteer and reconnect with the community that they're in. And so we're very proud of the progress we've made there. And then finally, on responsibility. The one I'm most excited about is our safety program. We had a record safety year last year in 2022. Our total reportable incident rate was at a really, really low level. It's historical low. It's in the top kind of 5% of all industrials. And so we feel really good about our safety progress and keeping our people safe. And then on the governance side of products, we've changed our new product development focus and our R&D focus to be fully aligned with the 3D strategy. And so last year, we launched over 20 new and redesigned products that were fully in line with supporting diversified, decarbonized or digitized. And so we're excited about what we've done there. And I'd say that's really just the beginning. We've doubled down on new product development and R&D, and we're excited about what the future holds there. So Joe, that was really it. I wanted to give a little bit of a precursor out to the ESG report that's out there. And again, for folks that are listening today, you can find the report on our website, flowserve.com, it's in the -- it's right there in the front, but you can also get there through the ESG page as well. So with that I'll stop sharing the slide, Joe, and we can go to Q&A.

Yes. Perfect. Thanks, Scott. So let's start, you mentioned energy transition. I think that's probably where we should kick things off. It's obviously one of the most sought-after themes in the market right now. You mentioned you did $140 million of bookings last year. How do we just think about where you're positioned? $140 million in bookings, that's great to see, but you're over a $4 billion order company. So like, where are we in that? How do we think -- how do you see yourself is positioned in that theme right now?

Sure. I'd say $140 million is a big number. It's not as big as we would like. And -- but what I would say is the opportunity set is substantial. And so we've seen our forward pipeline double now in the last 12 months, we've seen 30% to 40% increase since the beginning of the year. And this is by far the fastest-growing end application within our business. And the parts -- the areas that we're really excited would be the hydrogen side. We're seeing substantial long-term growth there, and we're repositioning both our pumps, valves and the mechanical seal portfolio to support hydrogen. But also, we like LNG. We like the carbon capture side. There's so much happening here on the energy transition that we continue to think about how do we put the Flowserve portfolio in the right place to capitalize on these advantaged markets. And we believe that with our history and our Flow Control Solutions that we're in a really good place here, we continue to sign partnerships, we continue to win more than our share of work, and it's something that we're really excited about as we go forward.

There are also like several paths, I guess, that the world can take towards a non-carbon energy production in the future. So how does that impact you? Are you kind of -- do you care if it's solar versus hydrogen versus LNG? Like how -- what's like the optimal outcome for you guys?

Yes. So Joe, we're a Flow Control company. And so we like the applications that have more flow. And so anything that has -- we like [ corrosive ] environments, we like things that have a high aftermarket entitlement. But with that said, right, I mean, there's so many different things happening. It's a little bit of the wild, wild west right now in terms of what's going to win out over the long run. And so we've got a broad portfolio. I'll just kind of hit through a couple of them, and we'll talk about how we play. But we're in an advantaged position and the ability to take products and offerings that we've had in the past and tailor them to the energy transition needs. And so concentrated solar power is a great example. You wouldn't think there's a Flow Control aspect to that. But when you're moving molten salt across the solar power field, there's a serious Flow Control dynamic there, and it's incredibly corrosive with the salt. It's extremely high temperatures and the technology there is unbelievable. And so we've migrated our pump and valve and mechanical seal offering into concentrated solar power. And then if we kind of jump over to nuclear, now there's ability to use -- or use the molten salt technology that we've done in concentrated solar power to small modular nuclear reactors. And so it's just kind of this like how do we connect dots and how do we continue to evolve the portfolio to support this. But nuclear is a big one, right? The EU has just declared that green at the end of last year. It's something that we're positioned incredibly well for in our existing pump and valve offering. The Velan acquisition only adds to our portfolio of ability to do more nuclear, and it's something that generates a significant aftermarket for us. And so we put that in the energy transition part. We can talk about energy security, they kind of go hand-in-hand there, but it's definitely a green form of energy as long as it's contained and safe. And then hydrogen, whether it's green, blue or gray hydrogen, there's a massive Flow Control element. So on the green side with the electrolysis, it's a water play, but there's some really technical aspects to how to do green energy. And so we've been involved in the first green hydrogen projects around the world. We've got some really good bookings and customer partnerships with that. And then on the kind of legacy hydrogen, this is through a steam-methane reforming process that we've been doing for decades now. And we've got the ability to continue to support that with our pump and valve offering. And so we feel we're incredibly well positioned on the hydrogen side. And then when we think about just the ability to do things differently, carbon capture is now becoming a substantial part of the energy transition and making sure that we can reduce greenhouse gas emissions. And we've got technology across again, pumps, valves and seals on the carbon capture side, and we participated in the first flagship project in Europe and now the biggest project in the United States. And our pipeline or outlook for CCUS is tremendous. And so we feel that, that's going to move forward at a rapid pace, and we feel that we're incredibly well positioned for that. And then just to carry on recyclables. We're in the middle of recyclable plastics. Folks are putting the recyclable plastics on the front end of chemical plants, and so we participate there. And that's a really caustic and corrosive environment. And so again, repositioning our existing offering, pumps, valves and seals into the recyclable world, we feel that there's a significant runway for us and the ability to do that. And so I think -- just a few examples, Joe, but I can keep going on and on about where we're participating here.

Well, how should we think about your content on something, like if I was to tell you that x billion dollars of spending is going to transition from traditional oil and gas and -- oil and gas and refining applications towards the things you just mentioned. How do I think about Flowserve's participation? I know you'll be there, but how much will you be there relative to like what your legacy business is participating?

Yes, I think it's not going to happen overnight in terms of this massive change. But what I'd say is that, you take that $140 million, you put a CAGR of kind of 30% to 50% on it. And you can see that, that becomes a big number pretty quickly for us. And so that's what -- that's kind of how we see it. In hydrogen, while it's great, there's still some technology that has to progress to make green energy scalable and economical. And I'd say the same thing is with the carbon capture side. And so while the incentives are spurring substantial development at some point, incentives go away and the technology and the efficiencies have to come through. But I just -- I feel like this train has left the station. It's moving fast, and we're squarely in the middle of it. And then one thing, Joe, just I don't want to be remiss and not talk about our existing customers because it's really important. And so let's just take what we'll call it a [indiscernible] kind of old refinery that's still fueling all our vehicles that still providing jet fuel for 95% of the aviation need. So that's still critical particularly important. And while there might not be a green or a greenfield or a new refinery in the U.S. or Europe, keeping these assets up and running, it's so critically important. And then all of the major customers that own these assets are now absolutely committed to making sure that they are energy efficient, that they're green, that they're taking different feedstock, and that's any time there's a modification. So let's just say they change the feedstock and go more biofriendly or a bio -- sustainable aviation fuel or something like that, they're repiping their existing assets. And when they repipe, we're now providing new valves, new pumps or upgrading the existing technology. And then on the energy efficiency side, we've launched a program called Energy Advantage. And so again, we used the refining example. But we'll come in to an existing asset. We'll talk to the executives of that team, and we'll talk to them how can they run their pumps and their flow loop more efficiently than they can today. And by doing that, it's not only a cost savings, but it's a CO2 savings as well because the input of energy goes down dramatically. And so that offering now is spiraling up in a big way, and we feel like we're helping our customers really think through their own ESG journey and helping them to reduce their CO2 footprint tremendously.

And I mean you mentioned this earlier, but I think we should also touch -- I know it's adjacent, but touch on energy security, particularly in light of what's going on. I think there was a hydro dam that got destroyed today in Ukraine. So how do you -- how have your customers in Europe in that region been talking to you? And what are they -- like what do they need to do coming out of Russia to kind of, I guess, totally reengineer the way they think about providing energy for their countries.

Yes. We had orders for pumps at the end of last year in Germany and coal-fired power plants. And I would have never ever guessed that at the beginning of 2022. So the reason I say that is every country now is critically concerned about how are they going to get their future needs for energy because of the geopolitical landscape. And they started with Russia and Ukraine, but there's other parts of the world that are concerning now, and people are really trying to figure out how do we have the secure supply of energy for decades to come. And so what that's doing now is relooking and I'll start with nuclear and we'll kind of work our way down, but nuclear is now in the EU is now considered green. They did that deliberately to promote growth and stimulate more energy. And so in Europe, we're seeing life extensions. We're seeing greenfield nuclear facilities. We're also now seeing this in India move forward. We're seeing life extensions in the U.S. And so energy security on the nuclear side is tremendous for Flowserve. This is currently a big market for us. It's growing extremely fast in the aftermarket component and the margins with nuclear are really, really good for us. And so like the Velan example, we're leaning in on the M&A side to get more nuclear rounding out that nuclear portfolio. The other big area that we're seeing tremendous growth is on LNG and so liquid natural gas. And so again, countries adding the ability to regasify at their doorstep and bringing in natural gas to be a source of energy for their economy and for their country. And so we've seen tremendous growth in our LNG offering. I'd say for Flowserve, we've historically done well with valves and with seals. We haven't done great with pumps. We are aggressively moving forward with a cryogenic pump offering that we'll be able to put into the marketplace at the end of the year. And so that will help us with our total available market tremendously. And then back to the Velan acquisition, they've got a far broader cryogenic offering than Flowserve does today. And so we'll continue to position ourselves really well into LNG. And so we think that's a great transition fuel for the future. We see LNG continuing to be part of the energy security need. And then I'd just say just on -- back to coal-fired power plants in Germany, investing in oil infrastructure around the world. I think every country is slightly different, but they're looking to how do they drive energy security. And most energy has some aspect of Flow Control. And then the last thing I would say is the green energy side of this is accelerating because of energy security as well. And so whether that's wind, solar or traditional forms, it's all moving rapidly because of the need for security.

Perfect. I want to pivot slightly to some of the operational stuff. Since you've joined, it's been -- it's certainly been an operational journey. It still feels like you haven't been that long. And then I was like, wait, when, you've been there...

Yes, for 6 years now.

I know. It's crazy how fast that goes. But if we strip out COVID, which I know is kind of impossible to do. But what's been the biggest like variance versus what you thought coming in? And where do you think you've done particularly well?

Yes. And so just as a background for folks, when I started in 2017, there are definitely some operational challenges. And we'll fast forward and talk about that there still are some. But we launched what we call Flowserve 2.0 to really focus on operational excellence and change the way that we think act and operate and ultimately perform. And I'd say we made great progress in 2018 and '19. And whatever metrics you look at, the internal operational metrics, the financial metrics and the margins in primary working capital, everything was moving in the right direction. COVID hit us. It took us down about 30%. And so it is hard to ignore COVID, given the massive pullback in the total volume and what that volume has -- the impact it has on the ability to operate. But what I would say is the maturity of Flowserve 2.0, while we made great progress was not fully ingrained when COVID hit. And so then think about sending your workers home and adding just ridiculous complexity into the operations on whether that's safety protocols with COVID or then all of the supply chain challenges that became at the end of the COVID pandemic. But we weren't in the position to handle that as well as I would have liked to. And so I really see that more as a maturity standpoint. What I would say, Joe, and you've seen this in the last couple of quarters now, 2022 was a challenging year for us, and that's where it showed up the worst in terms of our execution in Q1 and then Q3 with the ERP conversion. But since then, what we're doing now is building on what we had just started in Flowserve 2.0, we've made some operational changes that are now moving forward. The external environment is far more stable than what we've seen at any time in the last 2, 2.5 years. And so I feel really good about our ability to execute and continue to do the things that we were doing back in kind of 2018 and '19. So we are making progress, and we're moving in the right manner. And then I'd just say, to answer your question specifically, one of the things that is still surprising or still lacking is really the focus on products and in applications and making sure that we have a more consolidated offering, a more simple offering in the right end markets and the right applications. And so the 3D strategy is helping us. And then at the end of last year at the third quarter last year, we announced a restructuring. And that restructuring is really intended to kind of align with the 3D strategy. So think 3D strategy in markets and then really getting more product and service focused on that. And I'd say that's the one area, Joe, that just has been difficult. We made some progress in '18 and '19 with COVID and the operational challenges. We weren't able to do as much as we wanted, and we're now really focused on that with this restructuring. And so I think in the future, you'll see a more in-market focused Flowserve, a more product and service focus. You'll see our offering will be smaller than what it is today and more rationalized, but it will be rationalized on the things that we can create value for Flowserve and for our shareholders.

So to your point, it seems like margins kind of trough there. You have operational momentum, assuming -- your guidance assumes operational momentum exiting the year. I know a couple of years ago, I mean, there was just issues amongst even communication like between facilities. It's a big footprint at Flowserve. So where do you think you are on that? Is there more consistency across the enterprise today? Is that like tangibly different from where you sit?

Yes. So 2 things. We made a lot of progress on this last year, just making sure that we're leveraging the whole enterprise because it is a broad -- it's still a broad footprint of manufacturing and just we operate in 50 countries and have 170 different QRCs. And so it is a complicated network, but I'd say that this org design is really intended to reduce that complexity and drive simplicity. And so we've done a lot of things internally to move to a business unit focus, making sure that those business units are aligned with the end markets and then they've got the operational tool set, all within their control to execute on their business. And so again, we've made great progress in the last 2 quarters. We've got substantial positive momentum on our operations, and this redesign on the org will only accelerate and move that forward from here.

So energy sector has been pretty volatile of late. Saudi is making moves to [ retail ] production, but your orders have been really good for a while now. So where do you think we are in that cycle? And are your customers kind of has been paying a ton of attention with crude at 65, 70, or is that just like that's totally a fine number, and we don't have to stress out about 5% move here or there?

Yes. It's a good question. Gosh, if you watch the news or read anything online or on the paper, like it's a depressing backdrop. But what I would say is, we're not seeing that in our order rate. And so my commentary on today will be very similar to how I talked about the end market in the Q1 earnings call, a couple of things. So first of all, on the daily business, I think MRO, aftermarket, high-volume parts, services, things like that. We've got a nice dashboard that we can see our European bookings on a daily basis, and we can see the U.S. and Americas. And at this point, I get it weekly. I don't look at it daily, but our teams see it daily. We see absolutely no slowdown at all. There are some pockets of concern with the GDP-based businesses in Europe, but we're offsetting that with some of the other daily activity. And so again, when you think about like these big assets, they've got to be running at a high level. Productivity is important, keeping them up and running the aftermarkets coming through. And so right now, we see absolutely no slowdown on our daily business. And then on projects and capital, back to energy transition and energy security is offsetting any kind of GDP type recession at this point. And again, our funnel looks tremendous in terms of forward outlook. And at this time, our discussions with customers are not supporting any pullback or slowdown. And Flowserve is typically operated in a multiyear cycle. We're traditionally a late cycle business. I hate to say some of these because I know history doesn't always repeat, but we think it generally holds to a certain trend. And so we feel like we're in kind of the second year of a multiyear up cycle, and at this point, I don't see anything that changes that.

I think that's a good point to follow up on because outside of idiosyncratic things, ERP, let's just eliminate all of that. When I talk to investors, long-term investors about Flowserve over the years, I think some of the pushback we get is just, you have to catch it at the right time. It's a boom or bust type company. If you get it as orders are dropping and rising, like you're going to be fine but you have to know when to exit. And it's hard to get people in line with like, why do I need to own this over a cycle, right? Now some of that is the nature of what you do. I mean, you're never going to be able to strip out the cyclicality of the business totally. But what can you do here? What have you done over the last 6 years? Can M&A play a bigger role in smoothing like earnings performance, what is like in terms of whether it's subscription type maintenance type work, like how can you help assuage some of those concerns?

It's a really good question, Joe, and it's something that we're working on. And so I'll just start by -- if you look at capital intensity across any of our end markets, even if it's general industries, there's -- it is cyclical, like I mean it's just the nature of our business. But we recognize this even before the COVID downturn, and we started working on a diversified strategy, which ultimately led to our 3D strategy. And so we -- I feel very good about the 3D strategy, driving a smoother bookings growth and trajectory than what we've had in the past. And so obviously, the diversified lane is moving out of kind of the most cyclical side of our business, which is oil and gas, but also acknowledging the energy transition and making sure that we can do Flow Control outside of just hydrocarbons. And then the decarbonization side, again, is I believe that our existing customers -- so I think big refining, oil and gas, petrochemical, whatever it is, they're not going to slow down their decarbonization spending, right? They've made commitments externally. They've made commitments to governance. You've got government regulation. And so I feel like that continues to grow regardless of capital intensity. And then the digital side is really meant to drive Flowserve more and more into services and solutions. And so that's an important part of really trying to maintain a more steady revenue stream if we can get long-term service contracts, life cycle agreements and things like that, that strips out the volatility within our business. So I think the diversified side will get us into markets that are either one countercyclical to what we're in today or have less exaggeration on the up and down. The decarbonization lane will continue to grow despite what happens with capital intensity. And then this move from just providing products and parts to services and then ultimately to solutions allows us to be more of a recurring revenue stream, which simplifies and keeps things more steady than in the past. And so I think we're on the right path here. It won't change overnight, but I do think today is a much less cyclical business than what we've ever had at Flowserve.

Maybe one last question. I just wanted to touch on the water side. I know it's a business that you're very excited about, but it's still fairly small in the percentage-wise of total revenues. But just given what's going on in Colorado River Basin and much more intense focus on drought conditions and what we need to do. Like where do you see yourself positioned there? And how like -- can that ever be a significantly larger piece of your company?

Yes. I think it can, and there's 2 things, right? One is this is probably an area for M&A to really get us into water in a bigger way than we are today. But then secondly, we're putting our -- it's in the diversify lane on the 3D strategy. We're putting a lot of R&D dollars there. We've announced a pressure exchange technology, which is -- supports desalination in other water markets. We've done -- upgraded our offering in the water space on our submersible pumps. And so you'll continue to see us add things into water. Adding new product development will be relatively slow growth. And so this -- again, this is something that we'd look more inorganically to grow. But water is not going away. It will become the most critical resource in the world, and we believe that we're positioned to be a participant in a big market as we move forward.

Perfect. I think that's just at the end of our time there. I want to be respectful of everyone's schedules here. So Scott, I appreciate it. It's great to see you, as always, and thanks for your time.

Yes. Thanks, Joe. I appreciate you having us again, and have a good rest of the conference. Thank you.

Thanks.