Flowserve Corporation (FLS) Earnings Call Transcript & Summary

Good afternoon, everyone. Thanks for taking the time to join us today. My name is Joe Giordano. I cover Industrials here at TD Cowen, and thanks for joining our second annual virtual Sustainability Conference. [Operator Instructions] So to start off, we have one of our top picks with us here today. Very happy to have Scott Rowe, President and CEO of Flowserve. So we're going to kick things off with Scott with a couple of prepared remarks, and then we'll jump into topics. [Operator Instructions] So thanks, everyone. Scott, I'll turn it over to you, and we'll get going.

Yes, great. Thank you, Joe. We appreciate you having me, and thanks to TD Cowen for the support and letting us participate today. Given that it is a sustainability conference, I wanted to talk about our ESG report just real quickly, and then we'll jump into Q&A. But this went out, gosh, 2 weeks ago now, we're labeling it an extraordinary impact. And I think probably the coolest thing is the ESG report is very much aligned with our 3D strategy of diversify, decarbonize and digitize, and so very much aligned with what we're trying to do as an organization. And I'll just say that this report really tells the story of what we're trying to do with climate, what we're doing internally with our culture and what we do with the core responsibility of the governance aspect of our business. Some of the highlights, we put out a 2030 target for CO2 emissions intensity. We've exceeded that now in our first 3 years, and so we're now at 46%. So we'll need to come with a new target this year, but a really great effort on really driving intensity down. And then I'd just say our net carbon emissions also went down in this period. So really good work. Our safety program continues to be world-class. Our [ TRIR or TRR ], is 0.32. And for an industrial company that's in the top kind of 10%, if not higher. And so we're doing a really good job looking after our global workforce of over 17,000 people. And then on the bottom there, we do a really nice job with Flowserve Cares giving back to the communities where we live and work, and we take that very seriously. We've got a very robust effort there. And it's not just dollars, it's more about volunteer service working with STEM education in various parts of the world and some of the disaster relief because we're working in all kinds of crazy places, inevitably something is happening, and we're doing a lot to give back. So we've got a lot of recognition. We're in kind of the top quartile or top half of all industrials now when we think about our ESG program. And again, probably most importantly, what we're doing with ESG is very much aligned with our 3D strategy, helping our customers to diverse -- or decarbonize big assets, working on diversification programs and then ultimately making the world better place through our Flow Control technology. So with that, Joe, I'll take the slide down and happy to jump into any questions.

Yes, what you said there, it lines up well with what we're trying to do here, like where you have a really in-depth sustainability effort internally, but why this is interesting for this conference is like sustainability is kind of at the core of what you do and what you kind of provide for your own customers, [indiscernible] goes really nicely. It's funny. When I was writing up topics. You've been at Flowserve for a while now. It doesn't feel like it's been that long, I remember when you came on, and I guess it was making us both feel old, I guess, but...

Definitely getting older. 7 years now, at Flowserve.

The company is on firm footing now. It seems clear. It's not just 1 quarter phenomenon that we've seen. It likely took longer than you probably thought when you came on board. But outside of things like COVID, which I know derailed momentum you had earlier on. What maybe did you underestimate a little bit stepping in? And what do you think you're getting right currently as [indiscernible]?

Yes. Sure. I'd say it does -- I mean, some days, it feels like it was yesterday that I just showed up, but it has been 7 years now, and we've gone through a lot. And as you said, we're -- firm footing is a great way to say it. We've got a lot of positive momentum. So we're heading in the right direction. I'd say at the beginning, what did I not fully appreciate, I'd say just like the level of decentralization and lack of process and then just the systems landscape that was so disparate. And when you're trying to do that and change the culture, instill core values, drive a purpose-driven organization, it was just a lot of change at once. And I'd say we made really, really good progress kind of in those early years going '17 to '18, '18 to '19, and I'd say from a maturity perspective, we had kind of moved up that maturity ladder. We were making great strides across all of the major initiatives and COVID just ended up kind of really turning us upside down. Our business went down in bookings about 30%. And then we are working through the supply chain challenges and all that. But if we fast forward to now, like what's working is we've gotten through that. The end markets are very supportive, and we can talk about that if we want later on. And we continue to refine the operating model from what we were doing at Flowserve 2.0 to what we launched last year. What I'd say is I'm really excited about the org design that we put in place last year. And so for those that aren't familiar with it, we created 7 operating business units. And we did this categorize around our product offering, but more importantly, like that, the industries that we serve, the customers and the channel to market. And so we have 7 of these. We've got 4 on the pump side, which is engineered pump, industrial pump, our mechanical seal business and then services and solutions. And then on the valve side, we have automation controls, isolation valves and service and solution to do the aftermarket in the MRO there. But that level of focus now with these 7 P&Ls and the right resources at that level is really proving to do -- to move our business forward, not strategically but also operationally, and the business units now have all of the resources that they need to drive growth, to drive customer support, to drive a healthy P&L. And then the other thing we did was some pretty major changes in operational excellence. And so we changed some people out. We've doubled down on process and focus. And again, we made good progress pre-COVID and then kind of got sideways in some of the supply chain challenges, but we're in a really good place now. And so I feel good about what we're doing. And as you said, Joe, solid footing, but really, we're kind of now in 6 to 7 really strong quarters of continued improvement in operational momentum. I'll just finish up, I'll wrap up with a few high-level remarks. I'll start with the 3D strategy. It continues to work very favorably. The digitized side hasn't gone as fast as I would have wanted. However, we've now instrumented over 2,200 assets around the world, we're 25% higher than where we were last year. And we think we're at a real inflection point in terms of growth. And we remain committed to digitization. We really like the ability to collect data on our assets, pumps, valves and the mechanical seals. We believe that ultimately this helps us towards solutions with our customers. Additionally, the digitization side, we feel really good about our ability to work [indiscernible] to our operations and drive strong efficiencies with the digital perspective. And then on diversified side, maybe a little bit slower than -- a little bit more challenging here to reposition the whole portfolio into diverse markets. but something that we're very much working to do. So think of applications like water, specialty chemical, pharmaceutical, where we've got great products and able to reposition there. And then on the decarbonization side, this is where we're seeing the most activity, where we're getting existing assets like a refinery, a chemical plant, where operators are looking to decarbonize that asset. And so reduced energy consumption, carbon capture on the front end or on the back end, maybe a biodiesel or bio conversion throughout the facility, maybe chemical recycling on the front end, but a lot of different ways that we can help to decarbonize and drive energy advantage.

So the first question we discussed on where you guys stand and the momentum you have. On margins, I think that's pretty clear. And I think you could probably look at it 2 ways. One, you're seeing clear momentum there. But two, they're objectively still kind of on the lower side, right, if you were to compare to broad industrial. So how do you think about the potential there in the next couple of years? And what are the likely contributors to more meaningful expansion?

Sure. Yes. So we put margin targets out with last year at the Analyst Day and Investor Day. And so our target is 14% to 16% operating income by 2027. And that's roughly where we were last year, about 400 basis points from where we are now, but we're making good progress there. And so we feel very good about meaty step changes on margin improvement every year. We're doing that on the back of operational excellence. So that's where we see the early results. And then the product management and portfolio management, in the Investor Day, we committed to another 100 to 200 basis points of margin improvement on the back of that effort. I'd say we're in the very early stages of that, but we feel really good about the product initiatives driving another upwards of 200 basis points. And then we get up to the higher end of our range with just leveraging our scale and continued good cost control, which we've done pretty much throughout my tenure. So getting to this 14% to 16%, we've got clear line of sight. We're making good progress. We're seeing media improvements year-over-year. When we talk about kind of the broader industrial base that might be upwards of kind of 16% to 18% or even slightly higher, that's going to really require the mergers and acquisition side and the portfolio side to continue to move more and more into the industrial type products and then also continue to move more and more into our aftermarket, the higher margin. And so that's clearly part of the strategy. I would say, right now, we're very focused on the 2027 targets that we laid out. But by driving more diverse portfolio, by driving the aftermarket initiatives, we've got the ability to start to walk that up even higher.

I know we're a little bit stretch for time now. So I'm going to kind of go through these a little bit quicker, but just, I want to touch on the sustainability side, just from a messaging standpoint because I think there's still a lot of debate, and I could tell when my client discussions are like where does Flowserve fit into this whole concept because some might argue, you have a lot of percentage of oil and gas, but I think you can make an argument that, yes, but the transition of your customer base is you're going to be an enabler of that. So can you maybe talk about where you fit into the goals of your customers and what they're going to look like down the road?

Yes. So our products typically are in large installations. So refineries are single biggest market, right? When you think about a refinery, it's essentially a chemical plant. And what operators are doing, whether it's a pure refining company or an integrated oil company or a national oil company, they all have targets and some of it is regulation driven, some of it is government-driven, but others is just their own ESG targets. And they're trying to do the right thing to drive emissions down to make that refinery of that asset more efficient. And we're involved in all of that. And so we've had amazing work in what we consider the decarbonization lane supporting those existing customers really helping them through this journey. And I can go through -- we'll go through examples here, but a lot of them are doing biodiesel conversions or doing some sort of blended formulaic approach on the front end that's still delivering some sort of fuel that works in whether it's sustainable aviation fuel or a biodiesel plant or something blended into a normal gasoline. But when they do that, they're replumbing their system with different pumps and valves. And so we're involved in that. A lot of times on the front end now, we're seeing -- certainly on the chemical plants, we're seeing recyclable plastics. And so we're involved with technology to help the recycling aspects of plastics on the front end. We've got a program called Energy Advantage, which is a consultative program where we go in and we assess a flow loop and we look at the pumps and the valves, and we say, hey, this flow loop can be run more efficiently. And by running it more efficiently, your energy consumption drops down, your CO2 emissions gets better. And then on the back end is the carbon capture. And so we've got opportunities through some of our pump technology and valve technology to pull from their flare or flue gas, we can cover that carbon and then we're involved in the sequestration of that, whether they're putting it in underground storage or are they putting it back into their process. So we're doing a ton of work with our existing customers that we've been with for a long, long time. We have a massive installed base in these existing infrastructure, and we're helping them with their initiatives through ESG or complying with regulatory environment. So look, we feel like we're in the middle of this. Every day, we've got wins for our customers, and we're pretty excited about what we're doing here.