Fitch Affirms Flowserve's Ratings at 'BBB'; Outlook Stable
NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Flowserve Corporation (FLS) at 'BBB'. The Rating Outlook is Stable. The ratings cover approximately $1.2 billion of debt. A full list of ratings follows at the end of this press release.
KEY RATING DRIVERS
Fitch's ratings reflect Flowserve's strong credit metrics, good end-market and geographic diversification, well-established market positions, a substantial portion of higher-margin aftermarket business, fully funded U.S. pension plans, a sizable backlog, and solid operating performance which includes improving margins and strong free cash flow (FCF) generation. Fitch also notes Flowserve's technological capabilities and global presence.
FLS's operating performance in the past year was in line with Fitch's expectations and supports the ratings and Outlook. Despite slow aftermarket activity in some of its largest North American markets, the company increased its revenues by more than 4% while improving EBITDA margins from 16.9% to 17.4% in 2013. Additionally, FLS slowly decreased its past-due backlog, which had a negative impact on the FLS's operating margins in 2012 and 2011.
Company leverage (debt/EBITDA) of 1.4x remained within the lower half of Flowserve's target leverage range of 1.0x to 2.0x as of Dec. 31, 2013., FLS's leverage declined to 1.3x as of March 31, 2014, and Fitch expects it will gradually decline to 1.1x over the next several years assuming no additional debt issuance and barring unexpected economic downturn or operating issues. Current leverage affords FLS flexibility to issue debt to pursue small- to medium-sized acquisitions or fund moderate share repurchases at current ratings.
As of March 31, 2014, FLS's liquidity of $1.1 billion comprised $164 million of cash and $904 million in revolver availability ($1 billion less $96 million in outstanding letters of credit). Fitch expects Flowserve's liquidity will remain in the range of $1.1 billion to $1.3 billion over the next several years.
Fitch expects FLS to generate $350 million-$400 million of FCF after dividends annually over the next several years, driven by lower past-due backlog, improving margins and higher sales. FLS generated approximately $295 million of FCF for the last 12 months (LTM) ended March 31, 2014, down slightly from $302 million FCF generated in the LTM ended March 31, 2013.
The company's strong FCF generation should support its cash deployment strategy which focuses on sizable capital expenditures to achieve organic growth targets, a return of 40% to 50% of two-year average net income to shareholders, and medium-sized bolt-on acquisitions. Fitch notes that the company has financial flexibility to issue additional debt before leverage increases to the 2.0x level. Fitch expects FCF and liquidity to support approximately $400 million per year of spending on dividends, acquisitions and share repurchases. The company has a conservative debt structure, with no significant maturities scheduled before 2018.
Rating concerns include FLS's exposure to highly unstable geopolitical regions; possible margin pressures due to higher raw material costs and the impact of project delays; seasonal cash generation; heavy cash requirements to support large swings in working capital; cyclicality of certain end-markets; and competitive pricing pressure throughout the industry. These factors are incorporated in the ratings.
The net underfunded status of FLS's global pension plans at the end of 2013 was $164 million (positive $5 million in the U.S.; $168 million outside the U.S.). The company contributed $24 million to its qualified U.S. defined benefit pension plans in 2013. FLS did not make contributions in the first quarter of 2014; however, it plans to contribute $20 million during the year. Fitch does not expect pension contributions to be a major part of the company's cash deployment strategy.
Fitch expects FLS's revenues to increase by mid-single digits in 2014 with higher margins driven by operating improvements, the reduction in past-due backlog, and a rebound of aftermarket activities in North America. These margin improvements may be slightly offset by an unfavorable sales mix towards original equipment. Fitch expects geopolitical unrest in regions such as Ukraine and Iraq to have a limited impact on the company's performance.
A large portion of Flowserve's cash is invested outside the U.S. but the company does not currently plan to repatriate funds, which could result in adverse tax obligations.
Fitch may consider a positive rating action should the company demonstrate its ability to limit exposure to losses from large projects, consistently maintain its past due backlog at less than 5%, and generate more than $250 million FCF annually.
Fitch may consider a negative rating action if large-project pricing pressures or poor operating execution leads to a significant deterioration in the company's credit metrics, including an increase in the company's debt-to-EBITDAR ratio toward 2.5x or higher or an increase in funds from operations adjusted leverage above the range of 3.25x to 3.50x. In addition, a negative rating action may be taken as a result of aggressive cash deployment for debt-funded acquisitions or share repurchases.
Fitch has affirmed the ratings for Flowserve as follows:
--Issuer Default Ratings at 'BBB';
--Senior unsecured bank facilities at 'BBB';
--Senior unsecured notes at 'BBB'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage