Flowserve (FLS): Impressive Again

Despite owning very few names, I continue to keep up with many companies monitoring their results, cash levels, commentary on order flow and if the "death of the entire globe" story is a bit overdone. It's a moot point talking about commodities or financials as they spin in their own universes but a company like Flowserve (FLS) which has been thrown into the "global growth" garbage pail is one name I am interested in for multiple reasons. (note: unrelenting bitter sarcasm ahead)

We owned this name for a short time and lost a little money despite the company raising guidance last time around [Jul 31: Flowserve Mighty Impressive Earnings] - right now the market thinks every company with even 1 customer outside the US is apparently lying. To show how ridiculous this market is, at the end of July Flowserve increased their guidance to $7.20 - $7.50 a share UP from its previous forcecast of $5.90 to $6.20. Analysts were at $6.31. The reward for this? An absolute demolishment - we sold at $105 on September 11th. Yesterday it was trading down to $41s. That's what you get for having anything to do with global growth EVEN if you raise guidance. That's a 60%+ loss in 6 weeks for anyone who uses the old arcane arts we call "sense" and "fundamentals". We avoided that 60% drop, but the point is - this market is senseless. Just yesterday alone between early afternoon and late afternoon the stock rallies 17%? Again - senseless casino action. Buy stock, pull lever, ching ching! Buy stock, roll dice - black or red!


But it's still >50% lower than where we sold it even after yesterday's boffo rally, and now they are confirming their guidance that they raised massively 3 months ago and saying they will hit the upper end, despite the US dollar rallying against them. I know, I know - "but next year !! next year the story ends!!" Well they talk about that - not that it will matter because every company is an accused liar nowadays...

I'd really like to start buying up companies like this if I had any belief the market would not turn tail within hours/days and demolish any sucker who sticks a hand out at over 3x earnings. But again with our new casino... err market... mentality that every company will be destroyed next year and instead of growing see their business cut in half, we will assume half of Flowserve's customers cancel/implode/go back to pumping water by hand and return to life of the 1880s. In this scenario Flowserve will see its earning drop from say $7.40 in 2008 to $3.70 in 2009 (analysts currently say $8.54 for 2009 but remember the bears insist we price in Apocalypse to try to protect to the downside) So at the Apocalypse earnings of $3.70 x the Apocalypse PE ratio of 3 we see this stock should be $10 - so the bear tells me. If you believe the world will insist on running water even in Great Depression 2.0 than I suppose there is upside from there. But don't tell the bears. Or hedge funds who will be out of business by Dec 31st and have been selling this stock every day.

p.s. do bears need to drink water or will they be drinking from streams in '09?

Full report here

• The company announced third quarter fully diluted EPS of $2.04, up 86% (including items of $0.10, net), and operating income of $163.6 million, up 51%, both over the third quarter of 2007.
  
• This earnings growth significantly outpaced strong quarterly sales growth of 26%, compared to the same quarter of 2007, which was driven by a third quarter operating margin improvement of 240 basis points, to 14.2%.
  
• Flowserve also posted record third quarter bookings of $1.37 billion, up 30%, 22% on an organic basis (excluding currency effects and the acquisition of Niigata Worthington), over the prior year period, driven by continued strong growth of both its original equipment and aftermarket business.
• The company also indicated that it now expects full year 2008 EPS at or around the high end of the previously announced range of $7.20 to $7.50, despite adverse currency impact.

Great operation metric improvements & upgrade in debt

• Gross margin improvement, up 100 basis points to 35.1%
• SG&A reduction as a percentage of sales, down 170 basis points to 21.2%
• Corporate credit rating increased by Standard and Poor's to BB, with a positive outlook on September 29

Aha! They goosed earnings with tax rates - as the gypsy bear told me, this should be a $5 stock - maybe $1. Without such tax advantage they might of only made $6.50-$6.75 in 2008 instead of near to $7.50. If you slap a 3 PE ratio that means $20 stock at most. 50% down to go. Why 3 PE? That's what all the cool global growth stocks are getting now; even the ones growing 30-50%. 15 PE is reserved for subprime slimed banks and stuff.

• The effective tax rate of 18.7% for the third quarter 2008 decreased from 33.7% for the same period in 2007. The effective rate for the third quarter 2008 includes a net tax benefit of $12.4 million arising from tax benefits related to the company’s permanent reinvestment in foreign subsidiaries, release of certain reserves related to the closure of the statute of limitations on tax audits in various jurisdictions and repatriation of foreign source cash.
• The year-to-date effective tax rate of 23.8% decreased from 31.1% for the same period in 2007. The decrease is primarily due to the net impact of foreign operations, a favorable tax ruling in Luxembourg, benefits related to the reinvestment in foreign subsidiaries and the closure of the statute of limitations on tax audits in various jurisdictions.

But won't all your customers cancel every contract and you should go back to being a $10 stock?

• “We are continuing to see high quotation levels requested for our products and aftermarket services throughout our global markets, and at the same time are monitoring general global economic conditions very closely and are prepared to quickly respond to any changes in market conditions,” said Lewis Kling, Flowserve President and Chief Executive Officer.
• “We believe that our backlog is very solid, bolstered by the strong project completion needs of our customers,” said Kling. “Additionally, we have not seen any unusual cancellations to date,” he added. (but just wait - they will start next month! a gypsy bear told me - even though he told me they already started cancelling last month due to your stock price obviously showing that)
• “The third quarter was another very strong quarter for Flowserve, with record bookings, sales and backlog,” said Kling. “We continued to see strength in our global markets, specifically the oil and gas, power, chemical and water industries." (that just doesn't jive with the gypsy bear story - he says all these things stop happening below $80 oil - because as you know oil is water - it's all the same in commodity world. Something doesn't make sense. Well it doesn't matter - if it didn't happen this past quarter the bear just says "that's the past, look for the bad news in the future")
• “And while it is impossible to predict the impact of the current credit situation on the global economy, history has consistently shown that our markets may temporarily weaken during their cycles, but they do not go away and even provide a chance to grow market share for strong companies like Flowserve. (gypsy bear says they will go away - he insists)

Also a cute little feature I don't believe I've seen before on a balance sheet - they broke out debt due within a year ($21.7M) on its own line item. Talk about a management thinking about all the bear cases ahead of time. I assume the bear is planting many seeds of doubt so they are receiving many concerned phone calls. Anyhow their cash flow was near $0 so the bears can indeed find something to growl about.

Anyhow, based on the advice of the bears and judging by the stock price I have no idea how any global growth company can execute like this. There must be typos in this press release - I assume a revision will be out shortly with corrections. Just remember the bear credo - keep accusing the company of faltering and when the company executes just keep saying "we meant the next quarter is when failure and cancellations begin!". It is sort of the reverse of what the hypester bull does - he/she who promises the next quarter the [company/economy] will be just fine and dandy and you just have to look past the valley and into the bright light coming. And no it's not a train.

But in this perverse market we won't care about actual results and just hide under the bed and talk about boogey mans. While, if past is prologue (see summer 2008), on any sustained rally the market will reward the useless companies tied to the dying US consumer despite horrid results with promises of 'good times soon as the US consumer comes back strong! even as our results show nothing of the sort!' And ignore the "global growth" companies who serve many countries with governments and individuals who actually save money unlike us. Boo and Yah.

Anyhow at 3x earnings which is a "fair" figure for companies of this ilk if you go by the current market valuation methodology (i.e. "sell until the hedge fund is empty of all stock" valuation), this is one overvalued beast :) I look forward to owning it again when having a PE multiple at >10% of your growth rate is not considered excessive. (PEG ratio of 0.10 is fair value now for you IBD folks) Or if you are like most (ahem) "investors" today in the casino, buy it this AM in premarket and sell it by 4 PM for your pound of flesh. Because no company is good enough to actually (gasp) hold for 48 hours.

No position but one day we'll return when the hedge funds are done selling and people realize not every country is the United States of Subprime