Flowserve (FLS) Ugraded to BBB by S&P; Notes Good Operating Performance Bringing Credit Metrics Inline

Standard & Poor's Ratings Services raised its corporate credit and senior unsecured debt ratings rating on Dallas-based precision-engineered flow control equipment manufacturer Flowserve Corp. (NYSE: FLS) to 'BBB' from 'BBB-'. The outlook is stable.

"The rating upgrade recognizes Flowserve's good operating performance, which has resulted in credit measures that are now commensurate with the current rating," said Standard & Poor's credit analyst John Sico. We view the financial risk profile as "modest" as credit metrics are in the range of 45%-50% FFO/Total Debt and Debt to EBITDA is less than 2x. The company also has demonstrated discipline with respect to financial policy related to acquisitions and share repurchases. The rating on Flowserve also reflects our view of the company's "satisfactory" business risk profile and resulting good credit metrics. Management's focus on improving operations resulted in better margins, good free cash flow generation, and better-than-expected debt leverage. Our expectation allows for debt capacity for the company to undertake bolt-on acquisitions and shareholder returns in line with its stated level of 40% to 50% of average earnings. Although the company could do more share repurchases absent a large debt-funded acquisition, we view the company's debt capacity as sufficient to sustain its credit metrics, notwithstanding a transformative acquisition.

The company's sales and order bookings have improved gradually over the last few years. The company's backlog was $2.7 billion as of Dec. 31, 2014, with good portion related to aftermarket sales. The company's energy end markets are somewhat exposed to oil and gas prices but they operate predominantly in midstream and downstream markets. In addition, we see product demand to be less influenced by customer's capital budgets, and more insulated by customer's routine maintenance spending (and we have not seen cancellations on upstream projects). We also note that some uncertainty surrounding global economic conditions persists, which may influence the company's other end markets; as a result, we have incorporated the impact that a stronger dollar may have on its business in 2015.

The outlook is stable, reflecting the company's relatively good operating metrics and our expectation that it will sustain its performance over the next couple of years. Given its geographic and end-market diversity as well as its substantial aftermarket business, we believe that Flowserve can maintain its good internal cash generation.

Management has sustained the company's operating performance and refrained from any large debt-financed acquisitions. However, we could lower the rating due to weaker end markets, specifically if oil and gas markets weaken much further, greater-than-expected shareholder-friendly activity, or any large debt-financed acquisitions. Specifically, if we expect debt to EBITDA to deteriorate to more than 2.5x and FFO to decline to less than 40% for a sustained period, we could lower the rating.

Given some capacity for share buybacks, pursuit of bolt-on acquisitions, and increasing dividends to shareholders, we do not foresee an upgrade in the near term.

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