Last Friday, Flowserve Corp.
That's right, Flowserve still has to deal with asbestos litigation, shareholder derivative lawsuits, and an SEC investigation into the violation of the Foreign Corrupt Practices Act. That should be a big red flag for most investors to stop any further analysis and move on to another company. But with the stock up 250% over the past year and a half, maybe Flowserve is doing something right and deserves a second look.
So, how is business faring sans the shenanigans? Sales for the first half of 2006 increased 8% over the same period last year. Organic bookings, which are receipts for new customer orders, increased 32% over the same comparison period. To meet increasing demand, Flowserve has increased its manufacturing capacity in China.
More importantly, a greater portion of each dollar in sales is falling to the bottom line. Operating and net margins increased from 6.3% to 7.8% and from 1.1% to 3.3%, respectively. And the increasing margins helped to improve its return on shareholders' equity (ROE) to 8.7% on a trailing-12-month period. All in all, it looks like business is fairing well.
In the company press release, CEO Lewis M. Kling states, "We are encouraged by the success to date of our operational excellence initiatives, our strong operating performance, and our ability to take advantage of extremely robust markets, which we expect to continue."
However, I'm less sanguine about Mr. Kling's next comment, "Today's stock repurchase announcement further underscores our positive view and confidence in our company and our businesses." Sure, sales have quadrupled since 1996, but net earnings have remained flat. That's right. In 1996, Flowserve earned $43 million on $605 million in sales, whereas in 2005, it earned $46 million on $2,695 million in sales. Now, that is not something to get excited about. Consider that competitors such as IDEX Corp.
The bottom line is that no amount of positive spin can dismiss the fact that Flowserve isn't earning enough to meet its cost of capital or that any reinvestment, including the share buyback program, is anything but a value-destroying proposition. Until Flowserve cleans up its legal affairs and can figure out how to create sustainable shareholder value, it's not ready for this Fool's portfolio.
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