OREANDA-NEWS. Fitch Ratings has assigned Flowserve Corporation's (FLS; BBB/Stable) proposed senior unsecured notes a 'BBB' rating. FLS plans to issue EUR500m senior unsecured notes that will rank equally with the company's other existing unsecured notes.

FLS plans to utilise the raised funds to repay approximately USD255m in borrowings from the revolving credit facility it incurred in connection with the acquisition of SIHI Group B.V. (SIHI) completed on 7 January 2015. The remainder of the funds will be used for general corporate purposes including share repurchases.

FLS's ratings cover approximately USD1.7bn of long-term debt including the proposed EUR500m of senior unsecured notes. The indenture governing the proposed notes is not changed materially from those governing the company's existing senior unsecured notes.

Fitch notes that by issuing in euros, FLS will more closely match the currency exposure of its debt to its cash flow, as 19% of the company's 2014 revenue was generated in Europe. Additionally, SIHI generated approximately EUR270m revenues in 2014, and is expected to increase FLS's sales and cash flows in euros.

KEY RATING DRIVERS
The ratings reflect FLS's strong credit metrics, good end-market and geographic diversification, well-established market positions, a substantial portion of higher-margin aftermarket business, fully funded US 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.

Fitch expects FLS's credit metrics will deteriorate with the issuance of the proposed EUR500m of senior unsecured notes, and any further material weakening of the metrics could potentially pressure the ratings. Fitch estimates the company's adjusted leverage (adjusted debt to EBITDAR) will deteriorate to approximately 2.2x immediately following the issuance of the EUR500m senior unsecured notes, up from 1.6x at the end of 2014. Similarly, FFO adjusted leverage is expected to deteriorate to approximately 2.9x, up from 2.1x at the end of 2014.

FLS's operating performance in 2014 was in line with Fitch's expectations and supports the ratings and Outlook. FLS's revenues deteriorated by 1.5% in 2014, mostly driven negative currency effect (USD112m) and by a decrease in original equipment sales in Europe, the Middle East and Asia Pacific. Despite lower revenues, the company earned USD931m EBITDA up by 8% compared with USD863m EBITDA generated in 2013. FLS improved its EBITDA margins for the fourth consecutive year and reported 19.0% in 2014, up from 17.4% in 2013 mostly driven by a better sales mix of higher margin aftermarket products and by lower sales and administrative expenses.

Fitch expects FLS's revenues will increase by high single digits, mostly driven by the SIHI acquisition. Additionally, Fitch expects the company's EBITDA margins will deteriorate slightly due to an unfavourable sales mix and the effect of lower margin SIHI products.

As of 31 December 2014, FLS had USD1.4bn liquidity, comprising USD450m of cash and USD923m in revolver availability (USD1bn less USD77m in outstanding letters of credit). FLS's liquidity declined by approximately USD365m in 1Q15 immediately following the SIHI acquisition, which was funded using approximately USD110m in available cash and approximately USD255m in borrowings from the company's revolving credit facility. Fitch expects the company's will restore its solid liquidity as it repays borrowings under the revolving credit facility. We expect FLS's liquidity will remain in the range of USD1.1bn to USD1.3bn over the next several years.

Fitch expects FLS will generate USD350m-USD400m of FCF after dividends annually over the next several years, driven by a lower past-due backlog, improving margins and higher sales. FLS generated approximately USD353m of FCF in 2014, up from USD272 million FCF generated in 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 expects FCF and liquidity to support approximately USD400m 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 risks 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.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Mid to high single digit revenue growth in 2015.
- Lower overall EBITDA margins in the range of 18% to 18.5% immediately following the acquisition.
- FLS's leverage will remain mostly unchanged over next several years.
- The company will continue returning capital to its shareholders, in line with the stated policy.
- The company will generate USD350m to USD400m FCF annually.
- Capital expenditures will fluctuate in the range of 2.6% to 3.0% of revenues, annually.
- Fitch does not expect FLS to make sizable acquisitions in the near future.

RATING SENSITIVITIES
Fitch may consider negative rating action if large-project pricing pressures or weak 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, negative rating action may be taken as a result of aggressive cash deployment for debt-funded acquisitions or share repurchases.
Fitch may consider 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 USD250m FCF annually.