OREANDA-NEWS. Fitch Ratings has affirmed the ratings of Flowserve Corporation (FLS) at 'BBB'. The Rating Outlook is Stable. The ratings cover approximately \$1.6 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. The ratings and Outlook are also supported by management's commitment to a balanced capital deployment strategy, as the capital structure is managed to maintain a publically stated leverage (debt/EBITDA) target in the range of 1x to 2x.

FLS' leverage of 2x was at the high end of the company's target leverage range of 1x to 2x following the issuance of 500 million in euro-denominated notes in March 2015. FLS' adjusted leverage (lease-adjusted debt / EBITDAR) deteriorated to 2.4x, up from 1.6x, as of March 30, 2015. Fitch expects leverage and adjusted leverage will remain at approximately 2x and 2.4x for the next two years. Pressures in the Gas and Oil sector and FX headwinds are expected to offset anticipated revenue increase from the integration of SIHI Group B.V. acquired earlier this year. Fitch expects leverage will gradually decline after 2017, but notes leverage may decline to approximately 1.7x by mid-2016 if the U.S. dollar weakens or gas and oil price pressures soften.

FLS generates strong cash flows as the company's FCF (after dividends) margin has been in the range of 5.5% to 7.2% over the past three years. FLS generated \$353 million FCF in 2014, up from \$272 million in 2013. Fitch expects the company will generate above \$300 million FCF over the next several years.

The company's cash 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 above \$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' exposure to 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 in certain end-markets; and competitive pricing pressure throughout the industry.

The company is broadly exposed to the oil and gas market across several of its operating segments. The crude oil price declines have had a negative impact on midstream and upstream (E&P) Oil & Gas markets resulting in delayed deliveries on several projects and slower bookings in the first quarter of 2015. Fitch expects that a lack of recovery in current oil prices of \$60 per barrel may negatively impact the company's performance.

Additionally, Fitch is concerned with the sizable currency exposure. While the company hedges project-specific cash flow risk associated with certain transactions, it remains largely exposed to foreign exchange risk pertaining to periodic currency translation due to sizable sales outside of the U.S. (68% in 2014).

The net underfunded status of FLS' global pension plans at the end of 2014 was \$146 million while U.S. pensions were fully funded. During 2014, Flowserve contributed \$43 million to its defined benefit pension plans, including \$20 million to the U.S. pension plan. OPEB liabilities totalled \$33 million and \$31.5 million at the end of 2014 and 2013, respectively. Fitch does not expect pension contributions to be a major part of the company's cash deployment strategy.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for FLS include:

--Revenues will decline by approximately 6.6% over the next two years (inclusive of the anticipated SIHI sales) and low single-digit revenue growth thereafter;
--Steady EBITDA margins in the range of 16.5% - 17.5%;
-- Tax rate will be 30% and the company will pay approximately 95% of the taxes in cash;
--Share repurchases will decrease to approximately \$250 million annually beginning 2016; Fitch estimates FLS may repurchase as much as \$500 million in 2015;
--FCF margin will be in the range of 5.5% - 6.5%;
--Capital expenditures will be steady at 3.5% of revenues, annually;
--Debt level will steadily decline as the company repays its term loan;
--The company will not make additional acquisitions over the next several years;
--Dividends will increase modestly on an annual basis;
--Pension contributions are expected to be insignificant to maintain fully funded status.

RATING SENSITIVITIES
Fitch is not likely to consider a positive rating action in the near future given the recent increase in leverage as the company is at the higher end of the stated debt-to-EBITDA targets of 1x - 2x. The ratings may be reviewed for a positive action if the company reduces its leverage target and consistently maintains lower than 1.5x leverage while generating more than \$250 million in FCF annually.

Fitch may consider a negative rating if the company's leverage and adjusted leverage increase and remain above 2.25x and 2.75x, respectively, for a prolonged period of time due to pricing pressures or poor operating execution or aggressive cash deployment for debt-funded acquisitions or share repurchases.

LIQUIDITY
As of March 31, 2015, FLS' liquidity of \$1.25 billion consisted of \$334 million of cash and \$921 million in revolver availability (\$1 billion less \$79 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. 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. The majority of FLS' cash is located outside the U.S. to fund international operations; however, Fitch considers it to be credit neutral for the company.

Fitch has affirmed the following ratings:

Flowserve Corporation
--Issuer Default Ratings at 'BBB';
--Senior unsecured bank facilities at 'BBB';
--Senior unsecured notes at 'BBB'.