Flowserve’s outlook revised to positive at S&P amid proposed merger with Chart Industries
The proposed merger is expected to enhance Flowserve’s competitive position and profitability, assuming the integration process is successful. The combined entity is anticipated to have a more robust market position, more diverse product line and end-market, larger scale, and improved profitability.
However, the risk of integration poses a concern. The leverage on the combined entity will be higher than Flowserve’s current standing, which partially offsets the credit strengthening. The S&P Global Ratings-adjusted debt to EBITDA is expected to remain below 3x.
The positive outlook suggests that Flowserve’s ratings could be raised over the next two years if the merger with Chart significantly strengthens its competitive position, for instance, by increasing its scale, scope, and absolute profitability.
The merger is expected to boost Flowserve’s market position, product line, end-market diversification, scale, and profitability. The combined company will likely leverage Flowserve’s and Chart’s products to provide a more comprehensive system for several key applications, including mining, power generation, natural gas liquification and regassification, hydrogen fuel, and other industrial gases, assuming the integration process runs smoothly.
However, soft profitability could constrain the view of the combined business. If adjusted EBITDA margins remain 18% or lower two years post-closing, it could indicate a weaker competitive position or less favorable operating benefits. Despite supply chain challenges for Flowserve and Chart’s delay in offsetting inflation with higher prices in 2021-2022, each firm addressed its issue and took preventive measures.
Chart’s integration with Howden, which closed in 2023, is progressing well and contributed to a rise in adjusted EBITDA margin by 350 basis points in 2024. Nevertheless, profitability of this level could cause the combined company to be viewed closer to the capital goods manufacturers rated ’BBB-’ like Timken and AGCO, rather than those rated ’BBB’ like Ingersoll Rand (NYSE:IR) and Xylem (NYSE:XYL), unless it is driven by a significant cyclical downturn.
The combined company is expected to maintain adjusted debt to EBITDA of 2x-3x. It is forecasted that the combined company will generate solid free operating cash flow, which could be used to reduce leverage during a cyclical downturn. The combined company’s credit metrics are expected to be less volatile than Flowserve’s have been over the past decade, supported by the increased diversification of its product offerings and overall scale.
A solid balance sheet also helps win business from its largest customers. The combined company is expected to continue to prioritize its dividend as Flowserve did during the COVID-19 pandemic downturn. Since the merger does not raise incremental net debt, credit metrics have some cushion. It is not expected to breach 3x, the current rating expectation, for an extended period, even if demand weakens.
The outlook could be revised back to stable if the company experiences significant integration challenges or if its competitive position is weaker than expected. However, the ratings on Flowserve could be raised if the combined business’ competitive position is viewed more favorably after the integration of Chart, and if the company maintains S&P Global Ratings-adjusted debt to EBITDA below 3x on a sustained basis.
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