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Flowserve [NYSE:FLS] July 7, 2009 close: $61.86
52-week range: $37.18 (Nov. 20. 2008) - $145.45 (July 31, 2008)
Dividend = $0.27 quarterly = 1.75% current yield

Company profile by MSN MoneyCentral:

Flowserve Corporation is a manufacturer and aftermarket service provider of comprehensive flow control systems. The Company is engaged in developing and manufacturing precision-engineered flow control equipment, such as pumps, valves and seals, for critical service applications. Through the manufacturing platform, the Company offers a range of aftermarket equipment services, such as installation, advanced diagnostics, repair and retrofitting. The Company operates in three business segments: Flowserve pump division (FPD) for engineered pumps, industrial pumps and related services; flow control division (FCD) for engineered and industrial valves, control valves, actuators and controls and related services, and flow solutions division (FSD) for precision mechanical seals and related products and services.

After a spectacular run-up in sales and earnings from 2004 through this year’s March quarter, it is likely that EPS will decline slightly for the full year 2009.

To appreciate the extent that things improved, it is easiest to look over the data. Here are Flowserve’s per share numbers from continuing operations as reported by Value Line:

Zacks is now looking for EPS of $7.32 and $6.73 for 2009 and 2010 respectively making the forward multiples 8.5x and 9.2x.

Flowserve recently raised its dividend by 8% to $0.27 quarterly giving it a current yield of 1.75%.

The balance sheet looks good with no short-term debt and long-term debt of just $544 million as of March 31, 2009. Treasury cash stood at $201.5 MM at that time. Value Line rates FLS’s financial strength as ‘A’ and notes their stock’s ‘price growth persistence’ as beating 75% of all the 1700 issues in their main edition’s research universe.

The lowest average annual P/E for Flowserve over the past 10 years was 12x. Even that number is well above today’s projected multiple. A return to 12 times even the $6.73 estimate for 2010 would bring FLS shares back to $80.76 or about 30% above yesterday’s close.

Is that a reasonable assumption? I think yes. Flowserve shares actually topped out at $102.70 and $145.45 in 2007 and 2008 when EPS were $4.46 and $7.74.

With shares trading right now at $61.90 /share here’s an attractive way to play Flowserve over the next 6.5 months or so:

If Flowserve shares rise by 5% or better to at least $65 by Jan. 15, 2010:

  • The $65 calls will be exercise.
  • You will sell your shares for $65,000.
  • The $65 puts will expire worthless.
  • You will have collected $540 in dividends.
  • You will have no further option obligations.

You will hold no shares and $65,540 in cash for your original outlay of $44,000. That’s a best-case scenario net profit of $21,540 / $44,000 = 48.9% achieved in less than six and one half months on shares that only needed to move up by 5% from the trade’s inception date.

What’s the risk?

If Flowserve shares finish below $65 on Jan. 15, 2010:

  • The $65 calls will expire worthless.
  • The $65 puts will be exercised.
  • You will be forced to buy another 1000 FLS shares.
  • You will need to lay out an additional $65,000 cash.
  • You will have received $540 in dividends.
  • You will have no further option obligations.

You will hold 2000 shares of FLS and $540 cash.

What’s the break-even point on the whole trade?

On the first 1000 shares it’s their $61.90 purchase price less the $7.30/share call premium = $54.60/share.

On the ‘put’ shares it’s the $65 strike price less the $10.60/share put premium = $54.40/share.

Your break-even would be $54.50 (excluding dividends) or $53.96 (including dividends).

Flowserve shares could drop by as much as 12.8% without causing a loss on this trade.

Disclosure: Author is long FLS shares and short FLS options.

Source: Pump Up Your Portfolio with Flowserve