Flowserve’s solid operational performance in third quarter 2014 was overshadowed as issues such as delayed shipments and more volatile end-markets had a negative impact on revenue in the quarter and full-year outlook. Flowserve’s updated 2014 revenue guidance calls for flat revenue on a constant-currency basis, and EPS guidance were reduced to $3.65 to $3.85 from $3.65 to $4.00.
While the updated forecast still calls for revenue growth in fourth quarter 2014, it is significantly lower than our previous forecast and implies that there will be less revenue momentum in early 2015 than originally anticipated, despite backlog growth over the last several quarters. Therefore, we reduced our 2015 revenue growth assumption to 4% from 7% previously, and accordingly lowered our 2015 EPS estimate to $3.95 from $4.25. We remain encouraged with Flowserve’s ability to produce strong operating margin, but with lower revenue growth anticipated in 2015, we believe it is becoming even more critical for the company to show greater improvements in working capital and free cash flow to drive valuation multiple expansion. Given our lower EPS forecast and more uncertain growth environment, we are lowering our price target to $71 from $80, which now assumes shares trade at 18.0 times our revised 2015 EPS essentially in line with where shares have traded on average over the last five years.
Third quarter 2014 summary. Reported EPS were $0.93, which compares with our $1.02 estimate and consensus $1.00. Reported EPS included a $0.01 net benefit from foreign currency, which offset a discrete non-cash charge in the industrial products division (IPD) due to the write-off of legacy obsolete inventory. Sales decreased 2% yearover- year and slightly sequentially, to $1.2 billion, well below our estimate for a 7% improvement.
Original equipment (OE) sales (58% of total) decreased 8% year-over-year, more than offsetting an 8% increase in aftermarket. The largest segment shortfall relative to our estimate came in the engineered products division (EPD), where sales decreased 5% year-over-year primarily due to lower Middle East and Europe sales. Despite the sales shortfall, consolidated operating margin expanded 30 basis points year-over-year (60 basis points excluding the aforementioned non-cash charge), to 16.0%, though still below our 16.5% estimate. Flowserve produced better profitability year-over-year in EPD and IPD, offsetting lower margin in the flow control division (FCD).
One Wall Street analyst lowered 2014 EPS estimate to $3.70, from $3.85, and 2015 EPS estimates to $3.95, from $4.25. For 2014, the EPS estimate is now toward the lower end of the company’s updated guidance range of $3.65 to $3.85, and our revised 2015 EPS estimate is well below current consensus of $4.37. Our updated estimates account for a more modest growth environment, although we continue to anticipate strong operational performance as the company remains focused on further optimizing its businesses; we forecast 2015 operating margin of 16.3% compared with 16.0% in 2015. At the current juncture, we believe revenue growth will be the key variable to 2015 EPS, with potential for more aggressive share repurchases or acquisitions providing upside to our forecast.