Why I Bought Mueller Water Products

This week I purchased Mueller Water Products (MWA) for $15.88 per share. Mueller is the largest supplier of water and natural gas flow-control products used by municipalities.

Mueller was bought by Walter Industries (WLT) in October 2005 and partially spun off in May 2006 at $16 per share. There are more than 131 million shares outstanding and the market capitalization is approximately $2 billion. The stock currently trades at about one times sales. There is no dividend.

This is a de-leveraging play. Mueller has more than $1 billion in debt -- its tangible book value is a negative $5.60 per share. Yet the company generates lots of cash to pay it down and should continue generating cash for years to come.

Why? Because a lot of new infrastructure and repair projects are on the horizon as US municipalities and water utilities enter a major spending cycle to replace pipes and valves for the first time in as many as 50 years.

Eagle Capital Partners’ Meryl Witmer noted in Barron’s midyear Roundtable that the American Society of Civil Engineers gave the nation’s aging water infrastructure a grade of D minus in 2005. So Mueller should get a good-sized chunk of the new business in the future due to its excellent distribution network and the fact that it is a low-cost producer.

Top executives and directors of Mueller have been aggressively buying the stock. Among them is Chief Operating Officer Dale Smith, who has been with the company through a series of transitions over two decades, and who purchased $1.5 million worth of stock in June.

Risks with this pick include:

* New construction and repair projects could always be fewer than anticipated, foreign competition could erode pricing, and/or materials costs could rise faster than expected. These would hurt the company’s efforts to pay down debt.

* Walter Industries (WLT) intends to distribute its remaining shares of Mueller in the coming months. This overhang will probably limit share price appreciation in the near term.

* Mueller is still in the process of integrating operations that were combined to form the company last year. The company’s operating and earnings potential is likely to be masked by one-time factors and expenses over the coming quarters.

I view the negatives as being concentrated in the short term. With Mueller’s stock being bought below the IPO price, I like this pick as a long term holding.

But please, do your own due diligence before buying.

MWA 2-month chart: