Walter Industries, Inc., is a diversified company which operates in seven reportable segments: Mueller, Anvil, U.S. Pipe, Natural Resources, Homebuilding, Financing and Other. Through these operating segments, the Company offers a diversified line of products and services including water infrastructure and flow control products, coal, natural gas, home construction and mortgage financing, furnace and foundry coke and slag fiber. On December 3, 2003, the Company completed the sale of AIMCOR, previously a wholly-owned subsidiary of the Company, to Oxbow Carbon and Minerals LLC. The Company also completed the sale of JW Aluminum, previously a wholly-owned subsidiary of the Company, to Wellspring Capital Management LLC on December 5, 2003. As a result of the above sales, the results highlighted below have not been classified into discontinued operations.
5-Year Financial History
In the 5-year historical picture, Walter Industries had two major divestitures in December 2003 and two major acquisitions in October 2005. The 2002 – 2003 annual revenue and income impact is driven by the divestitures. Excluding these one-time impacts, WLT has been showing some nice revenue growth along with going into a profitable position. On a trailing twelve months [TTM], I am anticipating a 78% annual increase in revenue to $3.2 Billion mainly driven by the recent Mueller (MWA) and Anvil (AVM) acquisitions completed on October 3rd, 2005. In the past 5 years years, Walter Industries has maintained operating expenses at historical levels in the face of the divestitures and acquisition activity.
5-Year Stock Performance
If you had invested $10,000 in WLT stock on January 2nd, 2001, your stock would be worth $63,411 representing a +534% return or 36.0% annually. There were only two years that Walter Industries experienced negative price performance, in 2002 and 2006 year to date.
Value Assessment Scorecard
I use an 8 criteria selection grid to help me assess potential value in any equity assessment. These 8 criteria are mainly driven from my readings of Benjamin Graham. The security doesn’t have to pass all of the below criteria to be selected for my portfolio, the more the better. Some of the major items that I focus on are Price to Book ratio (Criteria D.) and the earnings and free cash flow yields metrics (Criteria G.).
The value scorecard illustrates WLT’s significant amount of debt compared to the current book value, currently at 3x on the last reported balance sheet as of Q3 2006. WLT’s price to book ratio has been steadily increasing from 2001-2005, with a correction on the TTM basis coming in at 2.8x. Slightly higher than what I am comfortable with. The company does provide FCF yield’s that are higher than the current 10-year note, but not 2x enough to provide me a safety margin in my investments.
With my growth reviews of stock, I use a few different valuation techniques to surround my assumptions.
- 5 Year Discounted Cash Flow model with terminal value
- Industry Price to Earnings multiples
- Industry Price to Sales multiples
- Current Price to Earnings sensitivity
From a growth perspective, there is some potential upside to the current market cap value. This is mainly driven by the Price/Sales ratio that I am using from the Morningstar website at 1.4x. If I use a 0.7x price to sales ratio that the stock is currently trading at, the overall growth market cap is 2,089 or 1.2% upside opportunity to the current trading levels.
In my 5 year discounted cash flow model, I am assuming 10% sales growth with net income margin improving to 4.1% and the free cash flow % to revenue of 6.0%, compared to 2.8% and 4.0% on a TTM basis. With a corresponding 5% terminal value and 10% cost of capital, WLT’s value is worth around $2.0 Billion.
Industry P/E and P/S multiples
With the diversified portfolio of Walter Industries, I have elected to capture the Morningstar.com industry benchmarks for Price to Earnings of 15.9x and 1.4x respectively. As previously mentioned, the 1.4x Price to sales benchmark is creating a potential growth opportunity for WLT. When you hold the 0.7x of Price to Sales the current stock is trading at, the potential growth has disappeared.
Current P/E sensitivity
With the Morningstar.com benchmarks, you will notice the Walter Industries is currently trading at 48.7x to earnings per share with the industry trading at 15.9x. I have selected a P/E of 15.0 to capture the market cap sensitivity on project future earnings growth of 10%.