We exited our position in Mueller Water Products (NYSE:MWA) on Wednesday (06/27) at $17.54 for a 29% gain in 3 months. A couple of factors, fundamental and psychological, weighed in on this decision.
The housing market has started the next leg down and the collateral damage has hit other housing ancillary companies I track like Cemex and Headwaters. Mueller has 40% exposure to new residential construction. Some local and state governments are starting to worry about impacted tax revenues due largely to the housing bust. This could impact Mueller's water infrastructure business as well if government budgets and credit markets tighten up. Mueller's debt load ticked up slightly, coming in around $1.1 billion. At fiscal end 2006, over $700 million was carried in a revolving float-rate credit agreement so rapidly tightening credit markets may increase interest expenses. 2nd quarter results (ending 03/31/2007) revealed lower volumes across 2 of 3 segments as well as rising costs. Management also expressed concern over margins coming under pressure if customers resist pricing.
A huge $2.50 spread had opened up between the initial IPO shares (MWA) and the superior spin-off shares (MWA.B). The B shares are identical except that they carry 10 votes vs. 1 vote so the 17% higher price for the A shares makes no sense. A much-smaller gap had existed previously, closed then reopened and now widened last week. The market also seems to be underestimating the full impact of the housing bust. My research suggests that commercial construction will follow residential down (why do empty neighborhoods need strip malls and office buildings?) but this is only recently being taken into account. Mueller seems to have fallen off the short interest ratio charts published by Dow Jones. I don't follow that aspect of the market too much so I don't know if those substantial shorts got unwound or what but that may also account for the gap. The market, in general, feels frothy so consolidating to cash is attractive.
As troubling as these headwinds may be, we were aware of them, except for the recently rising interest rates. Ultimately, it was the spread between the A and B shares that led me to sell despite the tax hit. This is a nice opportunity to switch out of the A shares and into the B shares eventually. I can't believe the spread will last as an activist shareholder or possible acquirer would definitely want the B shares. If the gap closes, my completely unscientific guess would be A shares coming down, not B shares rising.
At the end of the day, we cashed out at a 52-week high thanks to a fluky situation, pocketed a nice 29% gain in 3 months time and added cash in a market that scares me a little. If the stock takes a hit in the next few months, we'll back in with the B shares.
MWA 1-yr chart