The U.S. has neglected its infrastructure. Spending in this area has to increase... Walter Industries will benefit from infrastructure spending... Walter is extremely cheap on a sum-of-the-parts basis, and unlike many companies in that position, it has a new CEO who is doing something about it. The company has little Street coverage, always a plus.
Walter has two main divisions. Mueller Water Products produces infrastructure and flow-control products for water- and gas-distribution networks and waste-water facilities. Jim Walter Resources has 20 years of proven reserves of high-quality metallurgical coal, or met coal. It also produces natural gas. The company also has a home-building and finance unit, for which it may be best known.
Mueller, acquired in October from DLJ's leveraged-buyout group, has become a powerhouse in the water-infrastructure market. Walter is planning an IPO of Mueller, and later will spin off the remaining shares. Mueller is one of the three largest manufacturers of ductile iron pipe, preferred by most municipalities. It also makes valves, hydrants and fittings considered the Cadillac of the industry. The prospects for the business are fantastic for one reason: Water pipe installed in the U.S. over the past 100 years is beginning to fail. A large portion of America's water pipes and valves will need to be replaced in the next 25 years.
Barron's: Bad for taxpayers, good for Mueller.
Witmer: Mueller had pro forma Ebitda [earnings before interest, taxes, depreciation and amortization] of about $285 million last year. Assuming 8% growth and $50 million of cost savings, Ebitda could grow to $390 million in 2007, which would equate to after-tax free cash flow of $2.58 a share. This segment is growing, and should sell for 15 to 18 times free cash flow, and trade for $38 to $46 a share.
Walter's natural-resources segment next year should produce at least seven million tons of high quality met coal and eight billion cubic feet of natural gas. Met coal is an irreplaceable ingredient in the steel-making process. Walter's sulfur content is less than 1%, making it worth $30 a ton more than typical steam coal at today's prices for S02 [sulfur dioxide] emission credits. As world steel markets develop, demand should rise.
Barron's: What is the going price?
Witmer: Walter has contracted all of its coal through June '06 for about $107 a ton. While this price may not be sustained indefinitely, prices will remain firm. Using $70 per ton for coal and $8 per mmBTU for natural gas, we get "normalized" earnings of $2.50 a share. Based on current coal and gas prices -- $100 for coal, $10 for gas -- the segment would earn $5.50. Others are trading for about 14 times projected '06 earnings. We value Walter's coal segment at $35 per share, at least. The other segments are worth $2 to $3 a share. In all, Walter Industries should trade for $75 to $85 per share.
WLT 1-yr chart: