Mueller Industries: Gearing Up for a Housing Recovery

I recently ran across Mueller Industries (MLI) (29.43, $1.1 billion) on a screen designed to identify companies that have depressed margins and low P/S valuations. Having investigated it, I ended up adding a small position to a charitable foundation that I manage (click here for full list of holdings). For those who aren’t familiar with this Memphis-based company (probably 99.5% of the Seeking Alpha readers), here is the elevator pitch:

• Not widely followed (1 analyst)

• Trading at <2X tangible book value
• Low net debt
• 9.5 PE
• 4.3X EV/EBITDA
• #1 or #2 in all markets (30%-50% share)

MLI makes copper, brass, aluminum and plastic tubing and fittings that go primarily into new construction residential and commercial HVAC, but other markets as well. As you can see in the chart above, the valuation is at a 10-yr low off of relatively low margins. An EXTREMELY important thing to understand is that the price performance is much better than it appears. In late 2004, the company made a massive one-time dividend of cash and debt ($15 per share). If one adjusts for this dividend, the price performance over the past few years looks much better than the chart conveys.

I spoke to the CFO and discovered that this company isn’t too concerned with short-term blips. There are no conference calls or guidance, and the company doesn’t attend conferences. Mr. McKee informed me that the company seeks to be the low-cost producer of this commodity and wants their customers to view them as “easy to do business with”. I also learned that the company operates on a constant $ margin, which ends up suggesting lower percentage GM (GM) when copper is rising in value. What this means is that the higher copper prices go, the lower their profit margins are. Earnings, then, are more related to volumes rather than fluctuations of material prices. When I look at home builders, which are laden with debt and with above-market inventory, I see a disconnect. You can’t build a house without the stuff that MLI sells, so it should do well in stabilization. I have a strong belief that there will be growth in certain geographies that will ultimately outweigh the weakness in other geographies, like FL and CA. Unlike the builders, MLI, which does sell into other markets as well, has a great balance sheet – no inventory problems, no liquidity issues.

I can’t say that I am excited about this business, and I am hard-pressed to name any catalysts. To me, though, it looks like they know what they are doing. Housing turnover decline and copper prices would seemingly harm a company like MLI, yet their EPS have held up well since the housing market turned in 2005. I like the fact that they stick to their niche and understand what it takes to succeed in providing a commodity product. Because the material costs represent such a high percentage of the overall cost of their products, high shipping costs and the limited ability to benefit from lower labor costs protects the company from foreign competition. I conclude that the stock is worth significantly more than the current price, making it a good candidate for a core holding in the Industrial sector that is unlikely to suffer from margin compression that will be impacting so many other firms. Over the next 5 years, the stock has a great chance of enjoying an expanded valuation off of a higher earnings level. This relatively sleepy stock could actually double if that is the case.

Disclosure: Author has a long position in MLI

Comments

[number2son:]

Sleepy? The stock has rallied 24% in February.

I want to know your idea of a volatile stock!

But you do make a good point in looking for companies that have been sold off, yet still have strong earnings, revenue and low to no debt.

2008 Feb 24 10:12 AM

[Alan Brochs...:]

You are correct that it has been volatile since the lows, and I sure wish it had shown up on my radar screen then! When I called it a "sleepy" stock, I meant that it trades by appointment - $7mm a day. Also, it has been in a range for a long time. Including the $15 dividend from 2004, the stock is up only 60% over the last 10 years - not exactly exciting!

2008 Feb 24 01:48 PM

[Yael Pipano:]

I agree with you, but what about Mueller Water Products, MWA, their spin-off? That has been trading below $10/share for about 2 months now. Infrastructure/pipelin... is the way to go now...

2008 Feb 25 06:00 PM

[Jon Cramer:]

As someone that is in the industry, I can tell you that there are a couple of inaccuracies in the column above. 1) Mueller does FAR better when copper prices are high. Supply gets tight and they're able to pass on all cost increases to customers. Look no further than their record year of 2006 to see evidence of this. In addition to being able to pass on costs, it becomes VERY inexpensive to freight their product around as the value goes up. A truckload of copper tube used to cost a customer $50,000 back in 2002, 2003 and the freight as a % of sales ran 4%-5%. Now that same truck costs around $250,000 and freight is running them 1%. Lower prices are VERY BAD for Mueller. 2) Yes you can build a house without the stuff Mueller sells. It is called PEX plumbing tubing and it's becoming more and more prevalent across the United States. Lower labor costs and far lower material costs. Copper tube continues to shrink in the U.S. residential marketplace.

I'm not saying this isn't a well-run company (though that is highly debatable with the current CEO undergoing cancer treatment and not working on a daily basis). But this stock has zero chance of doubling anytime soon unless some European company comes in and buys them because of the weak U.S. dollar. Other than price increases, Mueller really has no way of growing revenue. Their copepr tube volumes in terms of pounds are down HUGE from 6-7 years ago.

2008 Mar 07 12:36 PM