A Look At What David Tepper Sees In Mueller Water Products

| About: Mueller Water (MWA)
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David Tepper’s Appaloosa Management is currently Mueller Water Products, Inc.'s (NYSE:MWA) largest shareholder with 11,230,822 shares as at June 30, 2011, representing approximately 7.2% of the shares outstanding, and a little more than 1% of Appaloosa’s portfolio. MWA is Appaloosa's 29th largest holding (out of 72 holdings), sticking out like a sore thumb in terms of its small market cap ($352 million) in relation to the other holdings. Tepper first filed a 13G for this holding in February of 2011, when the stock was trading at around $4. It’s now trading at $2.26.

Mueller Water Products manufactures and markets products that are used in the transmission and distribution of safe, clean drinking water. The business is managed through three segments, Mueller Co. (valves and fire hydrants), U.S. Pipe (ductile iron pipe), and Anvil (fittings, couplings etc., used in non-residential construction for HVAC, fire protection, industrial, oil and Gas). They also offer technology related products for advanced metering and leak detection.

Mueller was a victim of the slowdown in the residential construction industry. Net revenues associated with residential construction have declined from 40% of revenues in 2006 down to 5% today. The other 95% of revenue now comes from repair and replacement of water infrastructure (70%) and non-residential construction (25%). Our country’s aging water infrastructure is in need of upgrades, but municipalities strapped for cash are putting off the expenditures. Mueller has downsized, closed plants and streamlined operations in response to the slowdown.

A breakdown of its segment results for the nine months ending June 30, 2011 is shown below:

Net Sales
Income from operations
U.S. Pipe
Clearly the U.S. Pipe division is bleeding. The company is seeking strategic alternatives for this division and announced on August 10, 2011 that BofA Merrill Lynch is acting as advisor in this regard.

In terms of the balance sheet, they have $692m of long term debt, at a cost of 7 3/8% – 8 ¼%, with no significant repayments until 2015. Of the $692m, $49m is a separate ABL revolver that has an additional $174m available, as at June 30, 2011. The company had $45.8m of cash as at June 30, 2011.There is also an unfunded pension plan obligation of $85.8m as at year end 2010.

Non-current assets are mostly property, plant and equipment ($248.3m, net of accumulated depreciation of $430.1m) and intangible assets of $617.5m. Capex was $21.9m for the nine months ended June 30, 2011 vs. $21.4 for the previous year. They own approximately 5 million square feet of properties used for manufacturing (at $50 psf would have a value of $250m). Tangible book value is negative, but does not reflect the market value of its real estate or the fact that its equipment has been almost fully depreciated. Nevertheless, it’s still probably close to zero, after giving credit to these items.

Net income and cash flow from operations for the nine months ended June 30, 2011 was ($28.5m) and ($2.7m) respectively, versus ($38.2m) and $35.7m for the nine months ended Sep 30, 2010. The company does not see accelerated growth until there is a significant improvement in the housing market.

So, in term of cash flow from operations, the company is currently running at about break-even and appears to have stabilized at that level. If they are successful in finding a strategic partner for U.S. Pipe then that should increase its net income by $50m per year and possibly provide it with a cash infusion, depending on the type of deal they do (jv vs. spinoff).

So in terms of Tepper’s motive, perhaps he owns Mueller as a way to play the housing recovery. Mueller is a great way to play the housing recovery because they participate at the early stage of the home construction process. Looking at Tepper’s other holdings, he owns shares of KB Home (NYSE:KBH), DR Horton (NYSE:DHI), Pulte Group (NYSE:PHM), Beazer Homes (NYSE:BZH), and Ryland Group (NYSE:RYL), all exposed to residential construction, although the combined investment in all five of these companies is about the same as his investment in Mueller. The fact that he owns so many homebuilders speaks to his view of housing, but the scale of the Mueller investment in relation to these five, speaks to his conviction for Mueller.

But perhaps Tepper also sees the upside in the municipal water infrastructure maintenance business. With respect to municipal spending on water infrastructure, Mueller has some good things going for it:

  • The provision of clean drinking water is essential, and is one of those long term mega-trends that will always be important.
  • The Mueller brand is recognizable; they have the number one or two market position with most of their products.
  • They have an installed base of 10 million iron gate valves and 3 million fire hydrants which provides a steady stream of replacement revenue.
  • Our decaying water infrastructure will have to be replaced at some point, and when municipalities are able, Mueller will be a big beneficiary.
  • Mueller has made investments in smart metering and leak detection technology which currently is an $80m per year market, and is expected to grow at 20% per year. Echologics, the leak detection company they acquired last year, has received a number of contracts locally and is active internationally too. The company’s two way AMI meter reading technology could also be a vehicle for global growth, if meter compatibility and frequency issues can be addressed. The company announced its first AMI contract last month for the Tullahoma Utilities Board in North Carolina for a 19,000 meter install.

So in summary, while not currently profitable, management has stopped the bleeding, streamlined their operations, and positioned themselves well for the future. There are four components to making money with Mueller; completing the strategic alternative with U.S. Pipe should make the company profitable again and give the stock an immediate boost; an improvement in residential construction; a recovery in municipal infrastructure spending; and growth of their smart metering and leak detection businesses, both here and abroad. Tepper’s investment is under water at the moment, but has some good vehicles for growth, and should pay off big, when residential construction and municipal finances improve.

Disclosure: I am long MWA.