In the post “Water Works” on March 22nd we looked at data from the American Society of Civil Engineers (ASCE) and the U.S. Environmental Protection Agency that reveal the high cost of replacing and improving the drinking water infrastructure. Even at the current sluggish pace of water system repair of about 5,000 miles per year, the repair portion of the U.S. water infrastructure market value is near $5 billion. The Freedonia Group reports that world demand for water infrastructure equipment for both repair and expansion is expected to increase 6.5% to $101.7 billion in 2016. The growth is boosted in part by expansion of water supply lines in developing countries. Demand in developed countries is primarily for repair and upgrade of existing pipes and connections.
No matter how it is measured water infrastructure is a large market with numerous competitors offering, in many product categories, highly commoditized components. Strong brand recognition and a well entrenched sales network have helped Mueller win and retain market share. The company goes head to head with the likes of Tyco International (TYC: NSYE) with its well-developed fire and water division. While both McWane, Inc. and American Cast Iron Pipe Company are private companies and provide limited financial information to the public, it is clear that both are significant players in the business of pipes and values. McWane revealed sales of $1.7 billion in 2014, and American is through to be near $500 million in annual sales.
Mueller reported
$1.15 billion in total sales in the twelve months ending December 2015,
representing a top-line decrease of 1.7%.
The total sales performance figure is somewhat misleading in as much as
Mueller sells its pipe components and values into the oil and gas industry as
well as to water system owners. With the
price of crude oil and the entire petrochemical chain at record low prices,
shipments to oil and gas customers have been down. However, sales of the couplings, valves and
hydrants used in the domestic water systems have been robust. In the most recent financial report for the
quarter ending December 2015, Mueller management reported 9.2% year-over-year
growth in the domestic water segment.
In deciding
whether MWA is to be your play in the water infrastructure market, sales is
only one element. In a highly
competitive market, a profitable operating structure can deliver strong
earnings even if sales growth remains sluggish.
Mueller delivered $57.3 million in net income on $1.15 million in total
sales in the last reported twelve months ending December 2015. Reported net income represented a net profit
margin of 4.9% compared to 4.7% in the year-end fiscal year ending September
2014. Thus while Mueller has struggled
to keep its top-line up in the wake of lost business with its oil and gas
customers, a lean operating structure has helped drive more profits to the
bottom line.
The cash flow
from operations echoes the Mueller profit story. In the most recently reported twelve months
ending December 2015, 10.2% of sales were converted to operating cash flow. This compares to an average of 10.1% in the
previous three fiscal years. The strong
cash generation has enabled investments, debt reduction, as well as a
consistent dividend payment.
Crystal Equity
Research has a buy rating on MWA because we like companies that move quickly
and decisively to protect profits even when sales growth is challenged. Mueller management has defended its share in the
water infrastructure market and even more zealously guarded its profits.
Investors have
only been willing to pay 16.8 times projected earnings for MWA in recent
trading, which is slightly above the anticipated five-year earnings growth rate (12.5%) for the company plus dividend
yield (0.84%) that total 13.3. Mueller
has few direct peers for sake of comparison.
For perspective the broader industrial equipment and components market
of which the company is a part, trades at 15.5 times forward earnings multiple. Interestingly, the utilities sector, which
includes the public water system owners that bear the risk of dated and deadly water
infrastructure, is trading at a higher 17.3 times forward earnings.
Neither the author of the Small Cap Strategist web
log, Crystal Equity Research nor its affiliates have a beneficial interest in
the companies mentioned herein.
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