Mueller Water Products - Q2 2007 Update

This report lays out some of the reasons I like and have bought this stock. It does not constitute personalized financial advice. Please do your own due diligence or hire a financial advisor (if you're so inclined) before making any investment decisions. DISCLOSURE: Author is long this stock.

Mueller Water released their fiscial 2nd quarter results. The headline numbers look good (0.16 EPS vs. -0.02 loss last year) but that's pretty misleading due to the distorted comparables resulting from the spin-off transaction. Net sales are up 5.7% and headline operating income is up 90+% but adjusting for one-time 2006 costs, operating income is up 18%. Below are some of the highlights:

figures are up mainly due to higher pricing
lower volumes in 2 of their 3 operating segments (Anvil being the only growth)
increased costs (scrap prices increased 32%)

Some of the concerns to take away from management's conference call:

inventory is up but by design as they stock up at the start of the year or else lose that capacity
the housing bust is more severe than they expected; they are aggresively managing it with reducing overtime, cutting hours, closing plants, etc.
they may be reaching the limit of holding price increases and margin pressures may follow

For the silver liniing:

quotations are up 18% for future projects; note that quotations don't necessarily mean future business
discussed the EPA's $180 billion estimate for water replacement; they anticipate competing for 25-30% of this spending
reaffirmed 11% growth in AWWA municipality spending
expect continued growth in commercial construction and oilfield business which are drivers for Anvil segment
effective tax rate of 43.7% due to non-deductible interest expense; they have a tender offer to retire some of this non-deductible debt which will lower the tax rate in the future (FY 2008)

In summary, no real surprises here. We expected significant housing headwinds when we initially invested in MWA and voila, here they are. The only irritating circumstance is that I mistakenly tried to forecast Mueller's stock price based on these headwinds and have watched the stock price run away from me before I could build a full position. Bottom line, Mueller's exposure to new residential construction will be a factor for the foreseeable future. They've managed it well so far and any future weakness should be anticipated unless so severe as to undermine their ability to continue normal operations.

DISCLOSURE: Author is long this stock.

The Enlightened American

Mueller Water Products - Q2 2007 Update