Description

MRC is experiencing strong and improving fundamentals, which stock market investors continue to ignore. 

Let’s take a moment and review the last decade for MRC, a period in which the company and the majority of its end markets have experienced tremendous change and volatility.  A decade ago in 2012 WTI oil prices averaged over $110/bbl for the second year in a row and energy markets were booming with no end in sight.  There were no concerns of peak oil, Tesla’s market cap was under $4 bil., barely over 50k EVs were sold in the US that year, and shale oil production in the Permian had yet to explode.  MRC, the leading global PVF (pipes, valves, and fittings for those not familiar with the lingo) distributor to the energy, industrial, and gas utility end markets, had just completed its IPO in April of that year at $21/sh before rallying to nearly $28/sh by year’s end.  Times were good, needless to say, and its future seemed very promising. 

A decade later, MRC has certainly failed to live up to its initial hype.  Yet the explanation for this disappointment is quite simple given just how significantly global upstream CapEx has declined from 2012 levels.  So why then should anyone be giving this name another look?  And why won’t it remain a value trap?  All great questions that I’ll shed some light on below. 

MRC currently trades at a price of $11.50/sh and commands a market cap of roughly $1 bil. (assuming its $363 mil. of perpetual preferred convertible debt is not converted into 20.3 mil. shares of common), down meaningfully from its YE 2012 market cap of $2.3 bil.  Its revenues are expected to exceed $3.3 bil. in 2022 before growing another 10%+ y/y in 2023 aided by both cyclical and secular tailwinds.  MRC also just posted a record adj EBITDA margin in its latest quarter and remains a beneficiary of inflation given the cost-plus nature of its business.  Its adjusted EBITDA margin is poised to exceed 7.5% for the full year of 2022, up more than 200 basis points year over year, before expanding to above 8% in 2023.  Given that incremental EBITDA margins have historically averaged in the low to mid-teens range, it’s quite possible that its adjusted EBITDA margin in 2023 could average 8.5%.  This is quite a promising outlook considering all the geopolitical and macroeconomic uncertainty out there today.  But what about the balance sheet?

MRC’s net debt (excluding its $363 mil. of perpetual preferred convertible debt) was $312 mil. as of 9/22.  This compares to TTM adj EBITDA of $242 mil. and consensus 2023 adj EBITDA of $304 mil.  Net debt/TTM adjusted EBITDA ratio was 1.3x, or roughly 1x on expected 2023 adj EBITDA.  Meanwhile, liquidity exceeded $640 mil. at 9/22 despite an inventory build to support 25% year over year topline growth in the first nine months of this year.  Recall that distributors such as MRC possess countercyclical cash flow profiles whereby working capital ebbs and flows with the trajectory of its revenues.  MRC’s free cash flow generation should be meaningful in Q4 22 as activity experiences its typical seasonal slowdown.  And with annual CapEx needs of only $15 million, coupled with management’s expectation of at least $100 mil. of CFO in 2023 (despite continued double-digit year over year topline growth), MRC’s vastly improving FCF profile is also being overlooked.  MRC checks all the right boxes on the profitability and balance sheet fronts.  So there must be an issue with its end markets, right?

Well, that arguably used to be the case back in 2012 when nearly three-quarters of MRC’s revenues were derived from the cyclical upstream and midstream sectors.  But today’s MRC possesses a vastly different and superior end market exposure.  The upstream and midstream sectors represent less than one-third of MRC’s YTD 2022 revenues.  The gas utilities sector is now MRC’s largest end market, accounting for roughly 38% of its YTD 2022 revenues.  What’s unique about this sector is that it is a secular grower, and not just a low single digit grower, but a high single digit one.  MRC’s performance in this sector has been nothing short of impressive with its revenues increasing from $857 mil. in 2019 to an estimated $1.25 billion in 2022, or a CAGR of roughly 13.5%.  Aiding this growth are pipeline safety and integrity programs, smart meter installations, and other enhancements and upgrades on an ever-aging infrastructure.  Simply stated, this sector is generally resilient in the face of an economic downtown and provides MRC with a far more stable and predictable revenue base than before.  Lastly, the downstream, industrial, and energy transition (or DIET) sector now accounts for nearly one-third of MRC’s revenues and is its second largest sector.  The flurry of new chemical and LNG projects along the US Gulf Coast (aided by advantaged nat gas and NGL feedstocks) coupled with refinery and chemical turnaround projects provide a favorable backdrop for this sector.  Additionally, MRC’s fledging energy transition business, which mostly centers around renewable biofuel projects at the moment, is on pace to deliver $100 million in revenues in 2022 before expanding significantly in upcoming years.  All said and done, roughly 70% of MRC’s revenues today are not dependent on traditional oilfield activity, making MRC far more resilient today than it was a decade ago.  With all these great attributes, MRC certainly can’t be an inexpensive stock, right?

While MRC has recovered from its March 2020 pandemic nadir of $4/sh, the stock is still trading below its November 2019 pre-pandemic level of nearly $15/sh.  As highlighted earlier in this write-up, MRC is in a much more favorable position today than back then.  In fact, its adjusted EBITDA is running 30% (and soon to be 50%+) higher while its net debt is 40% (and soon to be 50%+) lower on effectively the same share count.  Yet, its stock price is nearly 25% below that November 2019 level.  Meanwhile, its arguably closest peer, NOW Inc. (DNOW) has fully recovered to its pre-pandemic levels.  Another one of its named industrial PVF distributor peers, Ferguson plc (FERG), trades at a 25% premium to its pre-pandemic levels.  Massive dislocations like this usually don’t last forever.

And what exactly do I mean by that last statement?  Well, MRC is trading at an EV/consensus 23 adj EBITDA of 5x, which compares to the far more cyclical and oil and gas exposed DNOW at 6.5x and the more residential and commercial construction exposed FERG at 9.8x.  On a normalized basis, MRC is once again trading at a 1.5x turn discount to DNOW and a 5x discount to FERG.  With its more resilient end market exposure, secular growth tailwinds, and better mid-cycle margin profile, I see no reason why MRC should be trading at a discount to DNOW, and I see no reason why MRC shouldn’t ultimately command at least at 7.7x normal adj EBITDA multiple, which is still a considerable discount to the 10x-13x range that industrial distributors fetch.

Conclusion:

MRC is less cyclical, more profitable, and less levered than compared to its pre-pandemic and decade ago self, but yet somehow much cheaper today than both those periods.  This is a stock that should be trading a lot closer to $20/sh than $10/sh.  There’s 50% upside from current levels to my $17/sh price target.  We’re still in the earlier innings of MRC’s re-rating, and this is a name with both cyclical and secular tailwinds that has plenty of room to run from here.

Catalyst

Value will out.