MRC GLOBAL INC MRC
February 04, 2014 - 12:38pm EST by
BTudela16
2014 2015
Price: 27.26 EPS $1.68 $2.06
Shares Out. (in M): 102 P/E 16.22x 13.23x
Market Cap (in $M): 2,774 P/FCF 12.06x 9.91x
Net Debt (in $M): 1,010 EBIT 380 470
TEV ($): 3,784 TEV/EBIT 9.96x 8.05x

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  • E&P

Description

MRC Global (MRC): Long
 

“During the Gold Rush, most would-be miners lost money, but people who sold them picks, shovels, tents and blue-jeans made a nice profit”

  - Peter Lynch

 
Summary: MRC is a high-quality, sticky business that is dominant in a growing space but is being valued as if it is unlikely to grow for a significant period of time. Given its exposure to the energy sector, I think this is at least a global-GDP-plus type of growth rate with potential to go much faster while improving margins. In an optimistic scenario, this could become a fairly world-class industrial distribution business (which are incredible at building value over time). Just on my base assumptions about the business, I come to a $36/shr valuation (32% upside).
 
Description
 

- #1 global distributor of pipes, valves and fittings (‘PVF’) for the energy industry, 100% distribution and service, 0% manufacturing

- Ranked #7 largest industrial distributor in 2013 by Industrial Distributor magazine

- Recent IPO (April 2012) of a private equity roll-up

- Predominately maintenance, repair and operations (‘MRO’) business, 2/3rds of sales under contract, 95% renewal rate

- Highly diversified customer and supplier base, but ~70% of revs from higher-margin, lower-volatility valve business

- Focused on the North American market, but growing rapidly internationally through M&A, global partnerships with organic demand growth


 Thesis:

- Inexpensive ‘picks and shovels’ service business with a story: multiple growth drivers and ongoing operational improvements

- Modest Valuation: 8x EV/2014 Adj EBIT (vs EBIT 3-yr CAGR: 42%)

- Management Scaling Back Low-Marging OTCG (in drill hole pipes) Business: Combined with a recent (brief) rig count decline in Canada, this had made the company look like its revenues are declining substantially. In fact, MRC has chosen to leave the low-margin OTCG ('Oil Country Tubular Goods') business which is highly commoditized and a drag on margins.

- Meaningful Growth Potential: E&P PVF is expected to be a rapidly growing space (mgmt estimate: 8-9%/yr organic for MRC through the cycle)

    * Management actively acquiring accretive bolt-ons (mgmt estimate: additional 2-3%/yr for MRC through the cycle)

    * Good leverage and exposure to ‘shale revolution’ (2-5x the economics of conventional drilling for MRC)

    * Aging US infrastructure requires refresh: 63% of pipeline infrastructure built before 1970

- Growing Margins/Operational Improvements: MRC is in the process of a) consolidating operations and acquisitions b) moving away from lower margin business and c) forming new, global contracts with large customers (eg Shell)

- Strong Management Team: Management has a very strong background in the space (C-level at Halliburton) and its incentives are well-aligned with shareholders.

- Catalyst: Continued execution since recent downward revisions to guidance shook confidence in growth story. Realization of margin improvement story.


Business History

- Born from a 2007 Goldman Sachs private equity roll-up of two major US PVF distributors: McJunkin Corporation (founded 1921) and Red Man Pipe & Supply Co. (founded 1976) to create McJunkin Red Man Corporation, name later changed to MRC Global

- Subsequent additional acquisitions made MRC the biggest E&P PVF distributor in the United States, later became #1 Canada

- Today, MRC is the number one E&P PVF distributor in the world 

- Between organic growth and acquisitions, MRC has grown revenues at a 19.7% CAGR (2008 is an anomaly in the below chart as it was a record year for energy capex)

- IPO’d in April of 2012 at $21/shr

- After two secondary offerings (Nov 2012: $22/shr, Mar 2013: $28/shr) plus 12mm of open market selling, Goldman Sachs retained a ~17% interest which they recently sold in a third and final secondary

  Acquisition History  
Date Name Region Revenue Cash Cost
Oct-08 LaBarge U.S. 233 206.2
Oct-09 Transmark Europe/Asia 346 55.5
May-10 South Texas Supply South Texas 9 3.1
Aug-10 Dresser Oil Tools Supply North Dakota 13 9.3
Jul-11 SPF Australia 31 37.2
Jul-11 VXC U.S. 13 4.6
Mar-12 OneSteel Piping Systems Australia 174 67.5
Jun-12 Chaparral Supply Oklahoma/Kansas 71 84.9
Dec-12 Production Specialty Services U.S. 127
Jul-13 Flow Control Products U.S. 28 – 
Dec-13 Flangefitt Stainless UK 52 28.0
Jan-14 Stream AS Norway 273 260.0


Business Description

- To get oil, gas and other hydrocarbons from the ground and, ultimately, to market the energy industry must build extensive amount of pipe and other materials (PVF) necessary to build and maintain these transportation networks, MRC takes the PVF and warehouses and delivers it to its customers.

- MRC distributes pipe but actually focuses more on valves, fittings and other critical, highly-specialized, highly-engineered SKUS

- Customers are global and run the full gamut of the energy industry from ‘upstream’ to ‘downstream’, MRC is #1 in each of these three segments

- MRC distributes 175k+ SKUs to 18k+ customers in 400+ locations across 44 countries

 

Why is MRC a Good Business?

Customer Value Proposition and Stickiness – Switching Costs and Scale/Scope of Offering:

- While its customers are largely considered energy companies (90%), MRC itself is a business services company - customers outsource their non-core functions to MRC

- Specifically, these functions are: just-in-time/multiple daily delivery, product testing and supplier assessment, purchasing and procurement, inventory management and warehousing, technical support, and supply chain IT

- These are extremely valuable to customers (eg downtime and delays are very expensive in energy) and so MRC tends to be tightly integrated with their IT systems and business plans.

- Customers often will move in to new geographies so having a global presence means not having to develop a new relationship anytime an energy company expands

- Smaller companies do not have the balance sheet to offer so many SKUs nor the scope to deliver so quickly and frequently in an integrated fashion

- As a result: 95% renewal rate on MRO contracts since 2000 and >20 year average relationship with top 25 customers

.....this Leads to Attractive Features for MRC’s Business:

- ~70% of MRC’s business is MRO, this is almost like recurring revenue. The remainder is project spend, largely driven by rig counts.

- Customers less price-sensitive on higher-value products since they want to avoid downtime and PVF represents a small portion of customers’ overall capital spend (eg approximately 5% of E&P CapEx budgets are PVF)

- Large customers beginning to opt for long-term, single-source global PVF contracts with MRC (eg Shell and Celanese)

- Limited PP&E means very low maintenance CapEx, ~0.5% of Revenues


What Drives the Opportunity?: In the medium to long-term, there are many growth drivers for MRC a) in the immediate, the ongoing recovery in rig counts since the sell-off and longer term growth in US production   b) shale/unconventional wells becoming increasingly common (a recent American Petroleum Institute study had it up +87.6% in 2011), these shale wells have 2x – 5x the economics of convention wells for MRC   c) aging US energy infrastructure with new legislation spurring a replacement cycle d) global E&P spend growth expected to be even faster than in the US (eg MRC’s new Iraqi business e) continued M&A activity by management f) MRC shrinking lower-margin OCTG business line g) new omnibus contracts with large companies

 

Valuation: Since we don't know exactly at what speed MRC is likely to grow, the key question here is to see what's implied by the stock price and ask if that's reasonable. This is exactly what a James Montier style Reverse-Engineered DCF is perfect for. For those unfamiliar, we take the forward projections from the street and then see what kind of growth needs to happen in later years to justify the current value of the stock. Using what I think are pretty reasonable assumptions, MRC currently is pricing in only .3% annual growth from 2016-2021, which seems way too low. Again, given that this business services the E&P industry and appears to be in a good spot within that industry, I think MRC is likely to grow at global-GDP-plus type rates and management is calling for a full-cycle average of ~8-9%.  

My assumptions:

Px/shr [Solving For] 27.26
Current MC (mm) $2,773.7
Shares O/S (mm) 101.75
FCF mgn 3.80%
Terminal Rate 1.5%
Discount Rate 10.0%
   
Implied Growth Rate  
2016-2021 Growth Rate 0.3%

So the stock is pricing in pretty mediocre results. Using what I think are more reasonable numbers, if the company performs closer to expectations then there is ~$36/shr today of value without assuming massive growth

Px/shr [Solving For] 27.26
Current MC (mm) $2,773.7
Shares O/S (mm) 101.75
FCF mgn 4.60%
Terminal Rate 2%
Discount Rate 10.0%
Valuation $36.43

Someone could perfectly reasonably quibble with these specific numbers but, more simply and to the point, you're buying a strong business with good management and growth prospects at a ~10% 2014 FCF yield. That is too cheap in my view.

There is obviously substantial further upside if management hits its full-cycle numbers ($45/shr by my math) but I consider that a low probability event. If MRC is able to get its operations and sales efforts in top-shape, I believe it will be able to create significant amounts of value, with WCC as my template (although probably not to the same degree as WCC). I have not tried to value this potentiality but I think it is worth mentioning just how value creating such businesses can be since I think that is in the cards here over the longer-term.

 

Management & Incentives: The CEO, Andrew Lane, has been with MRC since Sept 2008. Prior to that, he had a long tenure at Halliburton. Most recently, he was Halliburton's COO from Dec 2004 - 2007. Before that, he had been management for various Halliburton divisions and subsidiaries since 2000. This is a very strong background for MRC and leaves him with the kinds of operational background and industry connections that a business like MRC thrives on. 

Management owns 1.28% of shares, owns another 3mm shares worth of options and other equity incentives and is reliably compensated ~50% with equity every year at senior levels of management. According to the proxy, management is incentivized based on

 

  Adj EBITDA |Return on Average Net Capital Employed ('RANCE')| KPI's
Weighting 70% 20% 10%
       

While, there is an emphasis on Adj EBITDA that encourages acquisitions, acquisitions tend to be accretive and management's equity ownership probably discourages anything too counter productive



Risks: 

-The realistic bear case is that MRC does not grow with the energy space or that it is unable to expand margins
-Existential risk seems unlikely as energy is unlikely to go away and energy transportation will require pipe
-Leverage is substantial but coverage ratio is good and MRC has been paying down debt. Moreover, distributors are counter-cyclical - when the business environment deteriorates, working capital is freed up.
-A more mild version is simply that growth doesn’t materialize but, as per the RE DCF exercise, that seems to be priced in to the current stock price
-As of now, MRC is the only pure-play, but NOV is spinning out its comparable business (the #2 player in the industry) which could mean that a more focused competitor could limit MRC’s ability to take share and grow in new regions. MRC enjoys better margins than NOV here and is more international and MRO-focused, but could this dynamic change with the spin-off?
 
  Name 2011 PVF Sales (US$)
1 MRC Global 4.8bn 
2 Ferguson/Wolseley Canada (NOV) 3.2bn 
3 Wilson/CE Franklin 2.6bn 
4 Edgen Group 1.7bn 
5 HD Supply (IPVF)  700mm 

- Contracts like the one struck with Shell are new to the industry and could lock MRC in to a lower margin profile if executed poorly



 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- More details from NOV spin-off of biggest competitor
- Additional acquisitions
- Realization of margin opportunity
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