Description

Mueller Industries (ticker: MLI), not to be confused with Mueller Water Products is an old school industrial business selling copper tubes (and other manufactured products). Strong industry tailwinds, including housing starts and robust repair and remodeling volumes, along with a potential infrastructure bill should drive solid cash generation. At current prices, the shares trade for ~6x and ~8x my 2021 EBITDA and FCF estimates. Read further, because in all fairness, recent performance is unsustainable.

Management doesn't hold quarterely or annual conference calls and I haven’t seen any sellside research. However, they’ve proven adept at bolt-on acquisitions and paid special dividends in the past. In 2017, the company paid a special dividend of $8.00 per share ($3.00 in cash and $5.00 in 6% subordinated debentures). How many companies do you know who distributed a special dividend to shareholders via a bond?

A brief background on the business.

Mueller is a manufacturer of copper, brass, aluminum and plastic products in three segments: Piping Systems, Industrial Metals and Climate.

Piping Systems (67% of revenues / 65% of EBITDA) supplies the HVAC, refrigeration and plumbing markets with copper tube (1/8 inch to 8 1/8 inch), copper and malleable iron fittings, steel pipe, faucets, and brass and plastic plumbing valves. This segment focuses on parts to support flow control. Products are sold to wholesalers, distributors, building material retailers and OEMs.

Industrial Metals (19% of revenues / 17% of EBITDA) is composed of several sub-segments. Brass Rod & Copper Bar Products includes extruded brass, bronze and copper alloy rods and bars, valves and fittings sold to OEMs in the industrial, HVAC, plumbing and refrigeration end-markets. Impacts & Micro Gauge manufactures cold form aluminum and high-volume machining of aluminum, brass, steel and iron impacts and castings for OEMs within the automotive, aerospace, military and general industrials sectors. Brass Value-Added Products include forgings, valves, fluid control solutions and gas train assemblies.  

Climate (14% of revenues / 18% of EBITDA) includes a few sub-segments. Refrigeration products consist of valves, protection devices and brass fittings. Fabricated Tube Products includes tubular assemblies and fabrications. Westermeyer manufactures high-pressure components and accessories, whereas Turbotec produces heat exchangers and twisted tubes for various applications. ATCO manufactures HVAC flexible duct systems and Shoals Tubular manufactures brazed manifolds, headers and director assemblies.

Long-time VIC readers might also remember the name Tecumseh. The company was written up several times and has been a perennial disappointment. You can review prior write-ups to see the potential for that business. Mueller now owns it jointly (50%) with a PE shop, although they don’t seem to have succeeded in turning it around (yet). Book value is $37 million.   

As described above, Mueller is a manufacturer primarily targeting the HVAC, refrigeration and plumbing end-markets. The main drivers here are new housing starts and non-residential construction. Additionally, repairs and remodeling projects are important, and to a lesser extent applications within transportation, automotive and other industrial end-markets. North America is 89% of sales. COGS are linked to raw material prices, specifically copper, brass, zinc, aluminum and plastic resins. Copper is the principal ingredient in products accounting for ~87% of Mueller’s sales.

The capital structure is straightforward with ~$250 million of net debt and EV of $2.7 billion. Recently, Mueller refinanced the 6% subordinated debentures with bank debt at rates currently below 2%. Previously, the company implemented a 2024 Strategic Plan which calls for double digit compound annual growth in operating income over a six-year timeframe (2018-2024). 

Here are the summary financials:

Recent underlying performance is unlikely to be sustainable as margins benefit from FIFO accounting and rapidly rising copper prices. For example, EBITDA generated in 1H 2021 already exceeds all of 2020’s level. Still, run-rate margins should not revert to pre-Covid levels as the improvement in gross margin is partially a function of an increased mix of higher margin products and aggressive cost cutting measures (e.g. 2020 manufacturing costs were 5.6% lower when compared to 2019). Additionally, 2020 numbers include a weak 2Q and the figures do not capture a full year of two strategic acquisitions for $73 million and a small 2021 deal for $14 million.

Using my estimates for 2021, which are slightly above LTM figures, the shares trade at 6x EBITDA. My estimated FCF (pre-working capital) exceeds ~$5/sh. Even if EBITDA resets materially lower, FCF/sh should still approximate $3.50 in my view. Going forward, FCF will also benefit from lower interest expense as the company called the aforementioned 6% debentures and replaced this financing with cheap bank debt. 

Rest assured, I’m not trying to argue this is a great business. The market is competitive with risks including offshoring and substitution. However, Mueller has proven adept at navigating the space, the backdrop is strong and the shares look cheap. It’s not easy to find a perfect competitor. A listed competitor, Aalberts NV trades at 11x 2022E EBITDA. The US building universe trades at 7x-11x 2022E EBITDA. Core & Main, a distributor of water, wastewater, storm drainage and fire production products came public last week and trades at 15x.

Assuming a 9x EBITDA or low teens FCF multiple on a more normalized 2022 results in a low $50s share price on what I think are probably conservative estimates. Anticipated cash generation and an under-levered balance sheet leads me to believe another special dividend may be on the horizon. Besides a special dividend as a catalyst, I could see a PE shop taking a run at this business due to cheap financing, low capex requirements and incremental acquisition potential.  

Catalyst

FCF generation 

Strong 3Q numbers

Special dividends or share buybacks

Acquisitions or PE takeout?