Mueller Water Products, Walter Industries Remain Strong Buys

Two portfolio holdings, Mueller Water Products (MWA/NYSE) and Walter Industries (WLT/NYSE), both sold off sharply late last week.

Why? Because they committed the sin of reporting strong quarterly results -- just not as strong as Wall Street expected.

So Mueller Water closed Friday at $14.23, down 10.5% for the day. And Walter ended the day at $41.18, down more than 9.5% itself for the session.

Both are bargains, in my opinion. The Mueller Water and Walter Industries' stories have been out there for several months. Anyone thinking about buying them -- and who hasn't -- should strongly consider adding them here. Some like Walter more than Mueller. You know I like having BOTH as full portfolio positions.

On a side note, The New York Times mentions Mueller in a story on corporate spinoffs:

Mueller Water Products, the dominant producer of hydrants, values and pipe fittings for municipalities, was carved out of Walter Industries,  another conglomerate, in May and its stock has languished ever since. Mr. Cornell said he liked its prospects, though, especially once Walter distributes its remaining shares as expected by the end of the year.

With America’s aging infrastructure in need of fixing, Mueller, a solid moneymaker, would appear to be well positioned to handle its business alone, without having to share profits with a parent. That would be good for Mueller’s shareholders, which is the whole point of a spinoff, after all.

To view my original rationales for owning Muller Water Products and Walter Industries, just click on the appropriate company name in the "Current Holdings" menu at the right.

Comments

[Amit Chokshi]

I had posted the following on Seeking Alpha:

I am looking at MWA as well but haven't done all of my due diligence yet. The shares that will be spun from WLT are Class B shares that have more voting power from what I understand. I haven't done any real research yet so I could be wrong there but that's what I've gleaned so far. Do you think the MWA shares will be a good value relative to the MWA.B shares? Or is one better off waiting for the spin to occur and then wait for the B shares to experience the usual volatility associated with spins before buying?

[John]

Amit: Non-voting shares sometimes sell at a slight discount to voting shares. That may well happen with Mueller's two classes of stock, but no one can say for sure. I will end up owning both and have no problem with that.

Someone might consider splitting their Mueller holding across both classes, or put it all in the non-voting stock if it goes for a discount. But do your own due diligence and make up your own mind, please.

This blog just reports on what I'm doing -- and I'm owning both Mueller and Walter Industries.

[Amit Chokshi]

John,

Doing one's homework is essential to investing so I'm definitely going to do some indepth work. I realize that nonvoting shares sell at a discount which is why I may consider waiting until the B shares are issued and/or learn more about the A shares and overall ownership structure in regards to Mueller. Good luck.

[John]

Amit: Thanks. And, if you join me as a Mueller shareholder, good luck to us both! :-)

[Anon]

John,
It sounds like part of the bear case on MWP is that a big chunk of revenues (a Bank of America analyst said 40%) are tied to the slowing residential construction market. A decline here as construction slows could mean that new municipal water projects only get MWP back to even instead of providing an incremental growth opportunity. Have bulls on the stock spoken to this issue?

[John]

Anon: I actually read a report stating that nearly 50% of the demand for Mueller's branded products comes from housing starts. I haven't seen any articles or anything from bulls on the stock about this.

But I see it as a relatively short-term challenge, of which Mueller has several (hence the low price). Someone thinking that housing is in for a multi-year depression may feel differently.

[StupidDuhawk]

I work at a hedge fund, and I personally own both stocks (as does our fund). I think you're incorrect (or at least, incomplete) in your assessment of why MWA (and WLT, through its 75% ownership in MWA) got crushed. Far more than because it reported results below expectations, MWA's stock price was hammered because of management's bearish statements regarding near-term demand outlook. If you look at the current spin-out ratio of MWA/WLT (approximately 1.96 - so multiply MWA's stock price decline times 1.96 and subtract it from WLT - you will see that makes up the vast majority of the delta) and apply it to WLT's price post earnings release, you can see that most of WLT's stock price decline was related to losses on the MWA side of things. MWA has three divisions: Mueller, Anvil, and U.S. Pipe. Mueller has about 50/50 exposure to new build vs repair and replacement. Anvil has no exposure to new housing build, and U.S. Pipe has about a 65/35 split, for those of you who were discussing this. Keep in mind, however, that well over 55-60% of profitability is generated from the Mueller division. Regardless of the near-term hit, the long-term prospects of MWA are very strong. The company has an enviable market position, and is operating in an area that will grow at nearly 10% for the foreseeable future.

[John]

SD: I stand corrected, I probably didn't give the complete picture of Mueller's sell off. Thanks for your excellent comment, and for being a reader.

[Andrew]

what do you think of WLT's bond dilution of current share holders? any impacts to the stock price?

This stock is unfavorable for quite a long time.

[StupidDuhawk]

Well, it's not like the bond dilution is anything new to speak of, and it should already be priced in, but with a caveat described below. The converts have been well in-the-money for some time. In doing your valuation, you should definitely less the bonds out of your net debt, and assume they are all converted. The question is: Do you assume that the bonds convert prior to or after the upcoming MWA spin-off? That's the caveat I mentioned. If you assume they convert ahead of the spin-off, the spin-out share ratio is shifted downward, and you will receive less MWA per WLT share you own. If you assume the converts don't convert prior to the spin-off (more likely, in my view, given the optionality inherent in the bonds), you will see the dilution all on the WLT stub side. This all said, the company is going through some litigation with certain of the convert holders to decide exactly how the spin-out ratio will work (apparently there were some drafting errors in the bond indenture). Seemingly related to this, the company released an 8-K announcing that $2.7 mm of the converts exercised their convertible rights just recently, and were paid an inducement fee to do so. I assume this is related to the pending litigation, and there may be more, similar announcements in the near future.

[StupidDuhawk]

For those of you who have been following the situation, WLT has settled all of the litigation with convertible noteholders. Only $16.3 mm of convertible notes remain outstanding. This implies an exchange ratio for the MWA spin-out of approximately 1.67 shares of MWA for each WLT share one owns. This means that the share dilution is being spread over both MWA and WLT shares as opposed to only WLT shares (which would have been the case if no noteholder converted early).

[Mrk2Mrkt]

StupidDuhawk,

Is it 1.67 shares of MWA for each WLT share?

I know the that it was previously stated that 7.7 million shares could be issued in the conversion (10-Q, 11/09/2006, Note 17 – Subsequent Events), but the settlement was for 5 million shares and other cash consideration. Am I supposed to take this as 5 million shares being given in place of the 7.7? If so, then the conversion is 1.76 instead of 1.67.

Or was is my mistake related to only $89.1 mm of the convertible being involved in the settlement and $16.3 mm of convertibles still outstanding? But the ratio of settled to outstanding is 84% and the ratio of settle shares (5 million) to (7.7 million) is 64%.

Any help is greatly appreciated.

[Mrk2Mrkt]

I see:
http://www.sec.gov/Archives/edgar/data/837173/000127528706006229/wi8078ex991.htm

[StupidDuhawk]

I'm going to skirt directly answering your question and point to this press release.

http://www.sec.gov/Archives/edgar/data/837173/000127528706006229/wi8078ex991.htm

But beyond that, let me tell you the perspective I'm coming from. I'm not basing my analysis off the Q (which does, incidentally, state that if all the notes convert that the exchange ratio will be 1.65). The latest number I have, which is based upon the press release WLT came out with recently, is that $16.3 mm bonds remain outstanding. Assuming that number, I calculate that the current diluted shares of WLT are 43.7+7.4=51.1. The WLT-owned MWA shares are 85.8. 85.8/51.1 is 1.68 (my 1.67 number before was off slightly because I was using the Q2 share count). This number jives with the press release.

I hope this helps clear things up.

I think the only reason noteholders are converting ahead of time is because they had this frivolous litigation that the company was willing to pay a consent fee to force noteholders to convert and go away. Beyond that, it doesn't make sense financially for people to convert early and give up optionality.

[cfrankv]

The cutoff date mentioned for the Dec 14, 2006 MWA spin off is Dec 6, 2006.

[StupidDuhawk]

To those that still follow this thread, it's my opinion that the WLT stub has gotten fairly pricey at this level. As MWA has weakened/flattened and WLT stock has risen, the implied WLT stub price has gone up substantially, to ~$24.00 today. This is definitely approaching the fair value for the coal business, though there's still some upside from potential multiple expansion, and value attributable to the homebuilding/finance business. That said, the easy money has been made, and it will likely be longer-term before we see more WLT-stub upside, barring some huge announcement.

My concern is that management can't string together two sentences without saying "..and coal production guidance will be further lowered by 200,000 tons". I plan to take my profits in the WLT stub and retain my MWA.B shares.