April 29, 2008
Research Analyst: Madhurima Majumdar
Sr. Ed.: Ian Madsen, CFA; ; 1-800-767-3771, x9417
www.zackspro.com 111 N. Canal Street, Suite 1101 l Chicago, IL 60606
Zacks Investment Research Page 13 www.zackspro.com
Zacks Investment Research Page 13 www.zackspro.com
Mueller Water Products, Inc. / (MWA-NYSE) / $7.93Zacks Investment Research Page 13 www.zackspro.com
Note: FLASH REPORT; more details to come; changes are highlighted. Except where noted, and highlighted, no other section of this report has been updated.
Reason for Report: FLASH UPDATE: 2Q08 Earnings Update
Flash Update [earnings update in progress; final report to follow]
On April 29, 2008, MWA announced that its Board of Directors declared a quarterly dividend of $0.0175 per share for both its Series B and Series A common stock, payable May 20, 2008 to stockholders of record at the close of business, May 9, 2008.
On April 29, 2008, MWA announced its 2Q08 results:
· Revenue was $421.6 million versus $459.7 million in 2Q07. Net sales decreased $38.1 million y/y due to lower shipment volumes principally attributable to the continued difficulties associated with residential construction. The decrease was partially offset by slightly higher pricing and the favorable impact of Canadian currency exchange rates. Revenue reported was less than the Zacks Digest average of $436.8 million.
· Income from operations was $28.0 million versus $52.9 million in 2Q07. Operating margin was 6.6% in 2Q07 versus 11.5% in 2Q07. These results include cash restructuring charges of $1.5 million comprising severance and other costs in connection with the previously announced closure of U.S. Pipe's manufacturing operations in Burlington.
Excluding the restructuring charges, adjusted income from operations for the quarter was $29.5 million and adjusted operating income margin was 7.0%. The declines in operating income and margin were primarily attributable to reduced shipments and significantly higher raw material costs. Cost reductions of $10.8 million offset the negative impact of reduced production. Operating income was less than the Zacks Digest average of $37.6 million and operating margin of 8.6%.
· Reported net income was $5.7 million in 2Q08 versus $17.9 million in 2Q07. 2Q08 GAAP net income was less than the Zacks Digest average of $9.9 million. Adjusted net income excluding restructuring charges was $6.6 million in 2Q08, less than $11.0 million projected by analysts as per the Zacks Digest model.
· MWA reported EPS of $0.05 versus $0.16 in 2Q07. Excluding restructuring charges, EPS was $0.06 in 2Q08 versus $0.16 in 2Q07. GAAP EPS and adjusted EPS were both less than the Zacks Digest average of $0.09.
Management stated 2Q08 results reflect the current condition of residential construction, rising raw material costs and the general uncertainty of the economy. Management believes that it is taking the right steps operationally to deal with these factors, by reducing both fixed and variable costs to address declines in volumes, and implementing price increases to help counteract rising raw material costs. According to management, these initiatives are essential for the current economic environment and should enhance MWA’s profitability when the market rebounds.
Portfolio Manager’s Executive Summary [earnings update in progress; final report to follow]
Mueller Water Products, Inc. (MWA) is a leading North American manufacturer and marketer of infrastructure and flow control products for use in water distribution networks and treatment facilities. Its broad product portfolio includes engineered valves, hydrants, pipe fittings and ductile iron pipe, which are used by municipalities, as well as the commercial and residential construction, oil and gas, HVAC and fire protection industries.
MWA’s brands occupy leading market positions for approximately 75% of its sales and are a driving force behind Mueller's long-standing relationships with key distributors.
Among the firms covering the stock, most hold a cautious outlook. 8 firms provided neutral ratings while 2 firms rated the stock negatively. Among the 10 firms covering the stock, 5 provided target prices while only 3 firms came up with valuation metrics. One firm applied multiple of 7.5 on CY08 EBITDA estimate to arrive at the target price, while another firm based its valuation on 16xFY'09 estimated EPS of $0.65 & DCF analysis while the firm with the highest target price used DCF analysis. The firm with the lowest target price of $8.00 did not provide any valuation metric. Both the firms with the highest and lowest target price rated the stock neutral.
Cautious and Bearish (Neutral and Negative or equivalent outlook) - ten analysts or 100.0% - Target prices range from $8.00 to $13.00: MWA provides products that are essential to water/wastewater distribution systems for municipalities across North America. These systems exhibit attractive growth rates both through new residential and commercial expansion, but also repair and replacement. The water infrastructure within the U.S. in particular is in dire need for repair allowing MWA to grow above GDP on a long-term basis. Strong demand in the repair market and moderate growth in the non-residential market should help offset weakness in the residential market in the near term. Approximately 40% of Muller's sales stem from new residential construction spending. Continued decline in the market affects the Company’s performance, according to the firms. Firms consider MWA’s ongoing corporate actions to be positive and believe it will be better positioned to face improving conditions, when they occur. Firms believe that the company is taking the rights steps with price increases, cutting costs and controlling inventory.
Recent Events [earnings update in progress; final report to follow]
On February 20, 2008, Moody's revised MWA’s outlook to Stable from Positive citing expectations of lower volumes resulting from the residential construction slump and also reflecting slight margin erosion due to increased raw material costs and possible problems from implementing price increases.
On February 5, 2008, MWA reported its 1Q08 earnings results. Total revenue was $412.3 million in 1Q08 (0.1% y/y increase). GAAP net income was ($1.6) million in 1Q08 versus $17 million in 1Q07. Net income (excluding restructuring charges) was $7.9 million in 1Q08 and $17 million in 1Q07. GAAP EPS was ($0.01) versus $0.15 in 1Q07. Adjusted EPS was $0.07 versus $0.15 in 1Q07.
Overview [earnings update in progress; final report to follow]
Key investment considerations as identified by analysts, are as follows:
Key Positive Arguments /Key Negative Arguments
· Leading Market Position: MWA has the most comprehensive water infrastructure and flow control product line in the industry, and enjoys leading market position.· Lowest cost producer: MWA is the only manufacturer utilizing a lost foam manufacturing process, which saves the Company’s 15% cost versus its competitors. Further, the process is a very costly and time consuming endeavor for the competitors to duplicate.
· Corporate Strategies: Analysts expect management’s strategy to slash capacity and consolidate plants to show positive results in the coming years.
· Acquisitions: Management states that acquisitions will act as an important catalyst in improving growth rates. The Company will primarily target related companies that will continue to give it an edge in the specification process with municipalities. / · Slowing Residential Market: Approximately 35% of MWA’s revenue is tied to new residential construction spending. This market is experiencing a significant deceleration, and thus, poses a risk to the Company.
· Rising raw material costs: Rising raw material costs continue to be a challenge. While MWA is generally able to raise prices, in a rising material cost environment, this may not be sufficient to fully compensate for the negative effects.
· Focused US market: MWA’s sales are entirely concentrated in the U.S, which exposes it to the domestic economic risk.
· Concentrated Distribution: The Company generates 40% of its revenues from its 10 largest distributors and 30% from its three largest distributors. This kind of concentrated distribution is a high risk for the Company.
· Government Funding: Approximately 30% of MWA’s sales are repair and replacement in nature that are generally funded by the individual municipalities. Thus, MWA does have some economically cyclical exposure. Additionally, help from government funding has remained flat or has even been decelerating.
Headquartered in Atlanta, Georgia, Mueller Water Products Inc. (MWA or the Company) is a leading North American manufacturer of a broad range of water infrastructure and flow control products for use in water distribution networks, water and wastewater treatment facilities, gas distribution systems and fire protection piping systems. MWA operates through three business segments. The Mueller segment manufactures valves and fire hydrants utilized in the distribution of water and gas and in water and wastewater treatment facilities. The U.S. Pipe segment manufactures ductile iron pressure pipe, fittings, and other cast iron products used primarily for major water and wastewater transmission and collection systems. The Anvil segment manufactures cast iron and malleable iron pipe fittings, ductile iron couplings and fittings, pipe hangers, and other related products for fire protection, plumbing, heating, mechanical, construction, retail hardware, and other related industries.
More information can be obtained from the Company’s website, www.muellerwaterproducts.com
Note: MWA’s fiscal year ends in September; fiscal references differ from the calendar year.
February 15, 2008
Revenue [earnings update in progress; final report to follow]
CONSENSUS PROJECTED SALES
Total Revenue ($ in millions) / 4Q07A / 1Q08A / 2Q08E / 3Q08E / 4Q08E / 2007A / 2008E / 2009E / 2010EZacks Consensus / $486.0↓ / $1,811.0↓ / $1,879.0↑
Digest High / $475.0 / $412.3 / $449.8↓ / $513.6 / $520.0 / $1,849.0 / $1,887.3 / $1,953.8 / $2,024.2
Digest Low / $474.9 / $412.0 / $420.0 / $476.2 / $464.0 / $1,849.0 / $1,791.3 / $1,851.2 / $2,024.2
Digest Average / $474.9 / $412.3 / $436.8 ↓ / $492.1 ↓ / $487.9 ↓ / $1,849.0 / $1,8290 ↓ / $1,899.4↓ / $2,024.2
Digest Average YoY Growth / -8.3% / 0.1% / -5.0% / -2.1% / 2.7% / -4.4% / -1.1% / 3.8% / 6.6%
Quarterly Growth / -5.5% / -13.2% / 6.0% / 12.6% / -0.8%
1Q08 Summary: Revenue was $412.3 million, 0.1% y/y increase. Amongst the segments, only the Anvil segment posted y/y growth in the quarter. Revenue at both Mueller and U.S. Pipe declined y/y due to volume declines as a result of the ongoing weakness in residential construction demand. However, higher pricing across Mueller and Anvil segments, favorable impact of Canadian currency exchange rates and the acquisition of Fast Fabricators (in January 2007) helped somewhat offset the effect. Analysts note even though municipal repair and replacement work increased y/y, it was inadequate to offset the weak residential construction markets.
SEGMENT REVENUE
Segment Revenue ($ in million) / 1Q07A / 4Q07A / 1Q08A / 2Q08E / 2007A / 2008E / 2009E / 2010EMueller / $165.4 / $199.6 / $161.6 / $182.8 ↓ / $773.6 / $741.8↓ / $777.8 ↓ / $840.8
U.S. Pipe / $117.0 / $146.7 / $110.7 / $110.7 ↓ / $551.6 / $523.3↓ / $549.6 ↑ / $575.3
Anvil / $133.5 / $142.6 / $140.0 / $140.0↑ / $556.5 / $576.3↑ / $583.0 ↑ / $608.2
Consolidating Adjustments / ($6.2) / ($13.8) / $0.0 / ($7.8) ↓ / ($32.6) / ($24.9) ↑ / ($29.6) ↑ / ($37.7)
TOTAL REVENUE / $411.9 / $474.9 / $412.3 / $436.8 ↓ / $1,849.0 / $1,829.0↓ / $1,899.4↓ / $2,024.2
Provided below is the graphical segment analysis:
Mueller (39% of 1Q08 revenue): Segment revenue was $161.6 million, down 2.3% y/y. Unit shipment volumes of iron gate valves and hydrants were essentially flat. Brass service product sales declined sharply due to the direct impact of residential construction, causing a decline of $7.6 million in revenue. However, price increase of $7.1 million somewhat helped offset the effect.
U.S. Pipe (27% of 1Q08 revenue): Revenue decreased 5.4% y/y to $110.7 million in 1Q08 from $117.1 million posted in 1Q07. The decrease was due to lower ductile iron pipe shipments, which was somewhat offset by net sales from the Fast Fabricators acquisition.
Anvil (34% of FY07 revenue): Segment revenue was $140 million in 1Q08, a 4.8% y/y increase. It was the only segment to post y/y growth in the quarter, which was driven primarily by the favorable impact of Canadian currency exchange rates and higher sales pricing.
Pricing: Pricing remains a primary focus for the Company. The Company recently implemented price increases at U.S. Pipe (15%) in January ‘08 and Mueller Co. (5%) in February ‘08, although indicated that it does not expect to realize the benefits of these increases until 2H08.
Outlook: The new residential construction market has deteriorated substantially since the end of 3Q07. Approximately 35% of MWA’s sales are tied to it and thus sales have been affected. Management and analysts expect further decline over the balance of 2008 and thus believe growth will be hampered at Mueller Co. and U.S. Pipe, both of which are heavily exposed to the residential market. MWA expects overall revenue to be relatively flat in 2008 compared to FY07. Volumes will again decline in 2Q08 as strong demand from public infrastructure and stable commercial construction cannot offset the weakness from residential construction. 2Q08 is expected to be up from 1Q08 given seasonality, and 2H08 to remain roughly at par with 2H07. Management believes 2008 results should benefit from the recent Burlington manufacturing shutdown, which is expected to generate $15-$17 million in annual savings, with roughly $9 million net savings projected for FY08.
One analyst (Friedman, Billings) expects the public works market to continue to deliver sales growth in 2008, though hampered by weak U.S. residential construction markets, but aided by decent commercial construction markets.
However, one analyst (R W. Baird) notes commercial construction growth rates have begun to decelerate. Furthermore, growth in the repair and replacement market is closely related to municipal spending, which given the deceleration in tax receipt growth, could be negatively impacted, especially in 2009. Thus, while conditions have been strong in both markets recently, the analyst expects growth to slow in both and potentially impact MWA’s sales negatively in the near future. Another analyst (Suntr. RH.) also believes that municipal spending could start to slow down given the current credit crunch and lower tax revenue across the U.S. in FY08.