Mueller Water Lagging As Investors Turn Away From A Once-Hot Sector

 

Residential construction remains healthy, and municipals are already coming up with cash for water and wastewater infrastructure projects ahead of stimulus-driven spending, but that's not helping the water infrastructure space outperform recently. Between supply chain pressures and derating off of what were generally too-high multiples (at least in my opinion…), this has been a weaker sub-segment of industrials since the late fall of 2021.

I thought Mueller Water (NYSE:MWA) had better prospects on its leverage to residential construction and self-help, but that didn't work out quite like I'd expected. Although Mueller shares have outperformed Xylem (XYL), they've still lagged the broader industrial space and the S&P 500. There's still a relative value call to be made here, but margin pressure is going to last a while longer and I think investors can and should consider names like Zurn (ZWS) and Franklin Electric (FELE) alongside Mueller today.

 

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Mueller Water Lagging As Investors Turn Away From A Once-Hot Sector

Mueller Looks Undervalued And Has A Few Positive Drivers

I last wrote about Mueller Water (MWA) in late September, and despite liking Mueller's leverage to residential housing construction and potentially greater federal support for water infrastructure projects, I wasn't that sold on the shares. Since then, the stock has very slightly outperformed the S&P 500 and the industrial sector as a whole, more or less keeping pace with comps like Watts (WTS) and Xylem (XYL).

I'm still not all that bullish that federal infrastructure stimulus will mean much for Mueller, but I guess any help is help. I am more bullish on residential construction, though, as I do see ongoing strength and an under-supplied market. I'm also more bullish on the prospects for a manufacturing footprint upgrade to generate better long-term margins, with capex spending normalizing in a few years and adding a further boost to FCF margins. I still don't love the DCF-based valuation here, but the shares do seem undervalued on margins, and in an expensive industrial sector, this name does have some catch-up appeal.

 

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Mueller Looks Undervalued And Has A Few Positive Drivers

Mueller Water's Upside Rests On Good Government Decisions

It's been a long time since I've published updated thoughts on Mueller Water (NYSE:MWA). I wasn't very bullish on the shares back in 2016, largely due to what I thought were inflated expectations for municipal water investment/capex spending and the Technologies segment, as well as overly ambitious expectations for margin leverage. Since then, the shares have underperformed the broader industrial group by about 30% and the S&P by about 50%, as well as more water-focused peers like Evoqua (AQUA), Watts Water (WTS), and Xylem (XYL).

I'm relatively bullish on the outlook for residential construction, including land development, and I like the company's decision to reinvest in its manufacturing base to drive stronger long-term margins. What I don't like is how much of the valuation still seems to depend upon governments at all levels (municipal, state, and federal) making smart decisions, doing the right things, and finding the funds to reinvest in upgrading critical infrastructure assets like water. I'm also still quite skeptical of the Technologies business - while products and services like monitoring software and leak detection should be popular, something is clearly not working in this business, as it hasn't produced meaningful growth in five years.

Mueller doesn't look particularly attractive on cash flow, though my model reflects my own pessimism that needed infrastructure spending will happen. Relative to Mueller's margins, ROIC, and so on, though, the shares do look undervalued.

 

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Mueller Water's Upside Rests On Good Government Decisions

Mueller Looks Hard-Pressed To Reward The Market's Rediscovered Optimism

One of the ongoing mysteries of the market that I have yet to solve is the almost evergreen enthusiasm that investors have for water-related companies. While stocks like Mueller Water Products (NYSE:MWA) and Xylem (NYSE:XYL) do have their periods of relative underperformance, it seems like there's a strong "will to believe" behind this sector that doesn't seem related to the actual underlying long-term free cash flow growth or ROIC prospects.

Be that as it may, I'm not going to look a gift horse in the mouth - I thought Mueller looked undervalued earlier this year and the 50% move in the stock since then is definitely more than I'd expected. It's also more than I think is merited by the fundamentals. I understand that housing activity and municipal spending are both looking better, and this company has been doing well with margins in its core business, but even my expectations for almost a decade of sustained double-digit FCF margins (something the company hasn't achieved before) and solid mid-single-digit revenue growth isn't enough to generate a fair value above today's stock price.

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Mueller Looks Hard-Pressed To Reward The Market's Rediscovered Optimism

Seeking Alpha: Mueller Water Still Waiting For Orders To Really Flow

Construction activity has been getting better in the U.S., but you wouldn't really know it by looking at the performance of water infrastructure supplier Mueller Water Products (NYSE:MWA), nor other related stocks like HD Supply (NASDAQ:HDS) and Rexnord (NYSE:RXN). On the other hand, it's hard to say that Mueller's shares ought to be outperforming as the company has racked up three straight quarterly revenue misses and sell-side estimates have been moving lower.

I'm still optimistic that municipal spending will pick up, but it's not all going to materialize in 2016 for Mueller. What's more, investors are still concerned about the impact of the profound weakness in the oil/gas markets and the lack of traction in Mueller's water technology businesses. Mid-single digit revenue growth and operating leverage-driven margin improvements can still support a double-digit fair value, but the shares definitely need to see some beat-and-raise quarterly performances.

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Mueller Water Still Waiting For Orders To Really Flow

Seeking Alpha: Mueller Water Finally Looking More Like A Bargain

The housing recovery continues to develop at a slower pace than the bulls had hoped and that has weighed on the performance of Mueller Water Products (NYSE:MWA). I've had some reservations about this company's valuation and the likelihood that it would meet Street expectations over the past eighteen months, and during that time the shares have basically gone nowhere. While the company does appear to have resolved some of its manufacturing issues and municipal tendering activity has improved, weakness in the oil/gas sector has added a headwind and expectations for housing starts this year have moderated.

The sustained underperformance of these shares has given the fundamentals a chance to catch up and the risk-reward looks more interesting now than it has for most of the last two years. The weakness in metering is disappointing and the company is going to have to spend to support the growth potential of its leak detection business, but I think there's meaningful untapped profit/cash flow leverage remaining in the company's underutilized capacity. With the shares about 10% to 20% undervalued and still offering long-term recovery leverage, this name may be worth a closer look as other housing stories have already run further.

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Mueller Water Finally Looking More Like A Bargain

Seeking Alpha: Layne Christensen Bumping Along The Bottom

Water infrastructure company Layne Christensen (NASDAQ:LAYN) has been a hurry-up-and-wait story for a while now, and while there have been some encouraging signs of life in parts of the business, there is still a lot work ahead of the company. I do believe the shares look undervalued on a long-term basis, but this company has disappointed a lot of investors over the years and the departure of the CEO, CFO, and chief accounting officer in quick succession make me nervous, as does the company's ongoing leverage to highly competitive, lower-margin businesses.

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Layne Christensen Bumping Along The Bottom

Seeking Alpha: Mueller Water Products Showing Signs Of Real Recovery

Prior to a very strong August, the past six months finally saw Wall Street lose some of its ardor for water and flow control companies like Xylem (NYSE:XYL) and Mueller Water Products (NYSE:MWA). I did think that Mueller Water looked a little pricey on the fundamentals back in March, but I didn't expect the Street to ditch housing and water plays like Mueller just because of valuation. While the shares are down about 4% from my March article, it was actually quite a bit worse than that (a 20% drop) before a strong recovery after fiscal third quarter earnings.

Even though Mueller has lagged the S&P 500 by more than 10% over the past six months, that comes after a good run of performance and the shares aren't exactly strikingly cheap unless you're willing to go along with double-digit forward EBITDA multiples and aggressive assumptions regarding future cash flow. I do like this business, and it looks like both municipal spending and land development activity are improving.

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Mueller Water Products Showing Signs Of Real Recovery

Seeking Alpha: Life In The Slow Layne

Life hasn't been easy for companies that make their living off of municipal infrastructure spending, but Layne Christensen (LAYN) has still managed to "out-struggle" the likes of Mueller Water Products (MWA) and Aegion (AEGN) when it comes to overall performance. Granted Aegion and Mueller are of limited comparative value given the differences in business mix (particularly Mueller), but the point stands that Layne is struggling to find its way to profitability in the current environment. Management continues to tell an optimistic story of future success, but it takes pretty bullish expectations about the future to make these shares look appealing today.

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Life In The Slow Layne

Seeking Alpha: Mueller Water Tapped Into Wall Street's Housing Hopes

Investors are clearly expecting improvements in the housing market to continue, and that enthusiasm is helping to push Mueller Water Products (MWA) to a new 52-week high. I don't consider this altogether surprising, as I wrote about six months ago that Wall Street would likely stay on this name so long as the prospects for improved revenue growth and margin leverage remained tenable. While it is harder and harder to see long-term intrinsic value in the shares unless the housing recovery really surprises to the good, momentum and near-term profit growth prospects could take these shares into the low to mid teens.

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Mueller Water Tapped Into Wall Street's Housing Hopes

Seeking Alpha: With More Realistic Expectations, Itron Looks Interesting Again

Smart metering company Itron (ITRI) is a good example of why I'm always skeptical whenever I see people writing "don't worry about the valuation, just focus on the growth". This was a great growth story for a number of years, but the stock got expensive along the way and the high valuation only served to magnify the disappointment when the financial performance got wobbly.

Years later, I'm finding Itron more interesting. A lot of the wide-eyed optimism about the opportunity in smart metering and related utility smart grid technologies has been scrubbed out, and the global market potential is still pretty compelling. While a recently announced restructuring suggests that the turbulence within Itron isn't completely over, these shares seem like a reasonable opportunity in a market offering fewer and fewer of those.

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With More Realistic Expectations, Itron Looks Interesting Again

Seeking Alpha: Wall Street Betting That Mueller's Profits Will Start To Flow

The markets have long loved water/fluid-management stories like Xylem (XYL), ITT (ITT), and Franklin Electric (FELE), and if you can add a residential construction rebound, you have an even better story in the making. That has certainly worked for Mueller Water (MWA), as shares have risen more than 75% over the past year, 235% over the past two years, and about 300% over the all-time low set in November of 2011.

Not surprisingly, it looks like the market has put a definite premium on the recovery potential here. I do believe that residential construction is on its way back, and I also believe that Mueller's investment in advanced products like advanced metering (AMI), leak detection, and pressure monitoring will provide a nice kicker to its growth in valves and hydrants. Mueller shares do look pricey on a cash flow basis, and could be vulnerable if the residential recovery proves shallower than expected, but I won't ignore the possibility that strong leverage could lead to significant profit growth and even higher multiples.

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Wall Street Betting That Mueller's Profits Will Start To Flow