2023-12-10 01:34:06 ET
Summary
- Mueller Industries has shown improvement in key financial metrics, making it a good investment opportunity.
- The company has a strong balance sheet and is unleveraged, allowing for flexibility in deploying cash flow.
- Mueller Industries has demonstrated efficient cost management and high returns on invested capital, giving it a competitive advantage.
Investment Thesis
Mueller Industries ( MLI ) caught my attention because of its recent improvement in some key metrics that I deem to be important in an investment. I decided to delve deeper into the company´s financials to see if I should consider adding it to my portfolio. The company´s top-line growth isn't very exciting, which may deter many investors, however, the balance sheet and efficiency are outstanding, and even after very conservative estimates, the company is a good buy at these prices. Therefore, I rate it a buy and opened a small position to test the waters as I believe the company doesn't need top-line growth if it continues to improve profitability through margin expansion.
Briefly on the Company
Mueller Industries is a diversified industrial manufacturer, making copper tubes and fittings for plumbing, brass bars for tools, and also aluminum parts for airplanes. They are the pipe architects who design and build the pipes and valves that carry water, heat your home, and provide air for many different buildings. The company serves many different end markets like Building construction, industrial manufacturing, medical, electrical, transportation and equipment, and military and defense.
Financials
As of Q3 ´23 , the company had around $1.1B in liquidity available, against $1.3m in long-term debt or essentially the company is unleveraged. This is a great position to be in, and many investors like companies that have very little exposure to debt and interest rate risks associated with it. The company has the freedom to deploy its operating cash flow as it sees fit without the burden of annual interest expenses on debt. The company may reward shareholders in a way of dividends, share buybacks, or a more subtle way of expanding the company´s footprint and furthering the growth of the company, which will reward the patient investors in the long run. So, it is safe to say the company is nowhere near at risk of insolvency.
Furthermore, the company´s historical current ratio has been very strong, and in the latest quarter, it improved even further to around 6. This is a good thing and not so good because it is, I believe, a little inefficient. The good thing is that the company has no liquidity problems and can easily cover its short-term obligations, however, it is also not a very efficient use of assets, like cash, that could be used to further the growth of the company. I would like to see this coming down to around 2, so the company needs to use that cash for some growth initiatives instead of hoarding it. Of course, it´s not a bad thing to have a big pile of cash sitting in the account, however, I would prefer the management use it to grow.
Speaking of efficiency, the company´s ROA and ROE have been phenomenal over the last couple of years. One contributed to this increase was the company´s ability to increase sales while keeping the costs relative to new sales lower. In FY21, the company´s revenues increased by 57%, while the cost of goods sold and operating expenses went up by 49% and 12%, respectively. This tells me that the company is scalable as it can generate higher sales while keeping the costs more or less in check, and that is a good way to grow a business consistently. Even in FY22, the company saw only around a 6% increase in sales but managed to reduce the cost of goods sold by around 600bps y/y. The management seems to be very competent and knows where to reduce costs to become more profitable and efficient, and that is a very good quality.
One of the main reasons I decided to cover the company is because of its very high ROIC, which at the end of FY22 stood at around 28%, slightly lower than its previous year of 32%. It is still very impressive. Another positive for the management here is because it looks like they are good at allocating capital that provides great returns on every dollar invested. I usually look for around 10%, and MLI is well above that. For companies with such high ROIC, I don’t mind paying a little more, in terms of adding less margin of safety. Compared to the company´s ROIC to its WACC of around 8.6%, we can see that the company is successfully investing its capital to generate very high returns.
Furthermore, if we compare the company to its competitors, we can see a clear competitive advantage that MLI has over the rest of the by a long mile. The company has built a strong moat in the last couple of years, and that is worth paying a premium for (ROTC is slightly different from ROIC, however, since the company has barely any debt it can be used).
Moving on to revenues, the company managed to achieve a respectable 7% CAGR over the last decade, which is pretty good for an over-a-century-old company that is not known as a growth company by any stretch of the imagination. The revenue outlook isn't very exciting either for the company, with low-single-digit CAGRS across the industries it operates, which is fine with me, because top-line growth isn't the only way to grow the company. It is preferred by many because it's exciting, however, the next metric is what matters the most to me and that is the margin improvements.
Margins have steadily improved over the last 5 years, which is what I like to see, and these improvements aren’t miniscule either.
Even with sales coming down slightly y/y, the company manages to keep improving on margins consistently, however, I would expect operating and net margins to dip slightly in FY23 due to the tougher economic conditions we have experienced, in terms of high-interest rates, inflation, inventory buildup, which led to softer demand for many products.
Overall, I see a company that doesn't need to rely on top-line growth to drive value. The management is adept at managing the company´s costs and driving further profitability and higher cash flows, which in the end will translate to better overall health, and the patient investors will reap rewards. The company´s balance sheet is very healthy, and I wouldn’t have any trouble owning this stock for many years.
Valuation
For my valuation analysis, I decided to keep it simple, which will give me an extra margin of safety. For revenue growth, I went with -14 % for FY23, as that is what looks like to be after looking through the last 3 quarters of earnings, which matches the one analyst that covers the stock. Below are my assumptions for the base, optimistic, and conservative cases, and their respective CAGRs.
For margins and EPS, I decided to keep it conservative, even though the management possesses a remarkable aptitude for margin expansion. I went with stable margins that are consistently worse than FY22, for that extra margin of safety. Below are those assumptions.
On top of these assumptions, I went with a 10% discount rate instead of the company´s WACC of 8.6% to get even more margin of safety and 2.5% as my terminal growth rate. To further stress-test the company, I decided to add another 30% MoS on top of all these, just to see how low it can go. With that said, MLI´s intrinsic value is $56.69, which means even after such conservatism, the company is trading at a 34% discount to its fair value.
Comments on the Outlook
Margins are the key
Seeing that the company is not going to drive value through top-line growth, I do not see any catalysts on that end. What I would like to see from the company is the management´s ability to continue expanding margins and drive efficiency and profitability further, solidifying it as the leader of the sector, with a competitive advantage and a strong moat.
Even with keeping the margins where they are now, the company looks to be very profitable and will continue to perform very well in the future, and I don't mind owning such a company for the long term.
If the company is going to deploy the cash available to grow its top line inorganically, it is only going to be an icing on the cake. The key for such old companies is to figure out how to improve efficiency and, and generously reward shareholders.
Risks
In the short run, I believe there may be pullbacks in the share price. The company performed quite well YTD, being up 45% as of writing this article, so if there will be any misses on the next earnings reports, I wouldn't be surprised if some people decide to take some profits off the table.
A lot of the company´s sales originate from the construction sector. 85% to be exact, which poses quite a big risk in case the economy turns sour in the next year or so. A high-interest rate environment, coupled with persistent inflation, which drives up costs of materials and house prices, may bring upon softer demand for houses and other housing, which will impact the company´s revenue significantly. Even though that is a big risk to consider, the company did relatively well during the recessionary periods of the past as this graph indicates. I believe the stellar balance sheet played a large role throughout the tough times.
Closing Comments
Even after such beaten-down estimates above, the company is still a good buy, which is what I like to see in companies. The extra margin of safety is good if you want to have a good night´s sleep without worrying that you bought a company at the wrong time.
In the short run, I would be probably a little cautious because the company is up 45% YTD, however, I am not opposed to opening a position right now and developing a full position over time if it does come down slightly. In the long run, it looks like the company is trading at a heavy discount in terms of PE ratio and that is a good sign for me.
I did exactly that, opened a starter position in the company, and will see how the next couple of quarters develop because, with such high ROIC and efficiency, I am very confident the company will continue to perform well over the next 5-10 years, as it has in the past.
For further details see:
Mueller Industries: Boring Company, But Solid Performance Earned A Spot In My Portfolio