Investor Essentials Daily

Mueller Water Products has historically strong tailwinds, and the credit rating agencies are completely missing it

Mueller Water Products, Inc. (MWA:USA)
October 13, 2021

The Federal government has known for some time that American water infrastructure is crumbling beneath our feet. After years of talking, lawmakers are finally taking action.

Mueller Water Products is a crucial supplier to national water infrastructure, and business is about to be booming. But the credit rating agencies are rating the company as a high risk to fixed income investors. A closer look shows how wrong they are…

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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With all the talk about the debt ceiling, a potential default on American debt, and government shutdowns, one might wonder why politicians on Capitol Hill are pushing for an increased capacity to borrow and spend.

The multi-trillion dollar infrastructure bill currently being debated in Washington is being viewed by some as unkempt excess amid an economy that is supposedly drowning in debt.

No matter what fear-mongering pundits are trying to push, we have been banging the table to our institutional clients for some time now that American debt is healthier than it seems. Uniform Accounting reveals that the country has plenty of capacity to repay its debts or refinance when needed. 

The numbers tell a clear story: There is no need to panic over an unavoidable default.

Meanwhile, nearly every politician has acknowledged a need to update the nation’s infrastructure, some elements of which are over 100 years old.

As the 2016 issues in Flint Michigan remind us, while many are excited for a wave of spending on beautiful new roads, rails, and bridges, there is another critical need. American water infrastructure is crumbling under its exceptional age, and modernizing it can have a direct positive effect on millions of people’s health. 

That entails repairing and replacing old pipes, building new systems, and establishing more intelligent control mechanisms to prevent disasters similar to Flint. It is likely to require major spending, some of which may land with Mueller Water Products, a key supplier to American water infrastructure. 

Mueller sells the valves, pipes, couplings, tools, fire hydrants, and dozens of other crucial components of the complex system that enables the United States to have some of the cleanest water in the world. 

Mueller’s customers are cities and government-adjacent utility companies, including the San Jose Water Company, the city of Newport Beach, California, and the New Jersey American Water Company. 

This means revenue is largely dependent on what lawmakers are willing to spend.

Until the infrastructure bill passes, details about exact spending amounts are few and far between, and it is unknown whether water infrastructure spending will make it through the process. But Mueller isn’t worried. 

That’s because earlier this year, Washington quietly passed the Drinking Water and Wastewater Infrastructure Act of 2021, which sets $35 billion aside for water infrastructure spending. This marks the beginning of a landmark transformation for American national water systems.

Interestingly, despite the massive tailwinds, the big credit rating agencies are rating Mueller as high yield credit. Despite Mueller’s cash flows, size, and stability, Moody’s BB high yield credit rating implies that there is a significant risk of demand drying up, causing the company to imminently default on its debt. 

A cursory glance at the company’s fundamentals clearly shows the absurdity of this rating.

First, Mueller has only $46 million in debt on its balance sheet. This is miniscule compared to its $228 million cash position and its $2.4 billion market capitalization. But more importantly, a look at its upcoming debt shows none of it comes due in the next five years, and the company’s cash flows consistently comfortably exceed obligations, with ample headroom for other initiatives. 

We can use the Valens Credit Cash Flow Prime (“CCFP”) to visualize Mueller’s balance sheet strength.

In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

Take a look: 

Among the CCFP charts we look at on a daily basis, Mueller’s is exceptionally strong. This is especially true considering that companies involved with the utility industry often tend to be highly leveled. 

It is mind blowing that rating agencies could get a story this simple this wrong. When graded on the Valens scale, which incorporates Uniform Accounting and an honest interpretation of analyst expectations, the company comfortably earns an investment-grade IG3+ rating, with a sub-2% chance of default in the next five years.

CCFP analysis is a crucial element of Valens’ stock picking process for our institutional clients and the Conviction Long List. 

Click here to learn more about getting access to the Valens Research App, which includes CCFP analysis for over 25,000 companies. 

SUMMARY and Mueller Water Products, Inc. Tearsheet

As the Uniform Accounting tearsheet for Mueller Water Products, Inc. (MWA:USA) highlights, the Uniform P/E trades at 19.1x, which is above the global corporate average of 24.3x and around its historical P/E of 16.8x.

Low P/Es require low EPS growth to sustain them. In the case of Mueller, the company has recently shown an 8% Uniform EPS decline.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Mueller’s Wall Street analyst-driven forecast is for immaterial growth in 2021 and 32% EPS growth in 2022.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Mueller’s $15.85 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to remain unchanged over the next three years. What Wall Street analysts expect for Mueller’s earnings growth is near what the current stock market valuation requires in 2021, but above that requirement in 2022.

Furthermore, the company’s earning power in 2020 is 3x the long-run corporate average. Moreover, cash flows and cash on hand are more than 3x its total obligations—including debt maturities and capex maintenance. All in all, this signals a low credit risk.

Lastly, Mueller’s Uniform earnings growth is around peer averages, while the company is trading below its average peer valuations. 

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research