Mueller Industries, Inc. (NYSE:MLI) is a US-based, international housing and commercial construction small-cap play.
In my first report on Mueller Industries, I put the company and its common shares through my market-beating, data-driven investment research checklist of the value proposition, shareholder yields, returns on management, valuation multiples, and downside risk. The resulting investment thesis:
The bipartisan $1 trillion infrastructure bill signed by President Joe Biden in November 2021, combined with the current housing shortage, should create incremental growth opportunities for Mueller Industries. Their enduring, quality operations and below intrinsic value stock price exhibit a strong buy rating.
Unless noted, all data presented is sourced from Seeking Alpha and YCharts as of the market close on March 11, 2022; and intended for illustration only.
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Boring Industrial Staple Beats The Market
MLI is a dividend-paying small-cap stock in the industrials sector’s machinery industry. Its three segments, Piping Systems, Industrial Metals, and Climate, serve the heating, ventilation, air-conditioning, refrigeration, and plumbing markets in North America, Great Britain, Asia, and the Middle East. The company was founded in 1917 and is headquartered in Collierville, Tennessee.
Mueller Industries’ Multi-Channel Product Partners
Ultimately, investing in individual common stocks should aim to beat the benchmark indices over time. For example, the below chart demonstrates how MLI far outperformed its broader sector, represented by the Industrials Select Sector SPDR Fund ETF (NYSE:XLI), its small-cap peers per the iShares Russell 2000 ETF (NYSE:IWM), and the mid- and large-cap markets per the SPDR S&P 500 ETF Trust (NYSE:SPY). Moreover, the chart represents the last six months as growth stocks got hammered.
My value proposition elevator pitch for Mueller Industries: Commodity prices and construction business cycles notwithstanding, MLI is the relatively safe stock of a boring industrial staple.
Shareholder Yields Four Times The 10-Year
As part of my due diligence, I average the total shareholder yields on earnings, free cash flow, and dividends to measure how a targeted stock compares to the prevailing yield on the 10 Year Treasury benchmark note.
I target an earnings yield greater than 6 percent or the equivalent of a P/E multiple below 17 times. With trailing one-year earnings per share of $8.25, the earnings yield for MLI was 14.99%.
I target a free cash flow yield or FCFY of 7 percent and higher or the equivalent of fewer than 15 times the inverted price-to-free cash flow multiple. Based on $4.93 free cash flow per share, the FCFY for MLI was 8.95%.
Although not a dividend investor by definition, I prefer dividend-paying stocks for compensation in the short term while waiting for capital gains to compound over time. The trailing dividend yield for MLI was 0.94%, supported by a conservative 6.34% payout ratio. The dividend yield may appear modest; however, the board recently raised the dividend by a whopping 92.3%. And there is more room for dividend raises based on the payout ratio.
Next, I take the average of the three shareholder yields to measure how the stock compares to the prevailing yield on the 10 Year Treasury benchmark note. The average shareholder yield for MLI was 8.29% vs. 2.00% for the 10-Year. Arguably, equities are deemed riskier than U.S. bonds. However, securities that reward shareholders at more than four times the government benchmark, such as MLI, favor owning the stock instead of the bond.
Remember that earnings and free cash flow yields are inverses of valuation multiples, and each suggests MLI as undervalued. I’ll further explore valuation later in this report.
My weighted shareholder yields rating for MLI: Bullish.
Outstanding Growth, Margins, and Returns
Now, let’s explore the fundamentals of Mueller Industries, uncovering the performance strength of its senior management.
I am biased toward established growth instead of executive guidance and sell-side analyst projections when analyzing a business. Mueller had three-year YoY revenue growth of 41.50% vs. the industrials sector’s 15.18% YoY median growth. Keep in mind that Mueller is dependent on metals and other commodities pricing, which it passes on to its customers. For example, the price of its primary raw material, copper, has risen about 75% since Q2 2020, perhaps leading to the revenue spikes.
I screen for profitable companies to avoid unnecessary speculation, as witnessed in the money-losing disruptive growth stocks of late. Mueller had a trailing three-year steady pre-tax net profit margin of 12.43%, in line with the industrial machinery industry margin of 11.73% and almost twice the level of the 6.50% median net margin for the sector.
Return on equity or ROE reveals how much profit a company generates from shareholder investment in the stock. I target an ROE of 15 percent or higher to discover shareholder-friendly management. Mueller had an extraordinary trailing three-year return on equity of 47.87% against 18.89% for the industry and a 13.73% median ROE for the sector.
According to its most recent Form 10K Annual Report filed with the SEC on February 23, 2022, the company’s board of directors has extended, until July 2022, the authorization to repurchase up to 20 million shares of the company’s common stock through open market transactions or privately negotiated transactions. During the past two years, the company has purchased about 128,000 of its shares at prices between $48 and $59 per share. Noted is the company has underutilized its share purchase program during this period.
I believe value is recognized in buyback programs as well. When trading below intrinsic value, boards that repurchase shares offer shareholders the best returns.
Return on invested capital or ROIC measures how well a company uses its working capital to generate returns on its investment. I target an ROIC above 12 percent, and Mueller had a 37.61% three-year trailing return. The performance indicates that senior executives are highly efficient capital allocators. On the contrary, returns market-wide appeared challenged during the pandemic.
The ROIC needs to exceed the weighted average cost of capital or WACC by a comfortable margin giving credence to management’s ability to outperform its capital costs. For example, Mueller had a trailing weighted average cost of capital of 8.43% (Source: GuruFocus).
The ample spread between ROIC and WACC combined with positive topline growth, steady net profit margins, and outstanding equity and capital returns indicate superior management performance in Collierville, TN.
My weighted returns on management rating for Mueller: Bullish.
Deeply Discounted, Underbought Stock
I rely on four valuation multiples to estimate the intrinsic value of a targeted quality enterprise’s stock price. Our concentrated family portfolio of predominantly dividend-paying common stocks has collectively outperformed the broader market since 2009 based on an equal-weighted average total return of each position vs. the S&P 500 during the same holding periods.
The weighting of my preferred valuation multiples suggests that the market has deeply discounted Mueller’s stock price as of this writing. Therefore, based on the fundamentals and valuation metrics uncovered in this report, risks and catalysts notwithstanding, I would call MLI a bargain-priced, underbought stock of an enduring, quality operator in the industrial machinery industry.
The price-to-sales ratio or P/S measures the stock price relative to revenues. I target fewer than 2.0 times, and MLI had a price-to-sales ratio of 0.83. By comparison, the trailing P/S ratio was 2.73 for the industrial machinery industry, a median of 1.46 for the industrials sector, and 2.84 times sales for the S&P 500. Thus, the weighted sector and market sentiment suggest that MLI is undervalued relative to Mueller’s topline.
Although often a hit or miss multiple, I target price-to-trailing earnings or P/E of fewer than 17 times or below the target stock’s industry averages. MLI had a price-to-earnings multiple of 6.67, significantly lower than the industry P/E of 24.12 and sector median of 20.84, indicating that investor sentiment undervalues the stock price relative to Mueller’s earnings per share. Further, MLI appears trading at a discount to the S&P 500’s recent overall P/E of 23.68 (Source of S&P 500 P/E: Barron’s)
I target single-digit price-to-operating cash flow multiples for the best value. For example, MLI had a price to cash flow of 10.03, compared to the sector median of 15.64, indicating the market undervalues the stock price relative to Mueller’s current cash flows.
Enterprise value to operating earnings or EV/EBIT measures whether a stock is overbought, a bearish or neutral signal, or oversold, a bullish or neutral signal, by the market. I target an EV/EBIT of fewer than 15 times, and MLI was trading at 4.78, compared to a sector median of 17.49 times, signaling the stock was underbought or oversold by the market.
My weighted valuation rating for MLI: Bullish.
Attractive Downside Risk Profile
When assessing the downside risks of a company and its common shares, I focus on five metrics that, in my experience as an individual investor and market observer, often predict the potential risk/reward of the investment. Then, I assign a downside risk-weighted rating of above average, average, below average, or low, biased toward below average and low-risk profiles.
Alpha-rich investors target companies with clear competitive advantages from their products or services. An investor or analyst can streamline the value proposition of an enterprise with a moat assignment of wide, narrow, or none. Mueller Industries is rated number one of the 68 industrial machinery players in Seeking Alpha’s Quant Ranking. Thus, I assign Mueller Industries a narrow economic moat rating based on its long and enduring history in the piping, metals, and climate businesses and its outstanding returns on invested capital.
A favorite of the legendary value investor Benjamin Graham, long-term debt coverage demonstrates balance sheet liquidity or a company’s capacity to pay down debt in a crisis. Generally, one-and-a-half times current assets to long-term debt is ideal. However, as reported on its December 2021 financial statements, Mueller’s long-term debt coverage was 926.0 times, as it paid down its debt to just $1.1 million from nearly a half-billion dollars just three years ago.
Thus, the company has ample liquidity necessary to cover its longer-term leveraging needs. Moreover, in a further test of its paydown capacity, Mueller’s long-term debt to equity was a mere 0.09%, significantly below my 200% ceiling. In other words, investors should become concerned only when a company’s debt is more than twice its equity.
Current liabilities coverage or current ratio measures the short-term liquidity of the balance sheet. I target higher than 1.00, and Mueller’s short-term debt coverage was 2.66, providing more than two and half times the liquid assets necessary to pay down its current liabilities such as accounts payable, accrued expenses, and income taxes.
As a long-term investor, I use a five-year beta trend line and screen for stocks with betas lower than 1.25 or no more than 125% volatility to the market. MLI’s 60-month trailing beta was 1.20. However, its 24-month beta was 1.43, reflecting a stock that offers price volatility above the S&P 500 on the whole, typical of small-cap stocks due to liquidity limitations and perceived risks.
The short interest percentage of the MLI float was 2.92%, well under my 10% ceiling. Thus, one can surmise that bears view MLI as a core-level small-cap holding in institutional and retail portfolios.
Overall, Mueller remains a fundamentally superior company with an attractive risk profile.
My weighted downside risk rating for MLI: Below Average.
MLI: Small Cap to Mid Cap Opportunity
Catalysts accelerating or contradicting my overall bullish investment thesis on Mueller Industries include, but are not limited to:
- The primary catalysts are the infrastructure spending bill’s contribution to commercial construction projects, plus the anticipated demand for new housing units.
- Mueller’s debt reduction, dividend rate increases, and share buybacks continue to reward shareholders who bought at reasonable stock prices.
- Uncontrolled inflation or commodities pricing that Mueller can’t readily pass on to customers would negatively affect its fundamentals and stock price.
Savvy value investors buy small caps in advance of becoming mid-caps. MLI is a sleeper industrial small-cap stock with the pedigree and potential to ride the infrastructure rebuild and housing shortage to a mid-cap market value.
My finding quality + value recommendation for MLI: strong buy.