Gates Capital Buys More Mueller Shares

 | Jun 20, 2013 | 10:00 AM EDT  | Comments
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A 13G filed with the Securities and Exchange Commission has disclosed that Gates Capital Management, a hedge fund managed by Jeffrey Gates, has increased its stake in Mueller Industries (MLI) to a total of 1.4 million shares.

The fund had reported a position of 1.1 million shares in the $1.5 billion market cap provider of metal tubes and rods (including as plumbing and refrigeration components) in its 13F filing for the first quarter of 2013. With the recent increase in its holdings, Gates owns roughly 5% of the total shares outstanding therefore triggering the filing. While Mueller had done quite well last year, the stock is about flat year to date against a rising market.

Revenue fell by 3% in the first quarter of 2013 versus a year earlier. There were decreases in both the plumbing and refrigeration segment (which is responsible for slightly more than half of both revenue and operating income), and the original equipment manufacturing segment.

With net margins declining as well, Mueller recorded a 20% drop in earnings over the same time frame. Last fall, Mueller carried out a large repurchase of shares from major shareholder Leucadia National. Because of the lower share count, earnings per share were actually somewhat higher in the first quarter than a year ago. That shouldn't be taken as an indicator that future growth is likely -- in fact, the degree to which net income declined leaves us somewhat pessimistic on the business.

If we annualize the 93 cents per share that Mueller earned in the first quarter (trailing earnings per share aren't particularly informative given the size of the buyback), then we get a price-to-earnings multiple of 14. That's certainly not a high growth multiple, but we would say that it incorporates at least modest future earnings growth.

Wall Street analysts, despite the decline on both top and bottom lines which we saw in Mueller's most recent quarter, expect earnings per share to improve over the next year. As a result, the stock trades at 12x forward earnings estimates.

Other fabricated metal products companies include Reliance Steel & Aluminum (RS) and Valmont Industries (VMI). These two peers -- though the functions of their products differ considerably from the uses for Mueller's own offerings -- feature trailing earnings multiples in the 13-to-15 range. That is in line with where we found Mueller trading.

The sell side is also expecting modest increases in earnings at these two companies. As a result Reliance is valued at 10x its forward earnings estimates while Valmont's P/E multiple based on expectations for 2014 is 12.

Despite these similarities, these two companies are on very different trend lines going by the numbers from last quarter. Reliance experienced double-digit percentage declines in both revenue and earnings compared to the first quarter of 2012 while Valmont saw strength in both metrics. In particular, net income at the company -- which specializes in products used by infrastructure and utility customers -- was up 48%.

Mueller isn't in too bad a situation, but even if we focus on the revenue numbers we see a small decrease over the last year. Because of that, we wouldn't want to buy the stock at a price which counts on even a modest turnaround in the company's business. That's exactly what we see reflected in the current valuation.

Even after several months it's not particularly positive that Leucadia wanted to exit the business, either. We're not very familiar with Valmont Industries. But with its earnings multiples in a similar range and with the business appearing to do much better in the past few quarters than Mueller and Reliance, it might be a more attractive prospect for investors interested in industrials.

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