Mueller Water Products

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Mueller Water Products is a North American manufacturer of flow control and water management solutions, primarily serving the municipal and industrial sectors with products for water infrastructure.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

MWA’s moat is best described as a narrow one, earning a 3 out of 5 for moat strength. While they possess some key competitive advantages that allow them to operate with above-average margins, these aren’t unbreachable. The moat comes primarily from:

Reputation and Reliability: MWA is a recognized leader in water infrastructure. Their long history in the industry, dating back to the 1850’s, has earned them the trust of municipalities and contractors. This reputation for reliability, quality products, and customer service acts as a barrier for new entrants lacking the same track record. The replacement cycle in water infrastructure is extremely long-term (decades), so existing, large players, tend to have the advantage. However, the level of specialization required to enter this market isn’t insurmountable. This, and that prices for their products tend to be determined by government regulations and by bids that can change annually, reduces the strength of its reputation as an economic moat.
Distribution Network and Geographic Concentration: MWA’s established distribution network and their localized sales representatives give them a key advantage of delivering parts to their customers with speed. While there are several competitors in the water market, not all can match the distribution of Mueller Water Products. This allows them to retain customers with speed and maintain revenues with relative stability.
Switching Costs: Their highly-specialized products are deeply integrated in the infrastructure system making it costly for municipalities and contractors to switch suppliers easily. Any change would require retraining staff, new products must comply with specific rules and regulation, and the price of the old system cannot be directly converted. These create considerable hurdles in changing supplier.

However, these advantages are not impenetrable:

Limited Pricing Power: While they can command a slight price premium owing to the reputation of their products, the markets that they operate in tend to be regulated. Government regulations and budgetary constraints faced by municipalities restrict pricing power, and intense competition from other players limits their ability to substantially increase prices without impacting their volume.
Dependence on Infrastructure Spending: Revenue is dependent on government spending on infrastructure and therefore is highly correlated to government policies and fiscal positions. Budgetary constraints or a slowdown in spending could affect their revenue and profitability.
Risk of Imitation: While their reputation is difficult for new entrants to overcome in the short term, other manufacturers can produce similar products and compete through pricing. Some of their products are fairly commoditized. Though switching costs are a factor for their current customers, if a new player is offering better value, the switching costs for new projects are much lower.
Lack of Innovation: While MWA continues to innovate, it has not shown any particular technological innovations that create a wide sustainable advantage over their competitors. New technology can also change customer preferences, which would be an additional hurdle.

Risks to the Moat and Business Resilience: While MWA’s business model allows it to retain its share, it faces risks that may undermine the company:

Economic Slowdowns and Government Spending: As the core consumer base of this company is municipalities, the public revenue is a key factor for MWA’s revenues. Decreased tax revenue or a governmental focus away from water infrastructure may hurt revenues.
Inflation: Rising raw material costs could negatively impact margins. This risk is partially passed on to consumers using price increases, but this is done so with a delay, and might decrease margins. The cost of labor has increased sharply in the recent years which also puts pressure on profitability.
Competition: Increasing competition might reduce its pricing power. While there are some economic factors at play that benefit MWA, the company could also be hurt by increased market presence of competitors.
Product Obsolescence: New technologies might make their products obsolete and reduce the switching costs that currently prevent customers from easily changing supplier.

Business Overview:

MWA operates in two primary segments: Water Flow Solutions and Water Management Solutions.

Water Flow Solutions: This segment offers a broad range of products for controlling the flow of water in a distribution system, such as valves, hydrants, and pipe fittings. Their products are primarily used in the construction, repair, and maintenance of water and wastewater systems. This segment primarily includes North American water utility distribution and municipal water utilities. It serves small and large communities alike. They are expanding into new product verticals as well as new geographic markets, focusing particularly in digital and tech-enabled solutions.
Water Management Solutions: This segment develops and manufactures technology products that improve the performance of water systems, like monitoring systems, leak detection, and pressure management. This segment is characterized by high tech systems, software, and IoT capabilities. They are actively building their recurring revenue from this segment.

MWA’s revenues are primarily concentrated in North America, with 90% from the United States and Canada combined. They have been expanding to new geographic markets in Australia, Latin America, and the Middle East.

Industry Trends:

Aging infrastructure: Much of the water infrastructure in developed countries is aging and requires replacement or upgrades. This represents an ongoing demand for MWA’s products.
Growing focus on efficiency: Government and businesses are increasingly focused on water conservation and efficiency. This drives demand for MWA’s water management solutions.
Increasing regulatory standards: Stricter standards are putting pressure on municipalities to update their old systems, which can boost demand for their offerings.
Demand for sustainable solutions: Growing awareness for sustainable solutions will further incentivize upgrades and replacements of inefficient legacy infrastructure with solutions offered by MWA.
Digital transformation of the water sector: A rising trend is to include and adopt IoT solutions in existing infrastructure, which can further push growth opportunities in this area.

Financials:

MWA’s financials reflect a decent but not stellar performance. Their most recent 10-Q results (released at the end of November 2023) saw a revenue decline by 3.8% YoY to 322.7 million in the quarter from 335.3 million in previous year quarter.

The decline was attributed to a challenging demand environment. Despite this, their gross margins improved to 34.7% and the core earnings were above their original expectation.
Their net sales increased 10.6% from $1,157.4 million to $1,279.6 million during fiscal year 2023.
Operating Income increased substantially by 15.4% during the fiscal year 2023 from $130 million to $150 million, primarily from higher selling prices. Their operating margins improved to 11.9% from the previous year’s 11.2%.
They generated Net Income of $82.5 million with an EPS of $0.55.
During fiscal year 2023 they bought back shares totaling $44 million to decrease share dilution.
Their balance sheet remains strong and well structured with limited risk, and their long-term debt to equity ratio stands at 0.75. Cash on hand stands at around $200 million.
Their revenue guidance for the fiscal year of 2024 was $1.27 Billion to $1.35 Billion, with adjusted operating income between $240 million to $260 million.
MWA is primarily a North American business, and any currency fluctuations, although they do have a presence in other geographic areas, are not that significant.
Their adjusted EBITDA margins have been hovering around 20%, which is decent for this kind of heavy-industry manufacturer.
The company has been showing modest growth, as they are primarily a replacement business.
Management has expressed concerns on supply-chain issues and their dependence on materials that have been affected by inflation.

A notable risk is the large amount of goodwill reported on the balance sheet. They have around $740 million as total value of goodwill. It should be seen whether the company will be able to leverage that goodwill or whether it will need to be written off. A goodwill impairment can have a significant negative affect on the shareholders equity.

A look into previous year’s 10-Q filings also suggests that MWA is not averse to making acquisitions, and has a history of acquisitions that help drive their growth and margins. The most recent earnings call made it clear that their acquisition pipeline is active and they are looking to increase their earnings through these acquisitions. This could boost value in the near term, but a reliance on acquisitions also means that there’s a degree of integration risk.

While the company has increased prices of their products in response to inflation and other changes, the time lag between the price hikes and the rise in raw materials might impact margins temporarily. However, long term, these price increases are expected to aid in maintaining their profitability.

Understandability Rating: 2 / 5 While Mueller Water Products operates in the somewhat straightforward water infrastructure industry, it does contain some complexities that make it difficult to understand. Here’s why:

Product Complexity: Some of MWA’s products are highly technical and designed for specific applications, making it challenging to analyze without specific knowledge of the industry. Many of their technologies are IoT enabled, and their software segment is fairly opaque from the financial reports.
Long-term Contracts and Bidding: The nuances of government contracts, bidding process, and the long cycle time for investments in infrastructure make it less clear and easy to understand.
Balance sheet is complex: The level of complexity of the balance sheet is higher than average due to having items like goodwill and various operating and non operating components.

Overall, most of the underlying business is easy to understand but the intricacies surrounding the valuation and business model make it a 2/5.

Balance Sheet Health Rating: 4 / 5 MWA’s balance sheet is in good condition, getting a score of 4/5 for overall balance sheet health with very low chances of it failing or requiring intervention in the near term:

Low leverage: While the company does carry some debt it is well manageable, having a debt-to-equity of 0.75, implying that assets can pay the company’s liabilities.
Good liquidity: The company has sufficient cash reserves. They are able to handle short-term financial stresses.
Asset strength: While goodwill makes up a portion of total assets, the company does have a good amount of tangible assets that provide them more stability.
Consistent operating revenue: Despite the fluctuations that occur in different sectors, MWA’s recurring revenues give it a stable revenue base for the foreseeable future.

The only reason it didn’t receive a higher rating is the goodwill risk, and that the company is exposed to macroeconomic forces due to dependence on government projects and fiscal policy. However, this is not a great hurdle for MWA.