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This month, we have added a stake in Mueller Water Products (MWP) to the Contrarian Portfolio. The recession has taken a brutal toll on the company: between Fiscal 2006 and 2011 (fiscal year ends in Sept), sales fell from $1.9b to $1.3b while operating profits evaporated and the company posted consolidated losses after interest expense. Even worse, free cash flow had virtually evaporated in the past two years and the company had about $640mm in net debt as of the end of December (albeit down from $1.1b at the end of 2006). We kept this stock on our radar, however, because it is one of the leaders in most of its markets and many of its products are specified by design into municipal water systems, giving it a virtual lock on sales (when customers purchase).

Our catalyst for initiating a position in the company was the March 2012 announcement (and April completion) of the sale of the company’s US Pipe division. This unit is highly commoditized and suffered from significant operating losses of late. Mueller's profit outlook should be significantly improved after this divestiture. In fact, the company’s $59mm loss before taxes in fiscal 2011 would have shrunk to $13mm without the US Pipe losses. Even better, the $100mm proceeds can be used to reduce debt, reducing leverage and prospective interest expense. This improved financial position reduces risk sufficiently to lead us to believe that an initial stake in the company is warranted.

While we believe significant downside risk has been eliminated with this sale, improved sales are needed for the investment to really work. This shift seems like a reasonable possibility with depressed municipal budgets (even for repair/maintenance), only modest levels of non-residential construction, and residential construction at historical lows. All three areas seemed poised to increase in the next few years. One interesting slide in a recent company presentation is that 70% of F11 sales were from repair/replacement of municipal distribution and treatment systems, with 25% from non-residential construction and only 5% from residential construction. This compares to F06 breakout of 30% repair/replacement, 30% non-residential, and 40% residential construction. The once-biggest division has dropped to basically being a footnote in its operations (almost entirely due to economic conditions, not operational issues)!

We think Mueller is well positioned for a rebound in its core markets now that US Pipe has been divested. Beyond the simple improvement from the divestiture and debt-paydown, we believe sales could be poised for a rebound over the next few years and flow-through profitability should be impressive with efficiency moves executed through the downturn. With the company out of survival mode, we also think management can more aggressively pursue growth businesses, which include advanced meter infrastructure and pipe condition assessment/leak detection.

Brief description of the company from its web site: Mueller Co., and Anvil, Mueller Water Products, Inc., manufactures and markets products and services that are used in the transmission and distribution of safe, clean drinking water and in water treatment facilities throughout North America. Our broad product portfolio includes engineered valves, fire hydrants, pipe fittings, water meters, leak detection and pipe condition assessment which are used by municipalities, as well as the residential and non-residential construction industries.

(Apologies for the short summary of this investment, but I am catching up on lots of things and wanted to start getting my feet wet again by at least getting something posted)
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