A while back I wrote a post on Paul Mueller Company in which I highlighted the company’s promising improvements in profits and margins but expressed reservations about the company’s high financial leverage and large pension deficit. Ultimately, I decided the balance sheet issues were troubling enough to keep me watching from the sideline. Eighteen months later, the results are in. Anyone who had disagreed with my assessment and bought shares is sitting on a whopping gain. From the end of April 2013 to the present, Paul Mueller shares rose 190% from $18.00 to $52.25.
The big move in Paul Mueller Company’s stock is due to the combination of vastly improved earnings and a de-risked balance sheet. At the time of my original post, I had pegged Paul Mueller’s adjusted 2012 operating income at $5.9 million. Since then the company has made great strides, growing trailing twelve month revenues by 7.5% to $193 million and nearly tripling operating income to $15.4 million. No need for adjustments either, as the severance expenses that depressed the company’s 2012 EBIT are in the rear-view mirror.
Improved profits aside, the company’s leverage has declined meaningfully. Total debt has been slashed by a third, falling from $34.2 million at the end of 2012 to $22.9 million as of June 30, 2014. The reduction was funded entirely through free cash flow, but not by sweating the company’s assets; capital expenditures have tracked with depreciation. The company’s pension deficit remains material, though it has also declined 40% since 2012. The decline is mainly due to strong appreciation in the pension plan’s equity investments. The expected return on the plan assets was held steady at 7.25% from 2012 to the present, though the discount rate on plan obligations was increased from 4.48% to 5.34%. (Increasing a pension plan’s discount rate results in lower present value of future payouts. Changing a discount rate is a totally legitimate response to changing long-term interest rates, but aggressive companies have been known to choose a higher discount rate in order to minimize reported pension deficits.)
Back, for a moment, to Paul Mueller’s greatly improved results. Recently installed CEO David Moore has made several comments about focusing on bringing each business segment into the black and making the heads of individual business lines responsible for results for the first time. The company has also implemented “open book management,” a concept designed to increase transparency, improve management/employee relations and help employees see how their individual contributions result in increased profits and their own rewards. In the 2013 annual report, Moore specifically mentioned the head of each business segment and credits strong performers. Results for the first half of 2014 are up substantially over the same period in 2013, with revenues up 13.5% and operating income up 23.3%. The company’s backlog is $70.4 million compared to $55.1 million one year ago, strongly suggesting continued improvement in trailing twelve months’ results.
Despite the run-up, Paul Mueller Company remains very reasonably priced. Including the reported pension deficit in the company’s enterprise value shows an EV/EBITDA figure of 5.0 and EV/EBIT of 7.0.
These ratios are likely to fall if the company’s higher backlog results in increased earnings and as the company continues to apply its free cash flow to reducing debt.
Paul Mueller’s large pension deficit remains a risk, particularly now that equity securities comprise over 60% of pension assets. A weak stock market could undo much of the progress the company has made in reducing the size of its pension deficit. However, the vastly increased earnings and cash flow combined with significantly reduced debt make the pension much less of a concern than it was a year and a half ago. Paul Mueller Company’s ongoing debt reduction and improving earnings have shifted the risk-reward balance very favorably since I originally wrote about the company, and I no longer see compelling reasons to avoid the shares.
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Hi, Dave. An enjoyable read as always, about a security I sold too soon…
Another small Midwestern industrial name that might be of interest is Universal Manufacturing (UFMG on the pinks). I’ve just started looking at them, but it seems they offer a reasonably complete financial picture on their website. Reminds me somewhat of Mestek.
Have also been looking at Vitreous Glass on the TSX-V–sort of wonderful to find a company that doesn’t even have a web site, though they do file on SEDAR. I’m not sure it’s a home run investment for a few reasons that are probably immediately obvious when looking at any of their reports, but they are at least pretty good stewards of capital.
Out of curiosity, did you ever look at Lakeview (TSX-V) or Royal Host (TSX), which I mentioned last year (November, I think)? They’ve done well (the latter bought by Holloway, which is an interesting name) but may still be worth a look.
Interesting (and by that I mean boring) company. I peg their replacement value and EPV in the $70-$80 range. On a quantitative level I like it. Haven’t dug too much into the qualitative stuff yet. Any idea of what their industry is like? # of competitors? Position amongst competitors? From a simple google search there doesn’t seem to be too many other branded products of substance out there.
Your estimate is close to my own estimate of the company’s worth. I am not aware of any directly comparable competitors. Through reasonably reliable sources, I have heard that Mueller’s products carry a strong reputation for quality, and are typically priced at a premium (15% or so) to the market.
Any idea on the insider ownership? All i can find is that Royce owns about 9% or so. Would be curious what those running the show have at stake.
Appears they are expanding capacity in their Netherlands division, which I like as this appears to be somewhat profitable. But unsure my feelings towards the high turnover of the executives/board, including the CFO departure in August.
First Manhattan owns 11.3%. Royce has 9.4%. Mueller family has 7.4%. Other insiders: 4.9%.
I like the expansion in the Netherlands. The steel tank division is the company’s crown jewel.
The turnover doesn’t concern me much. Much of the turnover was a housecleaning of the previous leadership man. The new CEO, David Moore, is the man. He took a over-leveraged, bloated company with multiple losing divisions and cut debt, sold off non-core assets and returned all the division to profitability. He deserves twice his salary.
Thanks for the ownership data, and I very much enjoyed your presentation the other day. Good stuff.
Playing devil’s advocate, I’m not quite as sold as you are on Moore. He may be cleaning house, but he’s been with the company since 1997, not exactly a fresh faced outsider. And the asset disposals appear to have happened under Nosal’s (a known turn-around guy) watch in 2011 (could be wrong on this as he was only there for like 5 months, but $4.2 mill in divestments in 2011 under Nosal, verse $132k in 2.5 years since under Moore). Moore has paid down the debt only so much as he’s contractually obligated to. He actually increased the B.V.’s segment short-term debt in 2013 to fund the expansions. Considering the ROA of the dairy division is about 10% over the past few years, I’m reminded of Greenwald’s thoughts on expansions absent barriers-to-entry.
Even with all that negativity I just spewed above, I do have a moderate position in MUEL and am debating about adding before Q3 results. It’s creating gobs of cash and Moore’s letters do make it seem like they’re heading in the right direction. I’ll for sure be watching capex and debt levels going forward. With a cyclical business like this I’d like long-term debt low and short-term debt lower. I’m hoping Moore wasn’t a pusher for the expansion and the increase of debt in 2007, and that this is a continuation of that.
Cheers, and congrats on the success of your new business and blog (although the math tests in order to post comments are making me sweat).
A variant view is always welcomed. Can’t say that I mind the increased investment in Mueller BV. Business there seems to be booming with quarterly revenues up 32% year over year and up 23% for the rolling twelve month period. If short-term debt is the most efficient way of funding that expansion, so be it. When the segment eventually slows down and working capital investment/capex needs decrease, I think the short-term debt balance will rapidly decline.
And the CFO’s departure doesn’t bother me much. I see it as a guy jumping ship to a much larger and NYSE-listed company. Probably got a big pay increase, as well as a high-profile name on the resume. Mueller’s a fine company, but not exactly somewhere a mid-career guy with Fortune 500 ambitions wants to stay for a long while.
Even if Moore has only reduced debt to the degree required, he has at least resisted the urge to execute new debt agreements and is charting the company to a more sound capital structure, even if passively. Whether or not Moore is a capital allocation expert, I think he has brought some more enlightened and transparent management and management compensation practices to a company sorely lacking in accountability. For the first times, unit heads’ compensation is directly tied to profitability and I think that shows in the results.
OTC, any thoughts on 2014? Headline numbers weren’t good, but adjusted for one-time issues I thought they were close to my expectations. Revenues up. Operating margins after adjustments close to last year. Short-term debt rising worries me, but I’m hoping this was to fund working capital an can reverse soon. Pension liabilities perhaps up a bit more than expected, but with all companies moving the discount rate down this wasn’t unexpected. I’m picking up a few more share in the sell off today.