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Mueller Industries: Risk Factors Evolving in the Second Quarter

Carmine Romano

Carmine Romano

4 followers
On or around July 21, Mueller Industries will report its second-quarter earnings. This is a company Warren Buffett used to own, through Berkshire Hathaway (BRK.A)(BRK.B), from 2001 to 2005. Since third-quarter 2011, Leucadia National Corp. (LUK) has accumulated a total of 30% of the company’s shares. Its chairman, Ian Cumming, has been called a modern day version of Warren Buffett.

Mueller Industries' SEC filing lists several risk factors that have become elevated recently and will impact earnings and put pressure on its stock price for the remainder of the year. This includes raw material volatility and foreign currency volatility, which I first discussed in my Dec. 20, 2011, article on this website, “Alere Inc.: Foreign Currency Translations and the Euro."

About the company: Mueller Industries Inc. manufacturer’s copper, brass, plastic and aluminum products for the plumbing and refrigeration and original equipment manufacturers (OEM) segments. Products include copper tube and fittings; brass and copper alloy rod, bar and shapes; aluminum and brass forgings; aluminum and copper impact extrusions; plastic pipe, fittings and valves; refrigeration valves and fittings; fabricated tubular products and steel nipples. The Plumbing & Refrigeration segment is composed of Standard Products (SPD), European Operations and Mexican Operations. The OEM segment is composed of Industrial Products (IPD), Engineered Products (EPD) and Mueller-Xingrong. These segments are classified primarily by the markets for their products. The company is dependent on the housing market.

Recently, the company issued a Notice of Redemption to all the holders of its 6% Subordinated Debentures (the Debentures). The Debentures will be redeemed at par value totaling approximately $148.2 million principal and accrued interest totaling approximately $1.3 million. The redemption will occur on or about June 25, 2012. This is usually a good thing but in this environment, one might conclude that they were unable to get new financing.

Additionally, Joel Greenblatt purchased 17,312 shares during first quarter of 2012 at an average price of $42.27.

It appears only one analyst follows the stock, Edward Wheeler of Buckingham Research Group, which currently has a hold rating on it. That analyst expects $0.74 for the quarter. Earnings surprises were negative for three of the last four quarters. The latest quarter the company beat by 25%. That beat was mainly the result of two unusual items included in net income. The first quarter of 2012 includes the effects of a LIFO gain of $8.0 million, or 13 cents per diluted share, and a gain on the settlement of an insurance claim of $1.5 million, or 2 cents per diluted share. I do not recall any change to the $0.74 for second quarter of 2012.

Peter Lynch once said he gets excited if he can find a company with no analyst coverage. Old adages do not always work.

The company’s CEO, Greg Christopher, said in the first quarter press release, "We expect that the construction market will recover. The question is 'when.' No one knows the answer, but there are encouraging signs. Building permits for single-family homes and apartments in March 2012 were 30 percent higher than a year before. Permits are an excellent indicator of future business. In addition, home prices are affordable and mortgage rates are low. Although the recovery date is uncertain, Mueller is well prepared to ramp-up production when it occurs."

Risk Elevations:

Inventory:

3/31/20124/2/2011Change3/31/201212/31/2011Change
Raw Materials $ 43,349 $ 14,289203% $ 43,349 $ 42,2813%
Work-in-progress $ 31,915 $ 45,424-30% $ 31,915 $ 38,420-17%
Finished goods $ 166,452 $ 176,321-6% $ 166,452 $ 143,64816%
Valuation reserves $ (5,406) $ (4,764)13% $ (5,406) $ (5,156)5%
Inventories $ 236,310 $ 231,2702% $ 236,310 $ 219,1938%


On a trailing-12-month basis, work-in-progress inventory declined by 30%, raw materials inventory was the fastest-growing segment, up 203% and finished goods declined by 6%.

On a sequential quarter basis work-in-progress inventory declined by 17%, raw materials inventory increased by 3% and finished goods increased 16%.

What can be concluded by this data? It appears the company purchased a large amount of raw material inventory (203% increase) when raw material prices were significantly higher. Management appeared to be building up for strong demand in 2012. No sector in the U.S., including home building, has had strong demand in 2012. Additionally, Finished Goods increased by 16% and total inventory increased by 8% in the first quarter, signaling an inventory build which may be an indication of slowing sales.

Foreign Currency:

According to the company, “The strengthening of the U.S. dollar could result in unfavorable translation effects when the results of foreign operations are translated into U.S. dollars. Accordingly, significant changes in exchange rates particularly the U.K Pound Sterling, Mexican Peso and the Chinese Renminbi could have an adverse impact on our results of operations or financial position… The potential loss in value of the Company’s net investment in foreign subsidiaries resulting from a hypothetical 10 percent adverse change in quoted foreign currency exchange rates at December 31, 2011 and December 25, 2010 amounted to $18.1 million and $18.8 million, respectively."

The second-quarter 2012 decline for the British pound sterling was about a 2.2% and the Mexican peso about 5%. The Chinese renminbi is a controlled currency and thus only declined less than 1%.

Raw Materials Volatility:

The company states that “during periods when open market prices decline below net book value, the Company may need to provide an allowance to reduce the carrying value of its inventory." Copper prices have declined from about $3.88 at the end of March to $3.50 at the end of June. I would expect a reduction of its carrying value of its inventory for the second quarter.

Yes the company hedges. For example, according to the first-quarter 2012 filing, “In the next twelve months, the Company will reclassify into earnings realized gains or losses of cash flow hedges; at March 31, 2012, the net fair value of these contracts was an $803 thousand gain position.”

“At March 31, 2012, the Company held open futures contracts to purchase approximately $25.6 million of copper over the next 21 months related to fixed price sales orders. The fair value of those futures contracts was a $787 thousand gain position, which was determined by obtaining quoted market prices (Level 1 hierarchy as defined by ASC 820, Fair Value Measurements and Disclosures (ASC 820)).”

It is likely these gains were from the positive performance of copper in the first quarter of 2012. Copper prices came down like a brick in the second quarter of 2012. As a result these gains will most likely turn to losses for the second quarter of 2012 and be reflected on the consolidated statements of cash flows.

Union Contract Expiration Roll:

The company has four Union Contracts due to expire this year:

LocationExpiration Date
Fulton MississippiAug-12
North Wales PennsylvaniaAug-12
Belding MichiganAug-12
Waynesboro TennesseeNov-12
As all the risk factors above have evolved in the second and third quarter having additional Union Strike risk, it would seem difficult for an analyst to keep a hold rating on this stock. The expected markdown in the carrying value of its inventory in the second quarter 2012, an OCI Foreign currency translations markdown and a weak economy might make this stock difficult to hold and wait out the second-quarter earning release which is scheduled for July 23, 2012.

About the author:

Carmine Romano
By Carmine Romano. I have leveraged expertise in both commodity and stock markets to drive short-term and long-term trades for personal account. Integrated knowledge of economics, fundamental and technical analysis, and statistics / probabilities theories to realize portfolio growth and profitability.
Selected accomplishment:
• Realized average annualized returns on self managed IRA account of 14% from January 2004 to December 2012 (total return 150+).


Save on home energy bills at www.napower.com/224201

Rating: 3.1/5 (14 votes)

Comments

Carmine Romano
Carmine Romano - 1 year ago


Mueller Industries misses by $0.18, misses on revs

7:03 AM ET 7/24/12 | Briefing.comReports Q2 (Jun) earnings of $0.47 per share, $0.18 worse than the Capital IQ Consensus Estimate of $0.65; revenues fell 9.0% year/year to $594.1 mln vs the $611.09 mln consensus.
Carmine Romano
Carmine Romano - 1 year ago
Billionaire Ian Cumming sold all $440,000,000 worth of Mueller stock after my negative article on the company was written.

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