What to do with U. S. Pipe?
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AWI assesses the potential consolidation of the ductile iron pipe industry
Mueller Water Products’ (NYSE: MWA) announcement May 3 that it is seeking a sale or joint venture to operate its U. S. Pipe division represents a sad setback for a promising industrial venture. When Mueller was spun off from its corporate parent Walter Industries in 2006, its three divisions were structured so that U. S. Pipe could focus narrowly on highly efficient production of one product, ductile iron pipe for water and sewer systems, at a brand-new mini steel mill near Birmingham, Al., that could run 24 hours a day. Now, this carefully planned move into lean, efficient manufacturing seems to have backfired due to flat demand, competition, slumping product prices, and rising prices for its raw material, scrap steel.
The timing of the new mill turned out to be terrible. Greenlighted in 2006, at the height of the housing boom, the so-called Marvel City Mini Mill came on line in September 2008 only to find new home construction in a slump from which it refuses to recover. U. S. Pipe depends on two market segments, new home construction and municipal upgrades. Although the EPA estimates a need for $335 billion in water infrastructure investment over coming decades, the ongoing financial crisis means that many cities are deferring replacement of elderly pipes.
The result for U. S. Pipe: eleven straight quarters of losses in spite of cost-cutting efforts. And results for this year promise to be weaker than last year, as funding from the Investment Recovery Act comes to an end.
This magazine reported in January that Mueller had purchased a small Canadian company, Echologics, which makes equipment for detecting leaks in existing water systems. From a marketing perspective, Echologics helps water utilities avoid having to buy from U. S. Pipe until their pipes have actually broken. This makes sense as a source of income supplemental to U. S. Pipe in a time when municipalities are pinching pennies, but the new announcement indicates that Mueller does not feel it has time to let the new strategy work.
Outside of the brief announcement at an analyst conference call, Mueller is playing its cards close to the vest about its plans for U. S. Pipe. Although Mueller is not cash-rich, it has lines of credit available which would allow it to continue operations for several quarters if it was convinced that U. S. Pipe was about to turn itself around. Apparently this is not the case.
What buyers might find U. S. Pipe attractive? The most obvious candidates are Mueller’s three largest competitors in the ductile iron pipe business: McWane, ACIPCO, and Griffin Pipe Products, but a loss-making enterprise is clearly not an attractive buy unless the buyer believes it can make money where Mueller could not. All three competitors laid off employees in 2009 and 2010, and their own mills are older and less efficient than U. S. Pipe’s. McWane and Griffin have both shut down plants in the past two years, so neither has an obvious motive to buy more capacity unless they can achieve efficiencies by consolidating production in U. S. Pipe’s newer mill. If this is what Mueller means by a joint operating agreement, then we may be seeing a contraction of the industry which has not ended yet. In such a case, the Marvel City mill is the logical candidate to be the last man standing.
Other interested partners could include private investors or foreign firms seeking to enter the U. S. market in hopes of a market recovery. The long-term prospects for the pipe industry remain a matter of faith: new home construction, and the new water systems that go with it, have been predicted to recover for some years now. Furthermore, analyst Ryan Connors of Janney Capital Markets noted in a recent report that many miles of aging water and sewer lines are located in cities with declining populations.
For the investor who can afford to wait and who still believes in the long-promised recovery in home building rates, the U. S. Pipe mill might be a bargain. Says analyst Brent Thielman of D. A. Davidson and Co., “Mueller has a brand-new state-of-the-art facility. There hasn’t been a new ductile iron plant [in America] in decades.” Let’s hope they find a way to keep it running.