Notable Calls

Mueller Water Products (NYSE:MWA) is upgraded to Buy from Hold at BB&T Capital Markets with a $6 price target established.

Firm notes they believe the long-term story remains attractive, and the near-term outlook is showing notable signs of improvement. While the market is currently discounting both a potential housing bottom and further significant erosion in nonres construction, they believe the outlook for both markets will improve over the next year or so. Concerns remain, to be sure, as evidenced by the depressed stock price, but the firm expects fundamentals to start to improve going forward, pushing EPS and the stock price considerably higher. Simply put, they’ve seen enough stabilization to rule out a dire scenario, and believe they’ll miss it if we wait for confirmation of a housing and nonres rebound.

Solid long-term story. BB&T believes the long-term outlook remains bright, based in large part on 1) huge water infrastructure demand estimated at $335B over 20 years, and 2) MWA’s leading positions in oligopoly markets with solid barriers to entry. Importantly, the specification process, large initial investment requirements, and exclusive distributor relationships provide solid barriers to entry, so the firm sees little risk of new competition. Furthermore, MWA is typically #1 or #2 in its key markets, often with 25%–50% market share, and its competitors (mostly private and active in the space for decades) generally do not use price as a weapon to take share.

EPS power. MWA sees 20% EBITDA margins under more normal conditions, which won’t likely be “normal” until 2012, when housing and nonres should be much more robust. Firm estimates that MWA could generate EPS power of close to $1.00 assuming a 20% EBITDA margin, or $0.65 using a more conservative 17% margin. They typically wouldn’t discount potential EPS power that far out, but they see value in a $3.73 stock with the potential for $1.00 in earnings.

Compelling risk-reward. BB&T notes their timing may not be ideal, but the stock remains depressed on numerous concerns, yet trends are starting to improve. They see a compelling risk reward scenario with downside risk to the $3.00 range (down 20%, close to book value), but considerably more upside potential as housing rebounds in 2010, nonres bottoms in 2011, covenant issues are avoided, and investors discount much more robust earnings power. MWA trades at 13.6x and 8.7x firm's new FY’09–FY’10E EV/EBITDA. They are initiating a price target of $6.00, implying more than 60% upside potential, based on 10.5x FY’10E EV/EBITDA.

Notablecalls: I suspect they will drive this one nuts. The mention of $1 in potential EPS power makes sure of that. After all, MWA is a $3-4 stock. A Water play, I might add! These covenant plays (AXL, DAN etc) have been red hot lately. MWA is one. They tripped earlier this yr but things are beginning to look up as per BB&T.

I think this one can trade over $4 today and closer to $4.25 if the mo-mo crowd picks it up.