It's tough to argue with the second-quarter results from Motley Fool Hidden Gems selection Mueller Water (NYSE:MWA) (NYSE:MWA-B). With home sales and building in decline, the environment isn't favorable for Mueller. However, the company has been able to execute toward its goals and showed a solid improvement over last year's results.
Mueller, which was completely spun off from Hidden Gems selection Walter Industries (NYSE:WLT) a few months ago, saw sales increase 5.7%. But because the company has been focused on cost reductions and streamlining its business, operating income increased by a more robust 14.5%. To see the full year-over-year details on how margins and other metrics improved, I recommend taking a look at this Fool by Numbers.
As part of the company's synergy implementation plan to integrate its US Pipe, Mueller Co, and Anvil businesses, Mueller had originally targeted approximately $40 million to $50 million in annual cost savings. Halfway through the year, the company is at an annual rate of $45 million and believes it can hit the high end of its target.
Cost reductions are important to Mueller's success beyond the niceties of improved margins and higher income, because a year ago the company just barely covered its interest expense after adjusting for one-time charges related to restructuring the business. In this year's second quarter, with some of the cost reductions achieved, the company's operating income is more than twice its interest expense.
If you glance at Mueller's balance sheet, the long-term debt number will leap right off the page at you. Other than total assets and total liabilities, it's the only number that requires a comma to separate the digits. This adds to the risk of the business, but when sales are growing and costs are contained, the debt accelerates earnings. This is because the interest expense is tax-deductible, allowing slightly more cash to fall to the bottom line. Debt providing earnings leverage for a spinoff is not an uncommon occurrence. You can see it at work at Hanesbrands (NYSE:HBI) as well.
Assuming Mueller can continue to execute, the company should begin to enjoy the benefits of getting ahead on its debt. This means earnings growth will advance at rates closer to its sales growth, but that's not so bad, because it also means the company will have more flexibility to withstand the challenges that will likely hit the business.
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At the time of publication, Nathan Parmelee owned shares in both Mueller Water and Walter Industries. He had no financial position in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.
