|Shares Out. (in M):||69||P/E||11.4||9.9|
|Market Cap (in $M):||11,787||P/FCF||13.8||13.1|
|Net Debt (in $M):||1,171||EBIT||1,391||1,503|
|TEV (in $M):||12,958||TEV/EBIT||9.3||8.6|
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Mohawk was last written up by Value1929 in October 2020. He initiated the memo at $100, and closed the position one month later at $130. Great timing! I will use my memo to make the case that Mohawk, at $175 one year later, has a path to become a $400 stock.
Mohawk is the largest flooring manufacturer in the world. With housing growth and cost restructuring, we believe Mohawk can expand current 12% EBIT margins back to 15% margins, which it last achieved in 2016-2017. At 15x $26 EPS in 2024, the stock would be $390/share in YE 2024 (+30% IRR from $175/share today), which discounted back to 2022 is a $320/share price target (+85% 1-year return).
(1) Margin recovery
· Mohawk’s earnings could recover to 15% EBIT margins, +250bps above 12.5% consensus long-term estimates. Our EPS estimates are +30% above consensus as a result.
· Margins fell from 15% peak margins in 2017 to 8% trough margins in 2020 due to factory under-absorption, raw material inflation, negative mix, covid shutdowns and LVT startup costs. The underlying cause was capital misallocation into building greenfield ceramic, laminate and carpet tile factories instead of LVT.
· Margins recovered to 12% in 2021 due to growing volume, improving factory absorption, ceramic restructuring and positive price-mix.
· Margins should continue to expand in 2022 and beyond, despite investor fears about peak margins and cost inflation. Mohawk is getting price to offset commodity cost inflation in every business, while continuing to drive productivity and manufacturing efficiencies.
(2) Participate in LVT
· Mohawk currently sells $0.5bn of LVT (10% LVT market share, 5% of Mohawk sales). Their LVT import business is not well appreciated.
· They are three years behind competitors, but gaining share. Their US domestic manufacturing ($0.2bn sales) is improving quality and benefiting from 25% import tariffs and higher container shipping costs. Their China LVT import business ($0.3bn sales) is profitable and growing rapidly.
· Due to LVT’s growth, Mohawk’s Flooring North America segment is now outgrowing the market. Contrary to perceptions, the company is not declining or structurally losing share.
(3) Flooring demand
· Flooring is a big-ticket, discretionary, professionally installed category. The category is well positioned within building products.
· Flooring demand is driven by existing home sales, which continue to be strong despite limited housing inventory. Existing home sales should be strong in 2022: interest rates are low, home prices are appreciating, and housing affordability is still good. Home sales have been good despite a lack of inventory, which should improve as homeowners become more willing to list homes post-covid.
Mohawk is the largest flooring manufacturer in the world.
· $12bn market cap, $13bn enterprise value, $90mm ADV.
· Mohawk started as a carpet mill in 1878. Its modern history began in 1992, when it went public and used its equity to roll-up the carpet industry. The stock has a +11% total return per year since IPO.
· The company expanded to other flooring categories in the 2000s, buying Dal-Tile in 2001 ($1.6bn, ceramic tile) and Unilin in 2005 ($2.6bn, laminate). The flooring roll-up strategy picked up after the financial crisis, with 13 acquisitions for $3.7bn in 2012-2018. The biggest acquisitions were Marazzi in 2012 ($1.5bn, ceramic tile) and IVC in 2015 ($1.2bn, laminate).
· CEO Jeff Lorberbaum joined Mohawk in 1994, when the company acquired his parent’s Aladdin Mills. He currently owns 11% of the company (worth $1.2bn at market prices).
Mohawk is vertically integrated into manufacturing, distribution, transportation and some retail stores. We are particularly attracted by their distribution and transportation infrastructure.
· Manufacturing. 62 manufacturing plants around the world (27 North America, 28 Europe, 7 other). Flooring is a low value-to-weight product (~$1 per square foot at manufacturers prices), driven by distribution economics.
· Distribution. 340 distribution points, 1,600 sales representatives. Their US distribution network is built around trucking products out of their Dalton, Georgia manufacturing hub. In the US, flooring is sold through specialty stores (55%), contractors (25%) and home centers (20%). There are tens of thousands of mom & pop flooring specialty stores, in contrast to other building product categories which sell primarily through Home Depot and Lowe’s or directly to homebuilders. Mohawk and Berkshire Hathaway’s Shaw Floors are the only two flooring companies with nationwide distribution infrastructure.
· Transportation. 750 trucks, 2,500 trailers. Mohawk would be the 5th largest standalone trucking company!
· Retail. Ceramic has 280 retail stores in the US, 360 in Russia for the Daltile and Marazzi brands.
The company, with $10bn revenue, reports through three segments:
· Global Ceramic, 35% of revenue, 30% of earnings. $3.5bn revenue ($2bn US, $1.5bn Int’l). Mohawk has 50% market share in the US ceramic market, competing against imports.
· Flooring North America (“FNA”), 40% of revenue, 20% of earnings. $4bn revenue (~$2.5bn carpet, ~$0.5bn LVT, ~$0.4bn laminate, ~$0.2bn hardwood). Mohawk has 35% market share in the US carpet market (3 player oligopoly with Shaw Floors and Engineered Floors) and 10% market share in the fast growing LVT market.
· Flooring Rest of World (“FROW”), 25% of revenue, 50% of earnings. $2.5bn revenue. Leading positions in Europe (IVC acquisition in 2015), Brazil (Eliane acquisition in 2018), and Australia (Godfrey Hirst acquisition in 2018). Despite being half of earnings, this segment is rarely discussed.
Mohawk has transitioned from roll-up to growth to restructuring story.
· Roll-up (1992-2015). Mohawk’s business model is to bundle new flooring categories into their last-mile distribution network. After consolidating the carpet industry, they expanded into ceramic tile (Dal-Tile, Marazzi) and laminate (Unilin, IVC). The company always had modest organic growth (+5% per year average, even in good days), but acquisitions added +5pts per year and EBIT margins expanded +125bps per year, so earnings grew rapidly. The company spent ~$300mm capex per year (5% of sales) on brownfield factory modernizations with very high returns on capital, which drove most of the margin expansion.
· Growth (2015-2018). With no major acquisitions left and limited brownfield opportunities, but unwilling to return capital to shareholders, Mohawk pivoted to ill-advised organic growth. It spent ~$800mm capex per year (8% of sales) on greenfield factories all over the world, adding $1.2bn revenue capacity off a $10bn revenue base.
· Restructuring (2018-2020). Three years later, revenue was still $10bn. The extra capacity was sitting unused. Factory capacity utilization fell from ~85% to ~70%, and margins collapsed. The company stopped building greenfield plants. Mohawk closed old plants to right-size the manufacturing footprint and restore margins.
· Recovery (2021-today). Mohawk’s capacity is sold out, they are getting price in excess of cost inflation, and outgrowing a robust flooring market.
The stock has been controversial, to say the least.
· From 2011-2017, Mohawk was considered a “quality compounder”. Earnings grew from $3 to $14 (+20% per year), with consensus estimates that the company could earn $22 by 2020 with capital deployment. The stock increased from $50 in 2011 to $280 in 2017 (+35% per year), trading at a 20x earnings at peak.
· Since 2018, Mohawk has been considered “structurally broken”. Earnings fell from $14 to $8; the stock fell from a peak of $280 to $60 in March 2020.
· We believe Mohawk is neither a quality compounder nor structurally broken – it is a cyclical building products stock! In the upcycle, the market confused cyclical earnings growth for structural quality; in the downcycle, it has done the same. We are now entering a new housing upcycle, during which we anticipate Mohawk’s earnings and sentiment will improve.
Mohawk EPS estimates
Green= 2018; Red = 2019; Yellow = 2020; Orange = 2021; Blue = 2022
US flooring market
The US flooring industry has grown +5% per year over the last decade.
· Carpet (40% of industry sales) has grown +2% per year, as it loses share to hard surfaces. This is a secular trend that has existed for 30 years. Carpet now mostly exists inside bedrooms and offices as a replacement product.
· Ceramic (15% of sales) had grown +8% per year, before slowing in recent years. The most common flooring product globally due to its low manufacturing cost (other countries don’t have much carpet, hardwood or LVT), ceramic has a small share in the US market due to higher labor and installation costs.
· LVT (“luxury vinyl tile”) is a new technology which has grown +30% per year, from 4% share initially to 20% share today. LVT’s growth has crowded out the rest of the flooring marketing. More on this below.
· Hardwood (15% of sales, 8% of volumes) has grown +7% per year. Hardwood is a niche product because of its high prices. Due to tariffs on imported lumber and industry excess capacity, it is not profitable for US manufacturers.
· Laminate and vinyl (8% of sales) have +0% growth. With very low prices, they are used primarily in residential replacement for multi-family and entry level homes. They were the first category to be displaced by LVT.
· Stone (5% of revenues) has grown +5% per year. It is a niche product sold through separate distribution channels.
The flooring market slowed in 2018-2019, which contributed to Mohawk’s fall from grace.
(1) Housing market slowed. With rising interest rates (30-year mortgages rose from 3.7% to 4.8%), the housing market stalled: existing home sales slowed from +2% in 2017 to -3% in 2018. The flooring market follows existing home sales with a 3-6 month lag, so flooring volumes slowed from +5% in 2018 to -2% in 2019.
(2) LVT growth accelerated. LVT’s growth surprisingly accelerated off a larger base, from +30% growth in 2017 (+0.5mm sqft off a 1.6bn sqft base) to +45% growth in 2018 (+1bn sqft off a 2.1bn sqft base). This +4pt growth contribution (= +45% x 9% LVT market share in 2018) crowded out the flooring market’s growth, so the industry ex-LVT only grew +1% in 2018 and declined -6% in 2019.
(3) Imports increased. With a weak dollar, the USD landed cost of imports fell from 2012 to 2018. Import volumes have been growing +10% per year, increasing share from 35% to 50% of the US flooring market. Consequently, domestic production fell -4% in 2018 and -5% in 2019.
Source: Flooring Covering Weekly statistical reports, which are free and publicly available on floorcoveringweekly.com
Luxury vinyl tile has been growing rapidly.
· LVT is a vinyl-based product with the visual aesthetics of wood or tile. Consumers like its appealing visual aesthetics, low price point, durable quality, water-resistant features and ease of installation.
· LVT technology has gone through several iterations. It started as flexible LVT (which Mohawk’s IVC actually invented and patented), before moving into higher-quality rigid core technologies using different substrates such as stone plastic composite (SPC) and wood plastic composite (WPC).
· LVT has been growing +30% per year, from $0.7bn sales in 2012 (4% share) to $5.3bn in 2020 (20% share).
Despite inventing the product, Mohawk was late to LVT.
· Mohawk missed LVT. They built the wrong LVT product (flexible instead of rigid), they didn’t procure enough of it (late to importing), and instead spent capital on products the market did not need (building new ceramic, laminate, vinyl and carpet tile facilities, which the company is now shutting down two years later). This was a capital allocation mistake around a technology shift.
· Mohawk did not expect LVT to grow this quickly. Previous product inventions like ceramic, vinyl sheet and laminate had slower growth (10 years to maturity) and lower ultimate penetration (15%, 5% and 3%, respectively). Consequently, they planned for a smaller LVT market than was eventually realized.
· IVC invented LVT in Europe, where they now have three LVT plants. After acquiring IVC in 2015, Mohawk tried to bring the technology to the US. They announced a new $100mm manufacturing facility Dalton, Georgia in April 2016, with completion planned for Q4 2017. The factory was delayed several times – by the time it came online in late 2018, LVT technology had advanced from flexible to rigid core. Mohawk tried retrofitting the plant, but encountered quality issues, which have persisted through today.
· Mohawk was so focused on domestic manufacturing that they were late to importing product from China, which is where 90% of LVT comes from – they had not planned on needing to supplement their domestic volumes. By the time they tried in 2018, Chinese LVT production was sold out, and Mohawk could not get a full allocation. Their sourcing capabilities improved only by 2019, and our channel checks suggest their import logistics capabilities are still several years behind competitors.
· Shaw Floors faced the same problem of changing LVT technology. They responded by shutting down their half-built first-generation LVT plant in the US, and moved to a China sourcing model after acquiring US Floors in October 2016. They now have 35% market share in LVT imports and record profitability.
We believe Mohawk will participate in LVT. They currently have ~$0.5bn LVT revenue (10% product market share).
· Manufacture. Mohawk has two plants in Dalton, Georgia with $500mm of revenue capacity generating $200mm revenue. It has recently started building a third line.
· Import. Mohawk imports ~$300mm of LVT. This is underappreciated.
o The company has told analysts that their imported LVT business is larger than their domestic production. Since domestic product is $200mm, we estimate imports are ~$300mm (60% of LVT sales). Our channel checks have variously estimated that Mohawk’s import position is 50-80% of their LVT sales.
o In Q1 2020, Mohawk received a $13mm rebate for their imported LVT sold between September 2018 and November 2019, when the click LVT tariff was rescinded. That implies imported LVT sales were $52mm (= $13mm / 25% tariff), but Mohawk says they avoided most of the tariff by pre-buying LVT imports. Floor & Decor, a retailer with $440mm LVT sales in 2019, received a similar $13mm rebate.
o We believe LVT imports currently have 10-15% contribution margins, above the FNA segment average.
· Mohawk has been growing in-line with the market since 2019, which indicates it is participating in LVT.
o Comparing Mohawk’s FNA organic growth with publicly traded manufacturers (Tarkett, Interface) and retailers (Tile Shop, Lumber Liquidators), Mohawk has grown in-line with the market in 2019-2020 after losing share in 2018. See the appendix.
· Mohawk will participate in LVT because it is a distribution and transportation company, not just a product manufacturer. Flooring products are commoditized (would you pay more for a Karastan rug versus a store’s private label brand?), and once LVT becomes commoditized (technology stops changing, manufacturing becomes oversupplied), Mohawk will drive last-mile distribution economics as it has for the last 30 years.
Mohawk currently has 12% EBIT margins.
· After peaking at 15% EBIT margins in 2017, Mohawk’s margins collapsed to 8% in 2020. See detailed bridge below. The -700bp margin decline has come from Global Ceramic (-950bps) and Flooring NA (-920bps), while Flooring ROW (-90bps) has performed better.
· Consensus expects long-term EBIT margins to recover to only 12.5% margins. We expect EBIT margins to expand to 15% margins (Global Ceramic 12%, Flooring NA 12%, Flooring ROW 19%).
· We believe the company has a ~15% margin entitlement, given its vertical integration into distribution (5% margins), transportation (5% margins) and retail (1% margin contribution = 10% margins x 10% of the business). Their manufacturing business, which is currently money losing, should have positive contribution margin after it is restructured.
Mohawk Adjusted EBIT margins
EBIT dollars fell by -$670mm on flat revenues from 2017 to 2020. EBIT margins were cut in half!
(1) Factory absorption, -$180mm. Rarely discussed, but one of the largest drivers of Mohawk’s earnings.
· In 2017, inventories grew by +$270mm as Mohawk ran newly opened plants for demand that didn’t exist (inventory days grew +10%, from 100 to 110 days as finished goods inventory built up in warehouses). They were over-earning due to factory overhead absorption (e.g., plants running at 95% utilization instead of 85%), as costs were allocated to inventories that sat unsold in warehouses.
· In 2020, inventories shrank by -$440mm as Mohawk purposefully reduced their inventories (inventory days fell -17%, from 114 to 95 days). They are now under-earning (e.g., plants running at 70% utilization instead of 85%), which has been a painful but necessary restructuring to right-size inventories. Inventory days are now at all-time lows, see chart below.
· Sales did not change during this up-then-down, just factory production levels. The inventory swing from +$270mm to -$440mm was a -$710mm reduction in inventories over 3 years. At a 25% incremental margin, that is worth -$180mm EBIT (-200bps of margins).
(2) Depreciation, -$150mm. The ~$2bn of growth capex spent in 2016-2018 was essentially wasted. The remnants are -$150mm of higher annual depreciation running through the income statement. EBIT margins fell by -700bps, EBITDA margins by “only” -550bps.
(3) Inflation, -$260mm. Mohawk’s carpet business is essentially an oil refiner, turning oil-derivatives such as nylon and polyester into carpet. Higher oil prices and transportation costs in 2017-2019 were a cost headwind that Mohawk was not able to pass on to its customers in an oversupplied market.
(4) Mix headwinds, -$140mm. The flooring industry successfully put through prices increases in 2018 to offset raw material inflation (see PPI chart below), but customers responded by trading down into lower mix products. In carpet, they moved from broadloom to polyester; in ceramic, they moved into lower priced offerings.
(5) Covid shutdowns, -$160mm. Q2 2020 revenue was down -20% (-$535mm decline), which at 30% decremental margins had a -$160mm EBIT impact.
(6) LVT plants, -$40mm. Frequently discussed, despite not being very material. Mohawk’s two LVT plants lost -$40mm in 2019, they expect them to reach breakeven in early 2021. This will be important for MHK’s narrative.
EBIT Bridge ($mm YoY)
Source: Mohawk 10-Qs and 10-Ks. “Volume” and “shutdown costs” are related concepts. Our categories of “covid shutdowns” and “factory absorption” would fall into these buckets.
Mohawk inventory days
Flooring prices (% YoY)