Description

Summary

Apologies for the formatting - for some reason the google sheets method did not work optimally this time.

Mohawk Industries at 80 USD per share is in our opinion too cheap to ignore. The stock is down from highs of 210 USD during 2021 and 120 earlier this year on slowdown in the global construction market. We view this as a medium+ quality business that has a strong market position in a growing market, and with EBIT expectations for 2024 already down from 1,600m to 1,000m we find the current valuation at 8x EBIT to be an attractive entry point. We do not know when the construction/remodeling market will turn, but we feel very confident that the current entry point is attractive in Mohawk Industries as we view the earnings power to be 10-14 USD net income per share in the medium term. 

Business

Mohawk has been a frequent guest on VIC, the most recent notes came from 1) dsteiner84 in aug-18 @ 186 USD 2) Value1929 in oct-20 @ 104 and most recently by Glory_Warriors in dec-21 @ 171. I would recommend reading all, but in particular Value1929’s who did a great job explaining the different drivers of the company and why it was at an inflection point at that time. 

Mohawk is the world’s largest flooring company with 12bn USD sales. Its production sites are spread across 19 countries, 41,000 employees, selling in 170 countries. It reports three divisions 1) Global Ceramics 2) Flooring North America and 3) Flooring ROW.

Acquisitions has been a key driver 

The company has done 32 acquisitions since 2013, and as you can see in the financial section it has spent 40% of CFO since 2003 on acquisitions. Some of the most transformative acquisitions have been Dal-Tile in 2002, Unilin in 2005, Marazzi in 2012 and IVC in 2015. The latter was from a defensive point of view to get into the fast-growing LVT market where Mohawk was slow to adopt. In our opinion it has been one of the most important acquisitions as LVT has continued to take share from traditional flooring products.

Despite having spent 6.5bn USD on acquisitions since 2003, there is still ample room for further consolidation in its markets. It is also worth noting that even though it brands itself as a flooring company, it also produces other construction products such as insulation where it has a strong presence in Europe. This leaves further growth opportunities if it sees that it is running out of attractive acquisition targets in its core markets. The graph below from its investor presentation in 2021 shows that it has ample room for further consolidation even within the global tile market: 

Recent performance and drivers

It is important to remember that Mohawk’s key products are still the traditional flooring products such as carpet, wood, and tiles. The reason for the decline in earnings post 2017 was that the company was slow to react to the introduction of LVT, which took significant market share in the US (incl. Chinese imports). It had also been rapidly expanding capacity for its key products, and when consumer preference switched it faced itself with overcapacity. EBIT margins declined from 16% to 8%, the latter also being impacted by COVID and a significant rise in input costs. 

Further, in June 2020 the company received subpoenas from both the US Atorrney’s Office of Northern District of Georgia and the SEC, with allegations that the company was fabricating revenues (selling to customers that were bankrupt), inflating margins (overproducing and keeping it in inventories) and selling broken products to customers it knew would be returned because it was damaged. The company went through a thorough internal audit, and concluded that it had not done any wrongdoing and the share price has since recovered from this issue.

Although the current interest rate environment and housing cycle is not setup for a perfect inflection point like when Value1929 wrote it up (rather the opposite), we simply view the current valuation and expectations too favorable to ignore. Value1929 did a great job of identifying the right timing to get into the stock, and out again by closing out at $130, but we look at this as a long term opportunity when all things are pointing in the wrong direction for the company. The current EV of 8bn is materially lower than the EV of 10bn at the time of the previous writeup that worked out great. This is despite earnings and cash flow in the meantime being roughly as expected.

The recent decline in share price from >100 to < 80 could be on the fears of rising input costs again as it correlates with the increase in oil price. It could also be that investors are now more worried about a further global construction slowdown than it was 2 months ago, but this is hard to determine exactly. 

Financials

Mohawk has a strong cash generative business that it has been able to continue to grow through reinvesting in the business for more capacity, and entering new geographical and product markets through M&A. With solid CFO generation, high (enough) return on capital both organically and inorganically, we believe investors will get a medium+ return on equity with good capital allocation.

The company spent almost 30% of its free cash flow during 2021 and 2022 to repurchase shares, retiring a significant portion of its outstanding shares. With tbe benefit of hindsight, it is easy to say that management should have rather been paying down more debt than to repurchase shares. However, we view it as a key strength that management team paused acquisitions to rather repurchase shares, when it thought that was better use of capital. Dynamic capital allocation with a focus on value per share is key to driving long term value for continuing shareholders.

Valuation 

At 80 USD the market cap of the company is 5.1bn USD, and ~3bn of debt, meaning ~8bn EV. With north of 1bn of CFO, we believe this company has a robust balance sheet and see limited refinancing risk, which is important in today’s environment. The company finance itself mainly through bonds and the maturity profile is healthy.  

We find the current valuation of 8x EBIT very appealing for this kind of business. Most importantly is that estimates have come down from its peak during covid, and the EBIT in that valuation is down by 30% from its peak and in absolute terms is definitely conservative compared to what the company can deliver in a normal year. What is for sure is that 2023 and most likely 2024 will not be a normal year because of weak construction market, but with the current earnings yield we feel that we get paid a fair enough yield while waiting for a normal year to return. We are willing to bet on that people still need houses to live in and that people want to upgrade their floors in the future!

Risks

• Continued slowdown in the global economy that negatively affects flooring demand

• Higher interest rates where debt holders get a larger part of earnings

• Large acquisition that is too expensive 

Catalyst

- Lower inflation that lowers interest rate expectations and will be lead signal on catalyst below

- Better data on housing market, both existing home sales and new home sales

- Earnings beat on 2024