Mohawk Industries Stock: Finding A Floor (NYSE:MHK)

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In February of this year, I wondered where the floor was for shares of Mohawk Industries (NYSE:MHK). Little could one have imagined what a major global political conflict was upon us, as well as an environment of rapidly rising interest rates, as Mohawk has announced a bolt-on acquisition in the meantime as well, sufficient reasons to update the investment case here.

Recap

Mohawk is one of the largest floor manufacturers in the world, and with activities focused on all major product categories, it has been a strong 2021 amidst a raging housing market, albeit that inflationary pressures emerged towards the end of the year.

My take on Mohawk actually started in 2015, when the company acquired Belgium-based IVC in a $1.2 billion deal with shares trading at $170 at that point in time. Enthusiasm of investors in the day was based on a $7.8 billion revenue number on which the company posted just over a billion in EBITDA, both ahead of the IVC contribution.

With leverage approaching 3 times EBITDA, and the company trading at 19 times earnings, the valuation was more than fair, especially as shares had rallied quite a bit already. Little could I have imagined that shares rallied to $300 in 2017 amidst strong operating performance, only to see share trade at $120 again a year later as some inflationary pressures appeared, even as leverage already came down.

After a brief decline to $50 amidst the outbreak of the pandemic, shares rallied to $230 in May of last year, before pulling back to $150 early in 2022, actually below the levels seen seven years ago. In the meantime, the company has grown and part of the debt load has been repaid, which makes that the enterprise value has actually shrunken from the 2015 levels.

Operating Performance

During the pandemic year of 2020, the company managed to limit the fall in sales to 5% with revenues reported at $9.5 billion. Operating profits fell to $636 million, resulting in earnings per share of $7.24 per share, actually the third year of stagnation in the results after the peak in 2017. With the housing market making a roaring comeback in 2021, the business has been on fire as revenues came in at $8.4 billion in the first three quarters of the year alone, as earnings were posted at $12 per share over the same period of time.

This resulted in an earnings rate of $16 per share, all while net debt of $1.2 billion was far below the EBITDA numbers which trended at $1.9 billion.

This looked very compelling at $150 per share early this year, as the issue relates to the soft fourth quarter performance. Fourth quarter earnings were seen at just $2.80-$2.90 per share amidst inflationary pressures, material availability issues, higher energy prices and signs of a cooling housing market. With earnings power still trending at $11 per share, the situation looked still reasonable, but remember that this was still ahead of the Russia conflict, and all its impact on various parts of the economy.

A few days after writing the investment thesis early in February, Mohawk posted its fourth quarter results. Revenues rose by 4% and change to nearly $2.8 billion, as operating earnings fell back a bit to $253 million, with earnings coming in at $2.80 per share, for a full year earnings number close to $15 per share. Net debt inched up to $1.7 billion following reasonable aggressive buybacks towards the end of the year, with the share count now down to 67 million shares. Given the uncertainty, the company did not provide a 2022 guidance, yet it guided for first quarter earnings between $2.90-$3.00 per share, as an indication of real stabilization as inflationary pressures were offset by price hikes.

Late in April, the company posted first quarter results which looked quite decent as revenues rose 13% to just over $3.0 billion as operating earnings were flattish at $320 million versus the year before, with earnings coming in at $3.78 per share based on a 65 million share count. This was far stronger than guided for.

Buybacks made that net debt inched up to $2.1 billion, resulting in a leverage ratio of 1.1 times based on a trailing EBITDA performance just shy of $2 billion. Despite the rocky outside environment, the company actually guided for second quarter sales at a midpoint of $4.30 per share, which is quite strong if you ask me, certainly as the housing market is rapidly deteriorating in the US, but other parts of the world (read Europe) as well.

Valuation Reset

With investors being fearful that Mohawk is setting them up for a disappointment in the making, shares have fallen to $120 right now, resulting in a $10 billion enterprise valuation at the moment. Given the turmoil in some end markets, I was a bit surprised to see a bolt-on deal announced in June. Mohawk has reached a deal to acquire the Vitromex ceramic tile business of Grupo Industrial Saltillo in a $293 million deal, equal to 3% of the current enterprise valuation.

With four factories in Mexico, the activities generated $204 million in sales in 2021 from glazed ceramic, porcelain, mosaics and decorative tiles. This reveals that a 1.4 times sales multiple has been paid, while the own valuation has fallen below 1 times sales here. While just a bolt-on deal, no margin details have been announced as the deal likely provides a couple of pennies in accretion. With net debt inching up to $2.4 billion, leverage increases to roughly 1.2 times EBITDA, as strong earnings power in the second quarter should perhaps be used to be a bit more conservative with the balance sheet, given the uncertainty out there.

And Now?

While the near to medium term outlook for the earnings power of Mohawk is not good, and I am generally surprised by the second quarter earnings outlook, to which I see real risks, I like the long-term risk-reward here.

Leverage is manageable despite recent bolt-on deal-making and buyback activity, as average earnings power down the cycle should be more than sufficient to create a compelling risk-reward here at $120, albeit that investors likely have to stomach quite some volatility in the operating results in the coming quarters.

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