Turnaround Letter Buy-rated Mohawk Industries (MHK) reported modestly disappointing sales, adjusted EBITDA1 and adjusted per-share earnings that were slightly ahead of consensus, although adjusted operating profits fell 19% from a year ago. The company guided third quarter earnings to about 14% below consensus, as the revenue and profit headwinds will continue. The lower guidance led to a 20% decline in the stock price over the past few days. Mohawk shares had risen 33% year-to-date prior to the earning release, reflecting some overly enthusiastic short-term expectations, particularly as the company had beaten consensus estimates in recent quarters. We are impressed with the vigor that management is applying to improve Mohawk’s market share and cost structure, which we believe will ultimately lead to higher profits and a higher valuation.
Some color on the quarter:
The Flooring North America operations (about 37% of sales) remain challenged, as revenues fell 7% and adjusted operating profits fell 43%. Residential volumes were weak and the company lost market share to lower-priced carpets, although the commercial carpet business remains healthy. Mohawk is ramping its luxury vinyl tile (LVT) operations to fully participate in this rapidly growing category, which should boost profits once it begins to run at full efficiency. Flooring North America overall is under new leadership who we believe will produce much better revenues and profit margins over time.
The Flooring Rest of World segment (about 38% of sales) produced 9% revenue growth (15% in local currencies), driven by acquisitions, new product introductions and higher volumes. Adjusted operating profits increased 11% as product innovations, higher production of LVT and efficiency gains expanded its margins.
Global Ceramics (about 25% of sales) produced 3% revenue growth (5% in local currencies) but saw adjusted operating profits fall 15% Overall ceramic industry conditions remain modestly unfavorable due to weak housing demand, competition from LVT, and weak pricing driven by a surge of Chinese imports into the United States ahead of new tariffs. Once in place later this year, the tariffs should boost Mohawk’s pricing power.
The weak guidance (for a 20% decline from last year’s third quarter) reflects continued difficult conditions. On its conference call, management outlined an impressive roster of new initiatives, adjustments and responses to reverse the decline in profits. The company is clearly not standing still or passively accepting the sluggish market conditions. This vigor helps make Mohawk shares an appealing investment.
Mohawk’s balance sheet remains sturdy, with its $3.1 billion in gross debt at a very reasonable 2.0x multiple of expected 2019 EBITDA. The company continues to generate considerable free cash flow, likely reaching $700 million this year.
We continue to rate Mohawk Industries (MHK) shares a buy with a $220 price target.
Disclosure Note: One or more employees of the Publisher own MHK shares.