With Mohawk Industries (MHK, Financial) down 36% since September, including a 24% drop on Friday, the market is being overly critical of its latest quarter and the impacts of a housing market slowdown.
After the closing bell last Thursday, Mohawk reported earnings of $3.29 per share for the third quarter, which was well below analyst estimates of $3.60, sending the stock down to $115.03 over the weekend. This puts the stock back to its 2014 levels. On the conference call, management cited inflation and weaker demand as primary contributors to the profit shortfall, with lower sales being likely in the next quarter as well.
Mohawk Industries makes a wide range of flooring products. Selling carpets, rugs, ceramic tile, laminate, wood, luxury vinyl tile (LVT) and vinyl flooring has helped the company grow into a $10 billion business generating north of $1 billion in annual profit. The problem for the stock is that 63% of its revenue comes from the U.S., which is suffering a housing slowdown.
Long term, this consumer cyclical company will experience more good times than bad. Even with the expectation of declines in the next two quarters, analysts at ValueLine still have the per-share estimates pegged at $12.40 for the fourth quarter and $13.50 for first-quarter 2019.
These seem high, but despite heavy competition with Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) subsidiary Shaw Industries in carpet, the company has a leading share in most of its other product segments. Acquisitions (similar to Berkshire) have been a key part of Mohawk’s growth strategy, with 42 completed deals since 1992. Mohawk first consolidated the carpet market in the 1990s and later expanded into adjacent flooring categories and new end markets. Now, if the company does earn $13.50 in 2019, the after-tax profit will surpass $1 billion for the first time in its history.
From a valuation standpoint, Mohawk is an even better bargain now. Cyclicality across consumer markets is bound to happen, yet those challenges are opportunities for the company to buy back stock, improve processes or buy competitors at discount prices. In the last decade, it has successfully increased sales from $6.8 billion to upwards of $10 billion; profit has risen to $916 million from a $6 million loss; and the company's book value stands at almost $100 per share, up from $46 in 2009. Over that time, Mohawk has also improved both operating cash flow and profit margins.
The price at this level is more of a bargain than before, especially if the company does reach that earnings per share mark of $13.50. With the current state of the housing market, it is unlikely that investors will price Mohawk anywhere close to its five-year average price multiples, which would put the market capitalization well over $16 billion. Even a price-earnings multiple of 15 would lift the company's cap over $15 billion.
A risk that cannot be ignored is that oil and natural gas remain critical to manufacturing its products. The company also depends on diesel to power its trucking fleet. The company won't be able to pass these costs on to its customers as fast; over time, however, the prices will rise and automation will continue to help the company's output productivity. Unless something truly unforeseen happens or Mohawk's fundamentals begin to deteriorate rapidly, the stock is a buy.
Disclosure: I am not long or short MHK.
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