Mohawk Industries, Inc.
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system to service all of Mohawk's operations, and launched a more relevant
marketing campaign that
emphasized the strength of the Company's core brands. Lorberbaum’s restructuring efforts paid off as Mohawk
profitability steadily improved each year under the early part of his tenure and consistently maintained 9%-11%
operating profit margin since 2001. However, since the onset of the housing recession that began in 2006, the
Company has been unable to offset declining operating profit due to lower sales, the deleveraging of the
Company’s fixed cost structure and higher raw material costs. As a result, the Company’s operating margin fell
to 4.5% in 2009 from 9.9% in 2007. Management moved quickly to align MHK’s infrastructure with current
market demand, such as closing inefficient facilities, redesigning and automating processes, and upgrading
information systems and reporting tools. Also, the Company focused on managing working capital and limiting
capital expenditure to projects with immediate paybacks. All these actions have helped improved profitability as
operating profit margin improved 130 bps to 5.8% in 2010 and the Company generated robust free cash flow
as previously mentioned. Operating profit continued to improve in 2011 as first half 2011 operating profit
increased to 6.9%, up 50 bps from 6.4% in the same period last year. Management believes the Company can
eventually return to 8%-10% operating profit margin.
From 2001 when Lorberbaum was appointed CEO through the start of the housing recession in 2006,
the Company’s return on equity (ROE) ranged between 11.9% and 19.9%, and averaged 14.4%, while return
on invested capital (ROIC) ranged between 8.0% and 15.8%, and averaged 11.7%. As a result of lower sales
volume and higher raw material costs over the last few years, the Company’s ROE dropped to an
embarrassingly low 5.8% in 2010 and ROIC was a dismal 3.8%. We believe ROE and ROIC were negatively
impacted during 2010 reflecting lower sales volume (which we believe are cyclical rather than secular issues)
and higher raw material costs (which are a temporary mismatch between price and cost). Based on the
Company’s current capital structure, asset turnover level and a normalized tax rate, if management reaches its
targeted 9% operating profit margin, we estimate the Company can generate ~12% ROE, which translates to
approximately $6.00 per share in normalized earnings power.
Given this level of mediocre ROE and ROIC, one may question whether the Company is competitively
advantaged. However, the Company’s return on tangible invested capital has ranged between high teens to
high 20% range. We believe ROTIC is more reflective of the Company’s business model since ROE and ROIC
are diluted by management’s capital allocation and other temporary business conditions.
Growth Drivers and Catalysts
We believe Mohawk will be a prime beneficiary of a few favorable trends: the eventual recovery of the
new residential housing construction market, an aging housing stock, pent up demand for remodeling, and
international expansion.
Rebound in New Residential Housing Construction
As we mentioned in the introduction of our 2011 summer double Issue, Stocks Set For a Lift From a
Housing Recovery, new housing construction is currently near an all time low. Using housing permits as a
proxy for housing starts/construction (since this data is widely available and has closely tracked construction),
median housing starts totaled approximately 1.5 million homes per year since 1960. This figure is more or less
in-line with long term housing demand which is around 1.35 million per year. Between 2000 and 2006, sales of
new and existing homes increased by 14% and 26%, respectively. Home builders responded in kind and
increased production to meet demand, resulting in a cumulative 2.4 million new homes being over built relative
to long term demand between 2004 and 2006. At the onset of the recent housing recession, housing permits
dropped to under 1.4 million by 2006 and continued to decline thereafter, reaching the historic low point of
roughly 440,000 units in 2009. Since the overbuilding ended in 2006 and the ensuing decline in production,
there has been a cumulative 2.5 million fewer homes built relative to long term demand. This amount of under
building helped offset the accumulated 2.4 million surplus homes and has left the single family housing market
in an under-built state. In 2010, annual new home construction was just 600,000 consisting of 450,000 single
family homes, 100,000 multifamily and 50,000 manufactured homes.
Mohawk Industries, Inc.
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Source: U.S. Census Bureau; NAHB via PulteGroup, Inc., Investor
Presentation, June 2011
Source: Moody’s Analytics, “Housing Hits Bottom in 2011”
Home Replacement and Remodeling
The average carpet or laminate wood floor lasts approximately seven to ten years. One of the more
popular items homeowners like to remodel is their floor, either replace due to wear and tear or to get an
updated look of the room. According to The National Association of Home Builders (NAHB), Americans spent
$116 billion on improvements to owner-occupied units in 2010, down from a peak of $146 billion in 2006.
However, housing expenditures are expected to increase steadily as the broader housing market recovers
through 2011 and 2012, reaching $119 billion and $131 billion, respectively. Indeed, according to a recent
industry report, the Residential BuildFax Remodeling Index was up for the twentieth straight month in June
2011 and now stands at the highest point since August 2004. This trend bodes well for MHK since close to half
of the Company’s business is derived from the residential home remodeling and replacement end market.
BuildFax Remodeling Index
Mohawk Sales by End Markets
International
15.0%
US New
Residential
Construction
11.0%
US New Non-
Residential
Construction
29.0%
US Residential
Repair/Remodel
45.0%
Source: Buildfax.com
Source: Company reports