- Mohawk Industries posted a declining revenue source in the Russia region relative to its total revenue, making it susceptible to operating disruption.
- Potential peace talks between Russia and Ukraine, on the other hand, could result in an increase in demand for the company.
- It enjoys a double-digit year-over-year revenue growth and a controlled outlook for operating costs from the management.
- The company benefits from strong catalysts like expanding its capacity globally, aided by a robust buyback program and a positive insider trading by management.
- Mohawk Industries is trading cheaply at a trailing P/E ratio of 9.13x and is sitting at a logical support.
Employing more than 43,000 individuals and generating an annual revenue of more than $11 billion as of April 2022, Mohawk Industries, Inc. (NYSE:MHK) is a global leader in the manufacturing and distribution of flooring products for commercial and residential application. HMK primarily operates in three geographic regions: the United States, Europe, and Russia, among others. During Q1 2022, the company's operation in Russia contributed to a total 3.52% of its total revenue, slower than 4.43% recorded in its Q4 2021, leaving the company still susceptible to risks associated with the ongoing Russia-Ukraine war. Although there have been no positive update on peace talks, I believe on an eventual agreement, which could serve as a positive catalyst for the company, as there might be an increase in demand for renovation of damaged facilities around the region.
On the brighter side, MHK released a strong earnings report on their Q1 2022 with a beat on both of its top line and earnings per share consensus estimate, resulting in a huge gap up and closed with a 7.86% gain over closing on April 28, 2022. Despite challenges from labor and supply issues, MHK shows an outstanding 13% YoY growth on its total revenue and generated an improved trailing 12 months ROE of 12.19% compared to its 7.83% recorded in April last year. Additionally, the management expressed confidence about the stock with their improving capacity and the plan of improving their liquidity. MHK has fallen significantly from last year's high, resulting in a discounted EV/EBITDA multiple of 5.9x, compared to its 8.7x five-year average, and unlocking a better risk-reward opportunity at an initial fair price of $191ish. At today's weakness, this stock is a buy.
Flexing A Controlled Margin
Mohawk Industries enjoy a few strong catalysts which are their improving capacity, strong demand outlook from the management, and their cost reduction initiatives, which helps its operating margin at a controllable level.
MHK enjoys efficiency with its OPEX spending relative to its total revenue of 15.96% on a trailing 12-month basis recorded in Q1 2022, compared to its 5-year average of 17.69%. However, when it comes to operating margins, the company produced a lower figure of 11.81% than its 12.15% recorded in fiscal 2021, primarily due to a bloated cost of revenue, but remains above its pre-pandemic level, as illustrated in the image above. On top of this cost reduction initiative, the management expressed its flexibility to bend its strategy according to the market on their recent earnings call.
We improved the results by increasing prices more than we expected, and we enhanced our product mix to improve our results. We anticipated the Ukrainian clay problems and increased our inventory levels before the invasion to avoid interrupting our production. Our clay inventory should provide sufficient time to reformulate products with alternative materials without disrupting our operations. There is more market uncertainty in the second half of 2022 with economic growth expected to slow and energy costs higher than earlier estimates. We are prepared to adjust our strategies as necessary based on market conditions. Source: Q1 2022 Earnings Call
On top of the noticeable inventory build up this Q1 2022 which grew 25.87% YoY, the management provided a strong demand outlook in all of its operating segments supporting the growing projection for MHK's top line.
Enjoys Strong Demand Outlook
The company has three operating segments; Global Ceramic, Flooring NA, and Flooring ROW. All three segments enjoyed a double digit YoY growth in its Q1 2022 with 14.5%, 10.6% and 14.2%, respectively. This is thanks to the company's cost effective price and product mix and technological advancement which provides competitive edge over the market. During this Q1 2022, MHK's strategy is to increase its capacity level and maximize growth with its recent bolt-on acquisitions. The management provided reassuring updates on their ceramic segment as quoted below.
… we have initiated construction to expand capacity at our Tennessee countertop facility. We see our position in the U.S. ceramic market improving with new construction at high levels and strengthening commercial channels as we provide domestically produced options with outstanding visuals and features.
… The results of our ceramic business in Mexico and Brazil continue to be strong, even with our sales in the quarter being limited by low inventory levels. Our performance was supported by ongoing strength in residential construction and remodeling with commercial projects improving. Source:Q1 2022 Earnings Call
On top of the improving capacity catalyst, the management entered into meaningful acquisitions enhancing their next fastest growing segment which is Flooring ROW Segment.
… Our new French MDF facility has enhanced our product offering and extended the geographic reach of our business. We will enhance the plant's operations by improving processes, expanding capacity and generating energy from waste wood. Despite material constraints, our panel sales grew significantly in the quarter, including strong results in our mezzanine business, which is expanding with e-commerce demand.
… Our purchase of an insulation manufacturer with plants in Ireland and the U.K. increased our market share and sales of polyurethane insulation products. In one of the installation plants we acquired, a new production line with state-of-the-art technology is presently starting up. Source:Q1 2022 Earnings Call
To summarize, MHK offers both high-end ceramic flooring and a more affordable MDF board flooring option to meet consumer demand.
The Company Is Buying Their Own Shares
MHK bought back 8.5 million shares or 12% of its outstanding balance starting from 2020 and recently announced an additional $500 million share buyback program on February 2022. As of this writing, the company still has an available $230.2 million under its share buyback program. On top of this, it enjoys positive insider trading as shown in the image below.
MHK is currently enhancing its product portfolio, more precisely its capacity level, and despite the current multiple headwinds, the company and its President and COO are purchasing MHK's stock. This catalyst indicates that MHK is being undervalued at today's weakness.
Trading At A Reasonable Price
As of its Q1 2022, MHK generated a cheaper trailing P/S multiple of 0.82x, compared to its five-year average of 1.26x, and a trailing P/E ratio of 9.13x, compared to its five-year average of 15.30x. The stock is trading below my initial target price of $191ish, providing potential investors and traders a potential upside of 36% at today's price. This is derived from a conservative DCF model and simple relative valuation.
I modelled my DCF analysis with the figures provided by Wallstreet's analysts. I believe this model is very conservative considering its high discount rate and continued positive trend on its changes in working capital, as shown in the image above. Using a lower discount rate of 8.29% and maintaining all other assumption constant, the model can provide a 49% upside potential at today's price. Looking at its operating margin, I modelled it to start with a declining figure, growing to 12.6% at the end of the model. I also assume a continued investment of its inventory and growing CAPEX spending. As long as inflation remains elevated, consumer demand may fluctuate in response to market conditions, which investors and traders should monitor. As a result of this, the company may be unable to capitalize its inventory investment which may result in impairment charges, eventually putting pressure on its bottom line.
Trading At A Logical Support
MHK jumped more than 20% after its Q1 2022 report, however, faded at $159 level. This creates a massive gap below $140, establishing a logical support zone at $119. As shown in the chart above, the price was also rejected by its 200 day simple moving average; this may act as a psychological resistance, but another breakout of this level may signal bullish price action to investors and traders. This coincides with its MACD indicator, forming a possible bullish crossover, indicating the same sentiment as previously stated.
Final Key Takeaways
MHK shows strength on its future cash flow potential, thanks to its controlled operating cost. It has a strong ESG philosophy and invests in sustainable renewable energy, which benefits the environment while also assisting the company in managing its operating costs. As the largest manufacturer of ceramic tiles in the world and the largest manufacturer of laminate flooring in the US and Europe, MHK is uniquely positioned to maintain its competitive edge and productivity through an effective product mix strategy. By flexing its leadership in the market, MHK unlocks positive reward potential that outweighs its current risk, making it a stock to buy at today's price.
Thank you for reading and good luck to us all this May!
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of MHK either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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