Take a look at almost any building products name this year, and you’ll find an absolute massacre. It’s important in these times of almost indiscriminate selling to find names that have been thrown out with the bath water.
Mohawk Industries, on the face of it, may appear to be one such name. The company, which sells mainly flooring products such as ceramic and stone tile, carpet, hardwoods and LVT, has seen its stock cut in half YTD. This performance is much worse than other diversified building product names such as Masco and Fortune Brands, as seen below:
So is it time to dive in? Well according to consensus estimates, the stock now trades at just 10x 2019e EPS and 7x EBITDA. Unfortunately, I think consensus estimates are still too high.
I won’t re-hash all the problems of Mohawk here, but let’s simplify the issue down to: Mohawk has seen material margin pressure YTD. In fact, Q4 EBIT margins are expected to be down 400bps Y/Y! The company has called out raw material and freight pressure, customers downgrading choices resulting in a negative mix effect, and competition.
While the street has started to downgrade its expectations for 2019, I think they are still too high. And to explain that, we’ll do a quick history lesson.
Below is MHK’s EBITDA margins by year… the gray and light blue lines represent long-term averages for margins. However, I exclude ’08 & ’09 from these as these were obviously times of extremely diminished demand and not an accurate depiction, in my view, of normalized margins. Over the long-term, EBITDA margins averaged around 14.5%. However, we can see in 2015-2017, margins stepped up materially. Excluding these years, EBITDA margins were around 13.5%.
So what happened in 2015-2017? And would I view those years as “over earning”? Yes, I would.
Think about the main inputs into carpet and flooring? Resin, such as glues and plastics, as well as other chemicals are major inputs into carpet and vinyl and ceramics.
As shown below, the price of carpet staid relative flat while the raw materials declined significantly. Essentially, hold price steady while raw materials decline precipitously, and you’ll see great margin uplift. Now, that is clearly unwinding.
As such, I think the street targeting 17% EBITDA margins is too high. Let’s assume that margins normalize to 14.5-15.0% of sales and the street is right about the company doing $10.5BN in sales (though this could come down in the face of higher competition).
This points to the company trading at more like 8x 2019 EBITDA. The company’s long-term trading multiple as been 8.4x, though that is skewed by optimism in 2015-2016 when the company traded at >10x. Either way though, the stock hardly looks cheap on a normalized basis, it will also be hard for it to outperform when it is printing heavy margin pressure.
I’m a pass at these levels.