the 06/04/2008

Mohawk's Diversity Creates Value

  

Over the past year, investors have walked all over Mohawk Industries (MHK), a maker of carpet and other floor coverings. Sales are off with the slumping housing market; margins have beensqueezed by higher energy and raw-material costs; and the shareshave tumbled more than 25%, to around $75, from a high of $108 lastspring. The bear case for Mohawk is that the stock is dead money until theeconomy recovers. But some prominent value investors favor Mohawkat these depressed levels. They say that the Calhoun, Ga., companyhas evolved, adapting itself to changing customer tastes. Oncefocused exclusively on rugs and carpets, it has morphed since 2000into a full-service flooring specialist, offering increasinglypopular alternatives such as hardwood, laminate and ceramic tile. "They've used the cash from the carpet business to buy intofaster-growing businesses," says Brad Hinton, co-manager of WeitzPartners Value Fund, a big holder of the stock. Those businessesinclude Dal-Tile, a maker of ceramic and porcelain tile, andBelgium-based Unilin Holding, a laminate-flooring specialist. The bulls consider Mohawk capable of riding out a tough economy andthe housing recession. A big plus: The company has a healthybalance sheet and has been paying down debt, leaving itsdebt-to-capital ratio at a manageable 32%. That gives it theflexibility to make acquisitions, if attractive opportunitiesdevelop. "If something looks good and it makes sense at the time,we would consider it," says Frank Boykin, Mohawk's chief financialofficer. Another advantage Mohawk has is its heft. Mohawk and ShawIndustries, which Berkshire Hathaway acquired in 2000, togethercontrol more than 45% of the U.S. flooring industry, according toMorningstar. "Mohawk and Shaw have the only two nationaldistribution systems," says Mr. Hinton of Weitz & Co. "Thebarriers to entry are quite high." Fans like Meryl Witmer, a general partner at Eagle Capital Partnersin New York, say the real payoff will come when better earningsreturn. Ms. Witmer estimates Mohawk could generate "about $10 ashare in after-tax free cash flow," and could report earnings of $8a share "when housing starts normalize at 1.5 million" versus aboutone million today. Based on her numbers, the stock fetches lessthan 10 times future profit estimates and less than eight timesfree cash. Put a conservative multiple of 12 on her estimate, and the stockcould sell for $120 after the current economic downturn ends. Thatwould be a nice return for any company, especially one whose stockhas been swept under the rug.