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Morningstar | Mohawk's 1Q Earnings Beat Was the Highlight of an Otherwise Forgettable Quarter; $165 FVE Maintained

Mohawk's struggles continued during its first quarter, as the no-moat flooring manufacturer grappled with slowing global demand, unfavorable foreign currency translation, cost inflation, and manufacturing startup costs and inefficiencies. Reported sales grew just over 1% year over year, driven entirely by acquisitions. Excluding acquisitions, Mohawk's sales fell about 4%. To be fair, Mohawk's first-quarter sales were negatively affected by unfavorable currency and one less shipping day compared with the year-ago quarter. Adjusting for those two items, Mohawk's organic sales increased 1%. Mohawk's profitability took a beating, too, as adjusted operating margin contracted 360 basis points to 8.5% and adjusted EPS fell 29% to $2.13. Still, management had issued EPS guidance of $2.02 to $2.12, and the sell-side consensus had expected first-quarter EPS of $2.06, so the firm did notch its second consecutive quarterly earnings beat. We've maintained our $165 per share fair value estimate.

Based on second-quarter EPS guidance of $2.81 to $2.91 (down 17% to 20% year over year), management isn't expecting much relief. However, CEO Jeff Lorberbaum did say that he expects unfavorable year-over-year margin differentials will narrow throughout 2019. Given that Mohawk faces easier prior-year comparisons during the second half of 2019, we also expect Mohawk's year-over-year performance to improve. That said, we don’t think its 2019 financial results will outperform its 2018 campaign.

While Mohawk may be wallowing in the doldrums right now, we see stronger growth and improved profitability in the firm's future. Investors should give management more credit for the firm's ability to drive productivity savings. Between 2012 and 2017, Mohawk's GAAP operating income increased $975 million, with margins improving from 6.6% to the firm's 14.3% peak. Productivity initiatives accounted for $619 million of the $975 million operating income improvement.

Based on management's commentary during the first-quarter earnings call, it seems like there are plenty of productivity-related projects to work on, including reducing costs through consolidation, replacing high-cost assets with more-efficient options, improving manufacturing processes, and further rightsizing of overhead costs.