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Morningstar | Myriad Headwinds Persist for Mohawk, but Shares Move Higher on 4Q Sales and Earnings Beat

It was a tough 2018 for Mohawk Industries to say the least. Shares of the no-moat-rated flooring manufacturer, once a Wall Street darling due to its impressive track record of beating earnings expectations, reached an all-time high of $285 in late 2017 before plunging over 60% to a low of $111 per share by the end of 2018. The drastic change in investor sentiment occurred amid a string of earnings misses as the firm grappled with an assortment of headwinds, including slowing end-market demand, rising input costs, increased import competition, unfavorable price and product mix, and startup costs related to manufacturing capacity additions. However, Mohawk's streak of missing Wall Street expectations ended with its fourth-quarter results, which, in our view, were still nothing to write home about. Fourth-quarter revenue grew 3% year over year (0.5% excluding acquisitions and adjusting for currency translation) to approximately $2.5 billion, which beat consensus by about $14 million. While adjusted EPS of $2.53 was 26% lower than the year-ago quarter, it beat Wall Street's estimate by $0.04.

Management's first-quarter 2019 EPS guidance acknowledges that many of the headwinds the firm faced in 2018 will continue. Indeed, first-quarter 2019 EPS guidance of $2.02 to $2.12 came in well below consensus expectations of $2.29 and prior-year results of $3.01. Still, management remains cautiously optimistic about the firm's ability to improve financial performance throughout 2019. We expect to reduce our fair value estimate by approximately 3% due to our tempered near-term expectations. While our skepticism of Mohawk's ability to sustain the level of profitability it enjoyed in 2016 and 2017 proved to be prudent, we believe the market is now discounting Mohawk's growth prospects and its ability to improve margins, which had been widely accepted by the market before the firm's recent stumbles.

As a reminder, Mohawk is in the process of adding approximately $1.5 billion of new capacity over the coming years. Management noted during the earnings call that these investments will begin bearing fruit in 2020 and beyond. Of course, if global economic conditions worsen, the full benefits of Mohawk's capacity additions could be delayed.

While we think it will be tough for Mohawk to return to and maintain the level of profitability it enjoyed in 2016 and 2017, we believe margins can certainly improve from here as inflationary pressures moderate and United States new residential construction and repair and remodel activity pick up. With mortgage rates moderating and cautiously optimistic commentary from large homebuilders about the early spring selling season, new residential construction could surprise to the upside in 2019. We also think improving U.S. housing sentiment could increase consumer confidence, which could, in turn, cause R&R spending to accelerate. While Mohawk has a global footprint, approximately 60% of its revenue comes from the U.S.