Is There Value Underfoot?

If you take a break from your computer and look down at your floor, you might see your next investing idea.

Mohawk Industries (NYSE: MHK  ) is one of the two leading floor-covering manufacturers in North America, along with Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) unit Shaw Carpets. Whether you're walking on carpet, tile, or linoleum, there's a good chance you're looking at a Mohawk product. The company has recently expanded into hardwood flooring, too.

Beyond housing
Along with the rest of the stock market, Mohawk has taken quite a pounding. Not too long ago, shares topped $100 apiece; now they're around $60. Yet that's not surprising for a housing-related company. Drywall maker USG (NYSE: USG  ) has taken a huge tumble of its own, as have homebuilders such as Toll Brothers (NYSE: TOL  ) and KB Home (NYSE: KBH  ) .

But dumping Mohawk in with the struggling new-home market doesn't tell the whole story, since new construction counts for only about a quarter of the company's sales. Materials for commercial properties, along with replacement materials for existing homes, are big components of its business, too. Mohawk's multifaceted business provides a similar exposure to housing as Graco (NYSE: GGG  ) , which makes housing-related products like paint sprayers, as well as products with more industrial applications.

Addressing troubles
Mohawk has done well for a long time, but causes for concern remain. Look at its recent returns on capital and equity:

Ratio

2001

2002

2003

2004

2005

2006

2007

Return on Capital

15.2%

15.8%

11%

11.5%

8.4%

8%

6.9%

Return on Equity

22.1%

19.4%

14.5%

14.9%

13.5%

13.5%

16.8%

Source: Capital IQ, a division of Standard and Poor's.

You can see that both figures fell off steeply several years ago, and neither has yet recovered. It's particularly interesting that these measures of performance degenerated before the housing bubble imploded and oil prices reached their current stratospheric levels.

Mohawk has attempted to alleviate some of these problems through consolidation, purchasing makers of other, higher-margin types of floor coverings, such as ceramic tile or hardwood. These new divisions are indeed improving overall corporate performance. But it will take some time to see whether they can contribute enough to turn Mohawk back into a growth stock again.

Another small but possibly important point regards executive compensation. One executive was awarded incentive pay greater than that strictly prescribed by the incentive plan, for performance "in a particularly challenging business environment." Unfortunately, such behavior can all too easily turn what otherwise would be a good incentive plan into a guaranteed source of income, regardless of actual performance. To its credit, the committee also reduced an award in one case where a different set of special circumstances applied.

Value or value trap?
The final piece of the Mohawk puzzle, which becomes more compelling every day, is valuation. Mohawk just announced that its upcoming earnings would be lower than expected because of economic conditions. But even so, its forward P/E is still in the low teens. With the stock at a five-year low, it seems like it has nowhere to go but up when the economy recovers.

The problem lies in predicting when that recovery will happen. There are still a lot of unsold homes on the market, indicating a slow recovery from the housing meltdown. And while oil may fall slightly from current levels, it's likely to remain relatively high for the foreseeable future. Under these conditions, and with its poor financials since 2003, it's hard to recommend Mohawk right now. You're better off waiting until the housing market bottoms -- and with the way things are going, that could easily be more than a year away.

More on the housing slump:

USG and Berkshire Hathaway are Motley Fool Inside Value selections. See what other stocks our analysts think are poised to recover with a free 30-day trial subscription.

Fool contributor Ken McDonald owns a small position in Mohawk. Berkshire is a Motley Fool Stock Advisor pick. The Fool owns shares of Berkshire. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 685155, ~/Articles/ArticleHandler.aspx, 8/23/2014 1:33:31 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement