Mohawk Industries MHK S
February 18, 2009 - 3:10pm EST by
todd1123
2009 2010
Price: 31.50 EPS $3.50 $0.00
Shares Out. (in M): 68 P/E 9.0x NM
Market Cap (in $M): 2,155 P/FCF 5.5x 18.0x
Net Debt (in $M): 1,994 EBIT 425 50
TEV ($): 4,149 TEV/EBIT 9.8x 83.0x
Borrow Cost: NA

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Description

 

I am recommending a short position in Mohawk Industries (MHK) equity (currently at ~$31 - 32 / share) and long credit protection (CDS currently at ~350 level), which I believe presents a compelling near-term risk / reward proposition, with total return potential of 30% - 50% over the next 1 - 3 months (PT of ~$18 / share on the equity and credit protection target of >500 bps).  With sales of approx $7Bln, MHK is one of the largest suppliers / distributors of flooring in the US / Europe.  While the MHK business model is perceived to be pretty solid, there are five primary reasons why I think shorting MHK equity / buying CDS  in the near-term is timely / actionable: (i) US consumer concerns (longer-term structural shifts in consumption / saving trends will result in the deferral of large-ticket item purchases like flooring), (ii) European exposure is significant and will see a dramatic fall-off (MHK's Unilin division generates ~20% of sales BUT >35% of its profitability and has margins that are 3x that of its "core / legacy" US flooring business which is not sustainable), (iii) the industry construct is generally mis-understood by the Street (Street views the industry as an oligopoly structure - but the reality is that its much more fragmented / competitive w/ the top 10 mfters representing 68% of the total industry), (iv) the company's US tile / commercial division (Unilin) is on the cusp of a significant downturn (which has largely helped cloud / cushion the core underlying business prospects) and (v) MHK will likely be downgraded from its current BBB- rating to junk over the next couple weeks / 1 - 2 quarters (in which case the rate on the company's 5.75% and 6.125% senior notes - total $1.4Bln -  would increase by 0.25% per each step downgrade - max of 1%).

 

Longer-term (next 3 - 9 months), while the business seems adequately capitalized (approx 2.8x of net debt / 08E EBITDA - assuming ~$700MM of 08E EBITDA), there is a high probability of MHK tripping their total leverage covenant (60% of net debt / cap covenant versus current / Sep 08 of ~37%) in late 09E as they have >$1.6Bln of goodwill that will likely be written down (mostly related to European acquisitions).  While MHK should be able to get an amendment (very similar to WHR dynamic), the re-pricing should result in further earnings dilution.  Based on my 09E assumptions of -20% on the top-line and 25% flow-through (both are very generous as I think the FX rate impact could result in an additional 500 bps of top-line degradation on top of the -20%), implies 09E EBITDA of ~$350MM and EPS of $0 / share to -$1.00 / share loss (which implies total leverage of >5.8x and values the equity at approximately ~12x EBITDA).            

 

MHK operates through 3 divisions (summary performance jotted below): (i) core / legacy flooring division, (ii) commercial division - Dal-Tile and (iii) European laminates division - Unilin.  MHK's core / legacy business generates approximately 55% of its sales but less than 30% of its profitability (margins have contracted by >350 bps over the past 3-years within this business - currently sub 6% EBIT margins).  MHK's commercial division generates approximately 25% of its sales but less than 35% of its profitability (while sales have started to come off in the past 12 - 18 months, margins have held in pretty well in the 13 - 15% EBIT range).  MHK's European division has been the "work horse" growing at a ~14% CAGR between 2004 - 2007 and EBIT margins of >18%.  Given the health end-markets for both Dal-Tile and Unilin, margins grew over the past 4-years which I don't think is sustainable.

 

 

SEGMENT PERFORMANCE

 

 

 

 

 

 

 

 

 

SALES:

2004

2005

2006

2007

a

Mohawk

4,369

4,717

4,742

4,206

 

% YoY

 

8.0%

0.5%

-11.3%

b

Dal-Tile

1,512

1,735

1,942

1,938

 

% YoY

 

14.7%

11.9%

-0.2%

c

Unilin

993

1,102

1,237

1,488

 

% YoY

 

11.0%

12.3%

20.3%

 

 

 

 

 

 

 

OP INCOME:

 

 

 

a

Mohawk

428

427

387

255

 

% Margin

9.8%

9.1%

8.2%

6.1%

b

Dal-Tile

220

260

271

259

 

% Margin

14.6%

15.0%

14.0%

13.4%

c

Unilin

163

180

214

272

 

% Margin

16.4%

16.3%

17.3%

18.3%

 

CAPITALIZATION:

 

 

 

 

 

 

 

 

FACE

 

 

 

 

 

 

 

09E

 

Maturity

Coupon

Book

Price

Market

 

EBITDA

Cash

 

 

$62.0

NA

$62.0

 

 

 

 

 

 

 

 

 

 

Revolver ($900MM)

10/15/2010

 

256.4

100.00%

256.4

 

0.7x

5.750% Bonds

1/15/2011

5.750%

500.0

92.00%

460.0

 

2.1x

7.200% Bonds

4/15/2015

7.200%

400.0

92.00%

368.0

 

3.3x

6.125% Bonds

1/15/2016

6.125%

900.0

85.00%

765.0

 

5.8x

Total Debt

 

 

$2,056.4

 

$1,849.4

 

5.8x

 

 

 

 

 

 

 

 

Net Debt

 

 

$1,994.3

 

$1,787.3

 

 

 

 

 

 

 

 

 

 

Equity

68mm sh

$31.50

2,155.0

 

2,155.0

 

 

Enterprise Value

 

 

$4,149.4

 

$4,149.4

 

11.7x

 

 

 

 

 

 

 

 

Projections

 

 

Liquidity

 

 

 

 

2009E EBITDA

$353.4

 

Cash

 

$62.0

 

 

2009E EBITDA-Capex

$203.4

 

Revolver Availability (1)

644.0

 

 

 

 

 

Total

 

$706.0

 

 

(1) US coming due in Q4 2010, Europe coming due in Q4 2010 and A/R Securitization expiring in Q3 2009

 

UPSIDE / DOWNSIDE:

UPSIDE: assuming 1x multiple to tangible book value of ~$12.50 / share = $12.50 PT (vs current of ~$31.50 / share or approx 60%+ upside)

BASE: assuming 1.5x multiple to tangible book value of ~$12.50 / share = $18.75 PT (vs current of ~$31.50 / share or approx 40% upside)

DOWNSIDE: assuming 2x multiple to tangible book value of ~$12.50 / share = $$25.00 PT (vs current ~$31.50 / share or approx ~20% upside)

 

RISKS:

Key inputs include nylon, polyester and polypropylene which have fallen off in recent mths

Mitigant: demand destruction should offset most of this benefit

Earnings power (on current standalone biz) is greater than my view of $3.00 / share longer-term

 

CATALYSTS:

 

NEAR-TERM (1 - 2 weeks): Company reports on February 23rd (focus will be on outlook)

NEAR-TERM (likely 1 - 2 weeks): Company gets downgraded to junk by both Moody's / S&P (currently BBB-)

LONGER-TERM (1 - 3 months): Street appreciates the trade-down that consumers are currently making to private label / lower-price point products (per recent channel checks, surprising how significant this trend is especially w/in the large power-boxes - which is >25% of MHK's business)

LONGER-TERM (1 - 3 months): Street appreciates the fact that commercial / Europe have helped the business cloud its core / legacy results

LONGER-TERM (3 - 9 months): company writes down its goodwill and triggers its total debt covenant (forced to renegotiate rate w/ lenders)

LONG-TERM (1 - 2 years): Street recognizes the underlying earnings power of the biz is very different than the 2002 - 2007 period (in which we saw one of the greatest housing booms in both US / Europe)

Catalyst

 

NEAR-TERM (1 - 2 weeks): Company reports on February 23rd (focus will be on outlook)

NEAR-TERM (likely 1 - 2 weeks): Company gets downgraded to junk by both Moody's / S&P (currently BBB-)

LONGER-TERM (1 - 3 months): Street appreciates the trade-down that consumers are currently making to private label / lower-price point products (per recent channel checks, surprising how significant this trend is especially w/in the large power-boxes - which is >25% of MHK's business)

LONGER-TERM (1 - 3 months): Street appreciates the fact that commercial / Europe have helped the business cloud its core / legacy results

LONGER-TERM (3 - 9 months): company writes down its goodwill and triggers its total debt covenant (forced to renegotiate rate w/ lenders)

LONG-TERM (1 - 2 years): Street recognizes the underlying earnings power of the biz is very different than the 2002 - 2007 period (in which we saw one of the greatest housing booms in both US / Europe)

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