TOP CONTRIBUTORS

Jonathan J. Smith

Mohawk Industries (NYSE:MHK) makes flooring, including tiling and rugs, for homes and businesses. By the end of 2007 Mohawk and Shaw Industries controlled a combined 45% of the U.S. flooring market. Since only a handful of companies manufacture flooring, but many companies distribute it, Mohawk and Shaw have high pricing power. In 2007, only 5% of Mohawk's sales were via Home Depot (HD) or Lowe's Companies (LOW).^[1] This fragmented distribution helps Mohawk control pricing.

Petrochemicals account for between two-thirds and three-fourths of the cost of production of resin, a key input when making carpets, and so rising Oil Prices directly affect Mohawk's costs of production.^[2] The U.S. Housing Market also influences the flooring industry, but Mohawk has been partially insulated from the subprime-related housing crash since 48% of total flooring shipments go to replacement issues rather than new homes.^[3] Mohawk also has some immunity from the housing crash because 24% of Mohawk's sales are to commercial real estate customers.^[4] Historically a producer of carpet and rugs, Mohawk aquired Dal-Tile in 2002 and the European flooring power Unilin in 2005 to diversify its portfolio and now produces carpet and rug products as well as ceramic tile, laminate, hardwood and resilient products.

Business Financials

Mohawk products include carpets, ceramic tiles, hardwood, resilient, and laminate. These products are marketed under the Mohawk brands Aladdin, Bigelow, Custom Weave, Karastan, and Mohawk Home. 85% of Mohawk's net sales were from North America, with the remaining 15% coming from international sales.^[5] From 2003 to 2007, Mohawk's revenues grew 52%.

As seen in the graph below, carpet and rug sales dominate the flooring industry. Berkshire Hathaway (BRK) -controlled Shaw Industries out-produces Mohawk for the top ranking in carpet and rug manufacturing.^[6]

^[7]

Mohawk became the top manufacturer of ceramic tiles, hardwood, and natural stone in 2002 with their acquisition of Dal-Tile.^[8] In 2005, Mohawk improved in the European and laminate markets with the acquisition of European laminate power Unilin. Mohawk took a financial hit after acquiring Unilin, as the company's debt/capital ratio escalated from 25% to 52%. However, the acquisitions have helped Mohawk double its sales in the past five years, as seen in the graph below. Also, Mohawk's compounded annual growth rate increased more than 13.5%.^[9]

^[10]

Below are revenue and sector breakdowns. The carpet and rug sector contributes a majority of revenues due to its strong sales, but margins are lower on these products because of the high costs of resin production.

^[11]

^[12]

Below are the total assets, liabilities, and equity for Mohawk over the past four years. Assets surged in 2005 due to the acquisition of Unilin, which also caused an increase in liabilities. Equity has grown exponentially in the past four years, with a 6% increase in growth rate each year (15%,21%,27% for 2004-2005,2005-2006, and 2006-2007 respectively).^[13] Mohawk has suffered a 6% loss in revenue due to the housing crash, but this loss has been minimized due to Mohawk's involvement with replacement flooring (about half of all sales) and Commercial Real Estate. Competitor Dixie Group (DXYN) has lost 9% of revenues in the same time span.^[14]

^[15]

Trends and Forces

Rise in raw-material costs pressures Mohawk margins

Raw materials used for Mohawk's carpet and rug products include nylon, polypropylene, polyester and wool resins and fibers, synthetic backing materials, latex and various dyes and chemicals. Mohawk purchases nylon fibers from Invista Inc., the world's largest fiber, resin, and intermediates manufacturer, and its chemical materials from Solutia, Inc.^[16] Petrochemicals are crucial ingredients in resin production. Since petrochemicals account for between two-thirds and three-fourths of the variable costs in production, rising oil costs pressure margins. Petrochemicals are especially important in the production of resin, a key ingredient in the production of rugs and carpets. In order to preserve its margins, Mohawk must transfer these costs to its consumers - but it risks losing customers in doing so. In the first quarter of 2008, Mohawk's net profit margin decreased to 3.76% from 9.32% in 2007 due to rising costs.^[17] But even though the company took a margin hit, consumers continued to turn to lower-margin flooring in response to increased prices by Mohawk, and revenues have dropped 8% over that time span.^[18]

Demand for flooring influenced by U.S. Housing Market

The general economy controls the flooring industry, as income, interest rates, and government spending all influence demand for housing, and in turn demand for flooring. The fall of the subprime lending industry deflated the U.S. Housing Market. Before this crash, U.S. housing sales were already in decline - from February 2006 to February 2007, housing sales dropped 29.2% in the West, 26.4% in the Northeast , 22% in the South, and 19.5% in the Midwest.^[19] In that same time span, Mohawk revenues decreased 6%^[20] - not surprising considering 76% of Mohawk's revenues are from residential housing. The 6% drop looks better, however, when compared with other companies involved in the housing business. Competitor Dixie Group (DXYN), for example, has seen 9% loss in revenue in the same time span.^[21].A percentage (24%) of Mohawk sales come from Commercial Real Estate, which provides some immunity from the housing decline, as does the fact that 48% of its orders are for floor replacements rather than new home construction.

Competition with Shaw Industries, Inc. is both a risk and opportunity

Mohawk Industries competes with the Warren Buffet-mentored Shaw Industries for control of the flooring market, and together the two companies control 45% of the flooring market. While the consolidation of the industry works in Mohawk's favor in some ways, Buffet's endorsement gives Shaw Industries a wealth of resources and advising. However, Buffet's endorsement also gives Mohawk market longevity because investors are influenced by Buffet's view that there is value in the stocks of elite flooring manufacturers.^[22] Shaw is not the only competitor for Mohawk, however. North America is saturated with the world's top carpet and rug manufacturers. In 2006, the top 10 North American carpet and rug manufacturers accounted for $11 billion of the $15 billion total carpet and rug sales worldwide.^[23] Mohawk accounted for $4.74 billion of this total. ^[24]

Mohawk has affinity for acquisitions

Mohawk has made over 14 acquisitions in the last decade, most recently purchasing Columbia Forest Products on August 13, 2007. ^[25] Mohawk makes acquisitions to diversify its product line and to grow revenues - the acquisitions of Dal-Tile in 2002 and Unilin in 2005 have been the firm's two most important moves. Mohawk's debt more than doubled after the acquisition of Unilin, but this was offset by a similar increase in sales, which doubled between 2003 and 2007. While Mohawk has had success in the past navigating the risks of acquisitions, the firm could face significant challenges controlling multiple manufacturing locations and operating systems as its size continues to grow.

Competition

• Mohawk Industries (NYSE:MHK) - World's largest tile, hardwood, and natural stone flooring manufacturer.
• Shaw Industries, Inc. - World's largest carpet and rug manufacturer, owned by Berkshire Hathaway (BRK)
• Dixie Group (NASDAQ:DXYN) - Sells high end carpet and rugs, commercially and residentially.
• Interface (NASDAQ:IFSIA) - World's number 1 producer of commercial carpets.
• Cavalier Corporation (NZE:CAV)- Specializes in carpet, carpet tile, wool procurement, and wool scouring.
• Victoria PLC (LON:VCP)- Sells high end Victorian carpets in Europe.
• Tai Ping Carpets Group (HKG:0146)- Manufactures carpets, yarns, and mattresses throughout Europe.
• Beaulieu of America- Third largest carpet manufacturer in the world.

References

1. ↑ Seeking Alpha, "Mohawk Industries: An Attractive Long-Term Investment," 1/30/2008
2. ↑ MHK 2007 10-k, Item 1: Business, page 7
3. ↑ MHK 2007 10-k, Item 1: Business, page 3
4. ↑ MHK 2007 10-k, Item 1: Business, page 4
5. ↑ MHK 2007 10-k, Item 1: Business, page 3
6. ↑ MHK 2007 10-k, Item 1: Business, page 4
7. ↑ MHK 2007 10-k, Item 1: Business, page 4
8. ↑ MHK 2007 10-k, Item 1: Business, page 3
9. ↑ Yahoo! Finance: MHK
10. ↑ MHK 2007 10-k, Item 8: Consolidated Financial Statements and Supplementary Data, page 35
11. ↑ Mohawk Industries Corporate Overview, 05/2007
12. ↑ Mohawk Industries Corporate Overview, 05/2007
13. ↑ Market Watch: MHK Balance Sheet
14. ↑ Google Finance: DXYN
15. ↑ Yahoo Finance: MHK
16. ↑ MHK 2007 10-k, Item 1: Business, page 7
17. ↑ Google Finance: MHK
18. ↑ Google Finance: MHK
19. ↑ Wikinvest Concept Article: U.S. Housing Market
20. ↑ MHK 2007 10-k, Item 8: Consolidated Financial Statements and Supplementary Data, page 35
21. ↑ Google Finance DXYN
22. ↑ Seeking Alpha, "Mohawk Industries: Strong Growth, But Competes With Buffett," 04/03/2006
23. ↑ MHK 2007 10-k, Item 1: Business, page 8
24. ↑ MHK 2007 10-k, Item 6: Selected Financial Data, page 20
25. ↑ MHK 2007 10-k, Item 1: Business, Page 3
26. ↑ MHK 2007 10-k, Item 8: Consolidated Financial Statements and Supplementary Data, page 35
27. ↑ Google Finance (DXYN)
28. ↑ Google Finance (IFSIA)
29. ↑ Market Watch (NZ:CAV)
30. ↑ Victoria PLC Investors