Mohawk Industries (NYSE:MHK) is a manufacturer of floor covering products for residential and commercial uses. It posted a poor earnings release in July, and there were plenty of cautionary comments about the economy from management, but this pessimism may be about to pay off. Falling commodity prices should bring higher-than-expected earnings in the next quarter.
The company's prices and guidance was based on sky-high commodity input costs. Those costs are falling fast, yet its price increases are much stickier.
Mohawk traded for more than $100 back last summer and closed at $69 on August 11, 2008, as investors dumped the stock due to slowing consumer demand and the rising cost of raw materials. Now might be the time to reconsider.
Commodity Prices Actually Going Down?
It's a hard concept to get your arms around - the possibility that commodity prices may fall significantly over the next few months, and yet oil has already come down from $140 to $113 and many others have also retraced. The soaring costs of raw materials have been the source of much of the pain during second quarter earning season, as oil, natural gas, steel and other basic commodities reached new highs over the summer. Now that the trend has reversed, it is logical to assume that these same companies may be helped as the prices of commodities fall below the assumptions built into its guidance.
When Mohawk reported its second quarter it was the usual litany of causes for the down earnings. Jeffery S. Lorberbaum, chairman and CEO said, "Our results for the second quarter were impacted by the slowing economies in the U.S. and Europe and rapidly increasing commodity costs. Declining new U.S. home construction and residential remodeling, slowing European demand and rising raw material and energy costs have contributed to the flooring industry cyclical decline. The rapidly increasing costs are impacting our margins even as we raise selling prices to offset these costs."
The company gave guidance for the third quarter of $1.06-$1.15 per share. This was based on continued high costs of raw materials, and with several price increases including:
- 5% - 6% price increase for the U.S. laminate business during the third quarter.
- Three carpet price increases since December to offset rising costs.
- Mohawk also raised transportation fees. (For more on this measurement check out Earnings Forecasts: A Primer.)
The Margin Effect
While some of these price increases may not be fully implemented, we know that price increases are a lot stickier than the commodity costs, which are based on formulas and will drop immediately. "A lot of our raw materials and energy change with the rising costs. They are formula based, based on different pieces. So as those things changed they would almost immediately be impacted," Lorberbaum said during the conference call. Management said that the highest margins the industry typically sees are during falling material environments. They cited 2001 as the last time that occurred.
Operating margins hit 10.6% in the first quarter of 2001, compared to 7.9% in the second quarter to 2008. The reason for the favorable margins in 2001 according to the company was because Mohawk was "impacted by favorable material and fuel costs". (To learn more, read Analyzing Operating Margins.)
Other companies that may benefit from a broad based fall in commodity prices include Tyson Foods (NYSE:TSN) and Pilgrim's Pride (NYSE:PPC), both of whom are being impacted by soaring feed costs.
Bottom Line
If commodity costs continue to fall, companies like Mohawk will benefit on the cost side as its input costs fall, while price increases to its customers stick longer.
