Mohawk's Got That Value Mojo Working

This week's Barron's profiles Mohawk Industries, which trades in New York under symbol MHK. Mohawk manufactures carpets, rugs and flooring and its stock price is down because of the housing slump. I don't own it as of now -- which may well say something about me. But I noticed Meryl Witmer's firm lists Mohawk as its largest holding in its latest SEC filing. In fact, Witmer's firm increased their holding significantly from the beginning of the year.

If you follow the Barron's Roundtables closely, you'll remember Mohawk being one of Witmer's picks. Here's what she says about the company in the linked article:

[T]he real payoff will come when more normalized earnings return. Witmer estimates Mohawk could generate "about $10 a share in after-tax free cash flow," and report earnings of $8 a share "when housing starts normalize at 1.5 million" versus about 1 million today. Based on her numbers, the stock fetches less than 10 times future profit estimates and less than 8 times free cash.

Witmer's free-cash-flow projection comes from adding back amortization and depreciation, both non-cash charges. Put a conservative multiple of 12 on her estimates, and the stock could sell for 120.

Another interesting bit:

Investors give especially high marks to Lorberbaum, Mohawk's CEO, whose interests appear to be firmly aligned with those of shareholders. He and his family own about 20% of the company. "He has got his money where his mouth is," says Bruce Berkowitz, president of the Fairholme Fund, another big Mohawk holder.

An industry veteran with more than 30 years of experience, Lorberbaum has been CEO of Mohawk since 2001.

If you're thinking of buying Mohawk (I am), you might wait a few days. Sometimes stocks get a pop after a positive mention in Barron's.

Comments

[Alex]

I've been selling naked puts on MHK. I don't do that often, but it seems to me a good way to play what could be an extended slump in housing. I won't mind at all if I wind up owning some MHK, but so far that hasn't happened.

[John]

Alex: Selling puts, etc. is something out of my circle of competence. I just buy something or don't buy it, and if I wind up in cash so be it. (Though there are times when it seems simple buy or hold decisions are out of my circle of competence!) But I wish you all the luck :-)

[Al]

Since when is a FCF multiple of 12 conservative? It seems a fair multiple for a company nearing its maturity.

Regarding Alex's comment, selling out of the money puts on a good company is equivalent to being paid for posting a limit order.

[Alex]

Al makes a good point: if limit orders are not outside your circle of competence, then neither is selling an out-of-the-money put. It's a rewarding strategy when the stockmarket isn't going anywhere, and a frustrating, but still profitable, one when it's going up. You probably lose money when things are going down, but not as much as you would have lost with an outright purchase.

MWK's FCF wouldn't look good, except that business is poor right now. a few large companies that dominate a mature industry often have very good pricing power when things turn up just a bit.

[Amit Chokshi]

Selling puts against any position really makes no sense. It's risking dollars for pennies. The general notion is if you like a company at say $40, it's at $45, and it drops to say $38 and you are forced to buy it at $40, it's not a big deal. But i really think that's naive. Most options these days have little risk priced in, especially for some of the sleepy value stocks like MHK. So that means, you might think hey, i'll sell some OTM puts against MHK out say 3 months and if it goes under and i'm assigned the stock i'm fine with it. the problem is that the underlying business can materially change and if that change is negative, you might not want to own that stock at this point and then on top of that, trying to get out of that sold put position is going to be super expensive.

So if MHK is at say $75 now and you sell some OTM puts at $65 that expire in aug for $1.50, big deal, if it expires worthless at august you made $1.50. But say during the next 3.5 months some bad news comes out and MHK falls to $55 or $50, you want to be forced to buy that at $65 now factoring in that new info? Buying out of that put position will now be at least $10 or more too.

So really, it makes no sense to ever do that. And yes I know WEB has some sort of derivatives against the index but nobody is WEB nor do we know how much cash he needs to post against it. That's another thing to consider, if you sell naked puts you're trying up cash margin against it too.

Do whatever you want, just a warning that selling naked puts is russian roulette, you can price in and value a business across the board but you'll never price in that hidden risk that comes up every once in a while that will destroy you.

[Al]

Fair point Amit, but I wouldn't treat the exercise of the put as a second best option. The strike price should be at your desired purchase price.

If the business materially changed over the life of the put, you wouldn't necessarily be better off owning the stock versus purchasing the put again in terms of dollars lost.