Mohawk Industries, Inc. (NYSE:MHK) Q1 2024 Earnings Call Transcript

Mohawk Industries, Inc. (NYSE:MHK) Q1 2024 Earnings Call Transcript April 26, 2024

Mohawk Industries, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, everyone and welcome to the Mohawk Industries First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please also note this event is being recorded. At this time, I’d like to turn the floor over to James Brunk. Please go ahead.

James Brunk: Thank you, Jamie. Good morning, everyone. Welcome to Mohawk Industries’ quarterly investor conference call. Joining me on today’s call are Jeff Lorberbaum, Chairman and Chief Executive Officer; and Chris Wellborn, President and Chief Operating Officer. Today, we will update you on the company’s first quarter performance and provide guidance for the second quarter of 2024. I’d like to remind everyone that our press release and statements that we make during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties, including but not limited to, those set forth in our press release and our periodic filings with the Securities and Exchange Commission.

This call may include discussion of non-GAAP numbers. For a reconciliation of any non-GAAP to GAAP amounts, please refer to our Form 8-K and press release in the Investors section of our website. I’ll now turn the call over to Jeff.

Jeff Lorberbaum: Thanks, Jim. Good morning, everyone. Though economic headwinds are impacting our industry, our results reflect positive effects of the actions we are taking to enhance our performance. Our net sales for the first quarter were $2.7 billion, down 4.5% compared to last year. Adjusted earnings per share were $1.86, up 6% versus 2023 as a result of restructuring, productivity initiatives and benefits from lower cost of materials and energy, partially offset by weaker pricing and mix. Currency exchange rates continue to affect our operating income, with a negative impact in the quarter of approximately $12 million or $0.15 on EPS. Across our regions, market conditions remained similar to the prior quarter with significant pricing and mix pressure through the industry competition for volume.

Though slowing the commercial channel continues to outperform residential. Residential remodeling remained soft due to low housing sales and the impact of inflation on discretionary spending. Retailers have reported that consumers are reluctant to initiate higher ticket projects with flooring facing greater pressure since most replacements can be readily deferred. Our teams remain focused on managing through the near-term environment, realizing sales opportunities, reducing controllable costs and completing restructuring initiatives. We continue to manage our production levels to align inventories with market demand. To stimulate sales, we are investing in new product introductions with enhanced features that convey the value of our collections.

Given inflationary pressures and labor benefits and other items, we continue to take additional actions to reduce our cost structure and improve productivity. Globally, there is optimism about consumer confidence, improving interest rates declining, and a rebound in the housing market. The timing of this inflection in each market depends on inflation levels and actions by their central banks. Latin America aggressively raised interest rates to combat inflation and now the region is among the first to implement rate reductions. Brazil Central Bank initiated several rate cuts and Mexico recently lowered rates for the first time since 2021. In the U.S. and Europe, central banks are maintaining interest rates as they focus on achieving their targeted inflation levels.

The present forecast for U.S. new home starts and existing home sales is for a slight increase in 2024 with greater improvement in the second half of the year. In some countries, governments are subsidizing housing investments by reducing mortgage rates. In the U.S., builders are stimulating purchases of their properties by buying down interest rates for consumers. The U.S. Realtors Association recently noted that life events eventually require buyers and sellers to make moves regardless of interest rates. The desire for homeownership remains strong and people will find a way to realize that goal. Since our last call, Newsweek named Mohawk, one of America’s Greatest Workplaces for Women and Green Builder selected our PureTech PVC-free resilient flooring as one of their top products of the year.

We are pleased to be recognized for both our commitment to our people and our product innovation. Jim will provide a review of our financial performance for the quarter.

James Brunk: Thank you, Jeff. Again, sales were just under $2.7 billion, that’s a 4.5% decrease as reported and 5.5% on a constant basis due to year-over-year price and mix pressures continuing due to a combination of tight demand, the pass-through of lower input costs and the consumer trading down. Our Flooring Rest of the World segment was impacted the most by the price and mix issue in the quarter. Gross margin was 24.2% as reported or 24.4% on an adjusted basis versus 24.1% in the prior year, primarily due to lower cost, material and energy of $147 million substantially offsetting the negative impact of price and mix of $152 million, in addition to the benefit of our productivity and restructuring actions of $35 million.

SG&A expense was 18.8% as reported an 18.4% on an adjusted basis, basically in line with the prior year. That gave us an operating margin of 5.5% as reported. Non-recurring charges were $17 million in the quarter, giving us an adjusted operating margin of 6.1%. That’s a slight improvement over prior year, driven by the lower input cost of approximately $136 million and increased productivity of $47 million, offsetting the negative impact of weaker price and mix of $153 million, and the unfavorable impact of foreign currency of $12 million and temporary manufacturing shutdowns of $10 million. Interest expense for the quarter was $15 million at slightly favorable versus prior year. Our non-GAAP tax rate is 21.8% versus 22.6% in the prior year.

We expect Q2’s tax rate to be between 20% and 21% and the full year rate to be between 19% and 21%. That gave us earnings per share as reported of $1.64 and on an adjusted basis of $1.86 an increase of 6% versus the prior year. Turning to the segments. Global Ceramic had sales of just over $1 billion, that’s a 1.4% decrease as reported and 5% on a legacy and constant basis due to the unfavorable impact of price and product mix and lower volume as the industry demand remains compressed. Operating margin on an adjusted basis was 5%. That’s a decrease of approximately 130 basis points due to the unfavorable impact of price and product mix of approximately $40 million reflecting the continued difficult market conditions. And the unfavorable impact of foreign currency of approximately $11 million, partially offset by lower input costs of $32 million and productivity gains of $14 million.

In Flooring North America, we had sales of $900 million, that’s a 5.6% decrease as reported due to lower remodeling activity impacting volume as well as pressuring price and mix across our product lines. The business improved through the quarter and we are introducing new residential collections with unique features to enhance our carpet, laminate and resilient sales. Operating margin on an adjusted basis was 5.3%. That’s a significant improvement versus prior year with favorable impact of lower input costs of $57 million and productivity gains of $23 million as we benefit from our cost optimization and restructuring initiatives. This was partially offset by unfavorable impact of price and product mix of $20 million. And finally, Flooring Rest of the World had sales of just over $730 million.

That’s a 7.4% decrease as reported or 5.9% on a constant basis due to the unfavorable impact of price and product mix partially offset by an increase in our unit volume even in a generally weak environment across Europe. Operating margin on an adjusted basis was 10.1%. That’s a decrease of 250 basis points driven by the unfavorable impact of price and product mix of approximately $92 million primarily in our panels business, which has declined substantially compared to the high prior year comps when the industry was running near capacity. These were partially offset by lower input costs of $48 million, stronger unit volume of $11 million and productivity gains of $10 million. Corporate and eliminations was $11 million for the quarter, in line with prior year and our full year forecast is for $45 million.

Looking at the balance sheet. Cash and cash equivalents were just over $650 million with free cash flow in the quarter of $97 million. Inventories were just over $2.5 billion, with the year-over-year inventory decrease of about $200 million, primarily due to a reduction in costs. Our inventory days were reduced to 125 days versus the year-end level of 130 Property, plant and equipment were just shy of $4.9 billion. Our CapEx for the quarter was $87 million, with depreciation and amortization of $154 million. The company plans to invest approximately $480 million to $500 million in 2024 with D&A for the full year forecasted to be approximately $600 million. Overall, the balance sheet and cash flow remained very strong with gross debt of just over $2.6 billion and leverage at 1.4x.

At this point, I will turn it over to Chris to review our Q1 operational performance.

Chris Wellborn: Thanks, Jim. During the quarter, sales in our Global Ceramic segment remains soft across our regions. The industry is operating below historical levels and market competition to capture volume is affecting both our pricing and margins. Product mix is also declining as higher-value residential remodeling channel is softest and those customers undertaking new projects are selecting lower-cost options. Reduced energy prices are enhancing our results, though wages, benefits and other costs have increased. We continue to execute cost reduction initiatives, including utilization of lower-cost materials, product reformulations and reductions in SG&A spending. We’re driving productivity through increased efficiencies higher yields and consolidating our distribution network.

Our investments in new printing, polishing and rectifying technologies are delivering higher value sales and formats to improve our mix. We are introducing decorative innovations with new glazes, 3-dimensional surfaces and updated artisanal mosaics. We are launching larger formats in floor and wall tile and porcelain slabs along with smaller offerings that replicate handcrafted visuals. Our broad product offering, quality and service advantages are helping us expand business with both new and existing customers. In the U.S., cold weather caused the suspension of operations at a number of our manufacturing facilities and service centers in January impacting our cost and revenue. Our Tennessee quartz countertop expansion should be completed later this year, and we’re developing new products and enhanced marketing tools to support our additional capacity.

The U.S. ceramic tile industry has filed a petition against India in response to widespread dumping of ceramic tile in the U.S. market and expects tariffs between 400% and 800% plus additional duties for subsidies. Other countries where we operate are considering similar actions. In Europe, we’re seeing robust growth in porcelain panel sales after our recent expansion and sales have also benefited from our new smaller and larger sized premium products. European energy prices have moved to lower levels than forecasted, which should benefit consumers. In Mexico and Brazil, we’re optimizing our sales and improving our operations. We’re implementing new distribution and product strategies in each country, so our brands complement each other in the marketplace.

In our Flooring Rest of World segment, markets remained soft despite declining inflation. In the quarter, our volumes increased from the prior year’s low levels, which may be an indication of improving trends in our categories. So our results were impacted by pricing pressures as we pass through lower input costs in highly competitive markets. Our Quick-Step brand sales improved during the quarter as we realign price points, reflecting lower cost and increased marketing efforts to stimulate demand. We’ve completed the restructuring of our residential LVT program and are beginning to see the savings we anticipated. The change is delivering substantial growth in our residential rigid LVT, which is replacing our discontinued flexible products.

In Insulation, we’ve recently experienced material increases and are raising our prices accordingly. In our panels business, margins have declined from our cyclical high comparisons due to the underutilization of industry capacity partially offset by mix improvement in our decorative collections. We’ve announced selective price increases and panels to reflect rising material cost. We continue to implement productivity initiatives and cost containment projects across the business, including labor efficiencies, higher yields and alternative materials. We’re enhancing our bolt-on acquisition in MDF Boards, sheet vinyl and mezzanine flooring and will complete our premium laminate expansion this year. In Australia, New Zealand reduced input costs and increased productivity offset lower pricing and volumes in a slow environment.

In our Flooring North America segment, our results versus the prior year benefited from declining raw material and energy costs, partially offset by lower price and mix. While residential remodeling was generally weaker overall, market conditions vary depending on channel and product category. Sales improved through the quarter, though many retailers in some of our facilities were temporarily closed in January due to weather. Lower market demand and consumers trading down are creating a competitive marketplace, pressuring average selling prices and product mix. Based on builder optimism, new single-family home sales should improve through the year, positively impacting our flooring business. Commercial sales continue to outperform residential led by the specified hospitality, retail and government channels.

Retailers are embracing our new residential product launches, including PetPremier carpet and PureTech resilient planks. We’re optimizing sales of our coordinated accessories and growing our recently acquired rubber trim business. We’re increasing the sales of our non-woven acquisition with new customers and product expansions. Our West Coast LVT facility is increasing production, and our Georgia restructuring initiatives are being implemented. During the quarter, we delivered productivity gains across the segment with operational improvements, better yields and enhanced logistics. I’ll return the call to Jeff for closing remarks.

Jeff Lorberbaum: Thank you, Chris. The flooring industry appears to be at the bottom of this cycle, and we are managing controllable aspects of our business to improve our results. We continue to reduce our fixed and variable costs through ongoing restructuring and additional productivity initiatives. We’re aligning production with market demand to control working capital, which increases our unabsorbed overhead to enhance sales and margins, we’re upgrading our product offering with unique features and investing in new merchandising. This year, we’re completing our LVT quartz countertop and premium laminate expansion projects to support our products with the greatest growth potential when the market recovers. Our other capital investments are focused on reducing costs, delivering product innovation or maintaining the business.

Due to European vacation schedules, our second quarter sales are seasonally higher than the third quarter. Given these factors, we anticipate our second quarter adjusted EPS to be between $2.68 and $2.78, excluding any restructuring or onetime charges. Residential flooring sales should lead to recovery as consumer confidence improves, the housing market strengthens and postponed remodeling projects are initiated. Existing home sales will normalize and our meaningful catalyst for flooring since homeowners replace it more often before listing a property or soon after completing a purchase. Across our geographies, housing has not kept pace with household formations and substantial home construction will be required for many years to satisfy those needs.

Additionally, as homes age, increased remodeling investments are required to maintain property values. As the world’s largest flooring manufacturer, we expect to significantly benefit from our brand leadership, investments in new capabilities and recent acquisitions as the flooring market recovers. We have the products to inspire consumers the infrastructure to deliver superior service and the balance sheet to invest in opportunities for the business. We’ll now be glad to take your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question today comes from Matthew Bouley from Barclays. Please go ahead with your question.

Matthew Bouley: Hi, good morning, everyone. Thank you for taking the question. So obviously, the trajectory of interest rates is a little different than what the market thought earlier this year. I guess two parts. Are you have any different thoughts around how you’re thinking about earnings growth for Mohawk? I think previously, you had expected in the second half of the year that you could see growth year-over-year. Clearly, it was positive year-over-year in the first quarter. But any kind of thoughts around the cadence of the business into the second half? And then just are you managing the business any differently assuming this different rate environment, capital allocation managing capacity, any restructuring actions being considered. Any thoughts around how that has evolved here? Thank you.

Jeff Lorberbaum: The recent comments by the Fed that interest rates will stay higher could somewhat impact housing sales and the flooring industry improvement as we go through the year. The industry has been running at extremely low levels and eventually buyers and sellers have to do transactions. People who are not moving should increase remodeling over time and housing sales are expected to increase from their very low levels. At the same time, we anticipated commercial would slow significantly. It’s possible it could be better than we expected given the stronger economies at this time. We still anticipate improvement in the second half and exceed the results this year.

Matthew Bouley: Got it. Perfectly. And then I guess maybe sticking with the capital allocation side. You’re completing some of your capacity investments this year. What does that mean for capital expenditures beyond 2024? And just kind of any additional thoughts around the share repurchase within that capital allocation set of priorities. Thank you.

James Brunk: Well, first of all, just to remind you, our forecast this year is somewhere between $480 million and $500 million. That’s below D&A of about $600 million about 45% of that is really focused on cost reductions and product innovation. 15% is relatively to complete those growth investments that you just mentioned. And the remaining 40% or so is on the maintenance of the business. Going forward into next year, given the completion of the capacity projects, the focus will be on cost reductions, product innovation and the maintenance of the business, unless of course, we come up with new ideas from a capacity standpoint. In terms of other cash priorities, again, we’ll focus on broadening our product offering and innovations around products identifying acquisitions, whether they be bolt-on or acquisitions that would help us get into new markets. And then share buybacks are still being considered as part of that allocation.

Matthew Bouley: Thanks, James. Good luck, everyone.

Operator: Our next question comes from Tim Wojs from Baird. Please go ahead with your question.

Tim Wojs: Hey, guys. Good morning. Maybe just to start, just in the first quarter, I mean, price mix, I think kind of more than offset some of the raw material improvement or raw material cost improvement that you kind of saw on a year-over-year basis. So as you kind of think about the next few quarters, how should we kind of model or kind of think about that price mix cadence and maybe just price cost in general as we kind of go through 2024.

James Brunk: Let me start with some of the assumptions around Q2, that give us a baseline. As we enter Q2, we are seeing some signs of increasing volume, but are seeing continued price and mix pressure we expect seasonality to be more aligned with historical levels. We continue to invest in innovative products, process improvements and cost reduction to try to control our costs still anticipate that FX will continue to be a headwind as well. In terms of material costs in Q2 we would anticipate the benefits from lower costs from a year-over-year perspective to be offset by that price and mix pressure with the Flooring Rest of the world continuing to be under the most pressure.

Tim Wojs: Okay. Okay. That’s really helpful. And then just, I guess, on the panel kind of price mix kind of commentary, when do the comps there just get easier?

Chris Wellborn: I think the panels business is going to be under pressure all during this year.

Jeff Lorberbaum: Less – will get easier in the second half.

Tim Wojs: Okay. Okay, great. Thanks, Jeff.

Operator: Our next question comes from Susan Maklari from Goldman Sachs. Please go ahead with your question.

Susan Maklari: Thank you. Good morning, everyone.

Jeff Lorberbaum: Good morning.

Susan Maklari: Jeff, it seems like you are starting to realize more of the benefits of the productivity and the restructuring efforts even with the business continuing to be under pressure. Can you talk a bit about how that can contribute to the margin profile over time? And maybe where do you think that this can go even if the macro remains less supportive?

Jeff Lorberbaum: Let’s start out with the general view by different channels. In the residential flooring sales always rebound from the low level that they’re at consumer confidence improves, housing improves. You have to postpone remodeling that hasn’t been done in the last couple of years as they were pressured by inflation. So that comes back – we expect, as you said, the mix and average selling prices as the market improves, it actually changes because there’s more higher-value retail replacement business, and it helps the margins. We’ll benefit from all the different activities on a continuous basis that the cost reduction, the product investments, the growth initiatives, the different acquisitions that we’ve made over the past 1.5 years, we expect them to benefit our results significantly as the thing improves.

This will increase the margins with higher volumes, and we’ll get leverage in the SG&A and the other overhead costs as well as the increased productivity. So coming out of the cycle, we’re at a low level, which happened in the last big downturn. The first expectation is that we get back to 10% operating income and then continue to expand it further.

Susan Maklari: Okay. That’s helpful color. And then I guess, you mentioned that you still expect to expand in the second half of this year. Just any thoughts on more specifics around how that may come together? What some of the key factors could be, especially as you think about the Flooring North America segment?

Jeff Lorberbaum: Why don’t we start out with the – we think we’re going to have the normal seasonality, which means typically in the U.S., the peak of the year tends to be the end of the second quarter into the third quarter, and we think it’s going to be more normalized. At the moment, which we’ve said the demand still is weak with continued pressure on pricing. So until the volume gets back, we think there’ll still be the pressure there, along with the mix. What else is different. Again, we’re just assuming that the replacement business, which has been really low, at some point, they have to start if they’re going to stay in their houses, they’re going to have to start improving them. And then some of the people are going to have to move just because of their lifestyles so it can’t stay at the bottom forever.

So we’re assuming that even if interest rates don’t change a lot, that we’ll start seeing some of this improvement there. And as you look in the other countries around the world, they look like they’re going to start lowering interest rates sooner and faster. And the same thing should occur in those countries with consumer confidence and moving forward and doing more remodeling, which is the first thing that pickup.

Susan Maklari: Okay. Thank you for that color. And good luck with everything.

Jeff Lorberbaum: Thank you, Susan.

Operator: Our next question comes from John Lovallo from UBS. Please go ahead with your question.

John Lovallo: Good morning, guys. Thank you for taking my question. The first one, maybe just focusing on the second quarter. It seemed I think that previously, you had expected sort of on a year-over-year basis, energy cost reductions this offset negative price mix and that productivity would offset wage and benefit inflation. I guess the question is, is that the expectation still for the second quarter? And did that happen in the first quarter only in North America?

James Brunk: Well, first of all, in the first quarter, as I said, if I just look at materials and energy, it’s about $147 million favorable in terms of lower cost compared to the 153 unfavorable price and mix. The most pressure was seen, as we said, in the Flooring Rest of the World category and that is – that is the one place where materials and Energy did not offset the negative price mix. I would think in the second quarter, I would anticipate that trend continuing where the pressure is the highest in Flooring Rest of the world.

John Lovallo: Okay. Okay. Got it. And then just trying to wrap my head around the second half of the year. I mean, should we expect a negative impact from pricing to sort of lap to maybe less of a price mix headwind year-over-year, but also probably less favorable impact from lower input costs. And then sort of from there, you need volume to drive productivity to offset any additional inflation. Is that the right way to think about it?

James Brunk: Yes, John, it is the right way to think about it. What I would anticipate, as you start to lap the prior year price/mix will become less of a headwind. Again, we’re speaking about year-over-year. But you’re also right, I’m going to start to also at the lower cost. And so that will become less impactful as well. Really what it’s going to turn into is, as we anticipate volume getting a little bit stronger, you’ll get a pickup in volume, but you also get a benefit and less shutdown costs as well. And so that will be the focus as we go into the second half of the year.

John Lovallo: Great. Thank you.

Operator: Our next question comes from Phil Ng from Jefferies. Please go ahead with your question.

Collin Verron: Hi, good morning. This is actually Collin on for Phil. I just wanted to start on the commercial piece. You know that the commercial continued to outpace residential that’s slowing. Are volumes higher year-over-year in that commercial business? And then how are you thinking about your commercial floor in volumes as we move through the end of 2024. And then maybe just remind everyone of the size of that commercial business for each of your segments?

Jeff Lorberbaum: What we said was that the commercial business is holding up better than we had anticipated. We thought that it would fall off faster than it has, and it is we’re performing better than we thought. We still think it’s going to continue slowing through the year as new projects haven’t been initiated in the last year. So we’re still anticipating it slowing. Commercially, you also have pricings more resilient since the products are more unique, so you don’t have as much price pressure. And presently, the hospitality retail government channels are outperforming. And just as a comment on the back side, when we start getting better, it’s going to take longer for the commercial to improve because it takes a longer time to get the planning approvals and construction to begin on the business. Anything else you want to give?

James Brunk: And overall, the commercial makes up roughly about 20%, 25% of the overall Mohawk business with it being the highest in the ceramic segment.

Collin Verron: Okay. That’s helpful color. And then I guess I just wanted to touch on the India ceramic tile tariffs. Can you just talk about the price point of those Indian imports, how you’re positioned versus that price point? And what percentage of your portfolio would really benefit from the tariff on the Indian tile?

Chris Wellborn: Well, the prices of imports have been declining with excess capacity, energy and freight costs. And of course, India has been growing. The Tile Council of North America expects those tariffs to be between 400% and 800%. And that should help our volume and increase market pricing since it’s been pushed down so low.

Jeff Lorberbaum: They tend to be more focused in the low to mid-end of the marketplace to answer that part of the question.

Collin Verron: Great. Thank you, and good luck.

Jeff Lorberbaum: Thank you.

Operator: Our next question comes from Keith Hughes from Truist. Please go ahead with your question.

Keith Hughes: Thank you. Your comments around business improving earlier in the call, I know that was highlighted in the release. Have you also seen some volume improvements in Flooring North America?

James Brunk: At this point, no, in the first quarter, volumes were still lower in both the Florida North America and Global Ceramic segments, we did see, as we noted, some volume improvement in the rest of the world segment.

Keith Hughes: Okay. So no sequential movement in those to what you’re saying.

Jeff Lorberbaum: Remember, the first quarter is always lower than the fourth quarter.

James Brunk: I was speaking from a year-over-year perspective as well.

Keith Hughes: Okay. Second question in ceramic. I guess if you could talk about the end-user markets in North America, I know commercial has been strong. What areas of commercial have been moving the numbers up?

Chris Wellborn: Well, generally, the commercial business in ceramic, I would say, it’s been flat. It hasn’t decreased as much as we thought it would. But as Jeff said, we expect that to soften as we go through the year.

Jeff Lorberbaum: I think the comment was the – our business is about flat. I don’t think the market is.

Keith Hughes: And within commercial, I assume office is weaker, but what areas are offsetting is that right?

Jeff Lorberbaum: That would be the same one we talked about before.

Chris Wellborn: Yes, like hospitality, the medical schools, those things have still been strong.

James Brunk: And I would add to that government as well.

Keith Hughes: Okay, thank you.

Operator: Our next question comes from Michael Rehaut from JPMorgan. Please go ahead with your question.