Mohawk Industries, Inc. (NYSE:MHK) Q4 2023 Earnings Call Transcript

Mohawk Industries, Inc. (NYSE:MHK) Q4 2023 Earnings Call Transcript February 9, 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 day, and welcome to the Mohawk Industries Fourth Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, today’s event is being recorded. I would now like to turn the conference over to James Brunk. Please go ahead, sir.

James Brunk: Thank you, Rocco. Good morning, everyone, and welcome to Mohawk Industries quarterly investor call. Joining me on the 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 fourth quarter and full year performance and provide guidance for the first 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 by 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 over the call to Jeff for his opening remarks. Jeff?

Jeff Lorberbaum: Thanks, Jim. Our fourth quarter results were ahead of our expectations, with net sales for the quarter of approximately $2.6 billion, down 1.4% as reported or 4.1% on a constant and legacy basis. Lower demand in residential remodeling and new construction continued to impact our results. Our adjusted EPS for the quarter was $1.96, with benefits from cost containment, productivity and lower input costs. Pricing and product mix declined offset by lower raw material and energy costs during the quarter. Foreign exchange had an impact of approximately $22 million on operating income, or $0.27 on EPS. Turning to our full year results. Mohawk’s net sales were approximately $11.1 billion, down approximately 5% as reported or 7.7% on a constant basis with adjusted EPS of $9.19.

Last year, interest rates increased creating challenges for our industry, which is highly sensitive to rate fluctuation. Even though we have a diversified geographic footprint, all of our markets were impacted by similar conditions. During ’23, existing home sales declined substantially, remodeling projects were postponed and consumers traded down. New home construction was also constrained as rising interest rates and a weak housing market reduced home starts. Throughout the year, the commercial sector remained stronger than residential though investments began to slow as interest rates increased in lending types. These factors reduced industry demand across our business, creating unabsorbed overhead and shutdown costs. As a result, our industry reduced selling prices and we pass through declining cost in energy and materials.

Under these conditions, we focused on optimizing our revenues and lowering our costs through restructuring actions and manufacturing enhancement. We aggressively managed inventory levels, which reduced our working capital by over $300 million, excluding acquisitions. We also invested in sales resources, merchandising in new products with innovative features to inspire consumers to purchase flooring. As we integrate our recent acquisitions around the world, we are investing to improve their operations and product offering. In 2023, we completed two acquisitions in Latin America that extended our position as the world’s largest ceramic tile producer and solidified our leadership in the region. In the year, we focused our capital expenditures on product innovation and cost reduction, as well as product categories that should have the highest growth as the economy improves.

In Europe, our porcelain slab and installation expansions are now fully operational, while in North America our premium laminate LVT projects are progressing. During the second half of this year, we anticipate completing expansion of laminate in Europe and quartz countertops in the United States. We closed the year with debt leverage of 1.5 times, free cash flow of $716 million, and available liquidity of $1.9 billion. We are retiring a term loan of approximately $900 million in quarter one, which has a higher interest rate. We are well-positioned to manage current conditions and emerge stronger from this economic cycle when the rebound occurs. Finally, in January, Newsweek recognized Mohawk as one of America’s greatest workplaces for diversity.

Our talented people are our most valuable asset and we are proud that our teams mirror the communities in which we operate. And now, Jim will provide an overview of our fourth quarter financials.

James Brunk: Thank you, Jeff. Sales for the quarter were just over $2.6 billion. That’s a 1.4% decrease as reported and 4.1% on a constant basis as price and mix pressures and unfavorable FX offset limited year-over-year volume improvement. Gross margin on an adjusted basis was 24.7% versus 22.4% in the prior year. The improvement is due to lower inflation, offsetting unfavorable price and mix along with increased productivity, partially offset by the impact of FX. SG&A expense as a percentage of sales was 18% on an adjusted basis, which was in line with the prior year. That gives us an operating income as reported of 6.4%. On an adjusted basis, 6.7% versus 4.5% in the prior year as lower inflation of $156 million offset unfavorable price and mix of $127 million as well as productivity gains of $57 million only were partially offset by unfavorable FX of $22 million.

Interest expense for the quarter was $17 million. Our non-GAAP tax rate was 21.3% in the current year. We expect Q1 2024’s tax rate to be approximately 21% to 22%, and the full year 2024 to be between 18.5% and 20.5%. That gives us an earnings per share on an adjusted basis for the quarter of $1.96. Turning to the segments. Global Ceramic had sales of just under $1 billion. That’s a 0.6% increase as reported, or 4.7% decrease on a constant legacy basis, with all geographies seeing increased pressure in price and mix, driven by lower demand and decreases in energy costs. Operating margin on adjusted basis was 4.8% versus 7% in the prior year, due to unfavorable price/mix of $41 million, only partially offset by lower energy and material costs of $29 million.

Unfavorable FX of $13 million and a reduced sales volume of $10 million accounted for the balance of the decrease in the year-over-year margins and were only partially offset by productivity gains of $17 million. Flooring North America had sales of just over $900 million. That’s a 3.6% decrease as reported, as demand levels and tight budgets continue to pressure pricing and mix. Our commercial category outperformed residential led by the hospitality channel. In this environment, we are focused on new innovative products which are being well received and position us to take advantage of the pent up demand. Operating margin on adjusted basis was 6.9% and significantly ahead of the breakeven margin in the prior year, due to lower inflation of $73 million, especially in material costs, offsetting the weakness in price and mix of $37 million.

Also benefiting our results were gains in productivity of $29 million. In Flooring Rest of the World, sales were just over $700 million for the quarter. That’s a 1.5% decrease as reported and 4% on a legacy constant basis. Stronger volume in insulation, resilient and laminate were offset by continued price and mix pressures in all product categories. Consumer sentiment in Europe continues to be impacted by geopolitical events combined with higher interest rates, which is limiting remodeling activity and increasing the competitive environment. Operating margins on adjusted basis were 10.6% versus 7.7% in the prior year due to lower inflation of $59 million, offsetting unfavorable price/mix of $49 million. Productivity gains of $12 million and higher sales volume of $10 million also contributed to the year-over-year improvement in operating performance, only partially offset by unfavorable FX of $9 million.

Corporate eliminations for the quarter were $11 million. And in 2024, we expect them to be approximately $43 million to $48 million. Finally, turning to the balance sheet. Cash and cash equivalents were $643 million for the quarter with free cash flow of $56 million in Q4 and $716 million for the full year. Inventories were just shy of $2.6 billion, with total inventory reduction of approximately $300 million, excluding acquisitions with a reduction of eight days versus the prior year to 130 days. Property, plant and equipment were just shy of $5 billion with Q4 CapEx of $240 million and the full year at $613 million and D&A of $630 million. The company plans to reduce CapEx by approximately 20% to $480 million in 2024 with D&A of approximately $610 million.

The balance sheet and cash flow of Mohawk remained very strong with gross debt of $2.7 billion and leverage of 1.5 times, positioning the company well for the market rebound. Now, Chris will review our Q4 operational performance.

Chris Wellborn: Thank you, Jim. In our Global Ceramic segment, industry volume remains low, which is compressing prices and margins. All of our geographies are experiencing similar competitive conditions and the industry passed through declining energy costs. We’re managing our production to align with demand and have significantly reduced inventory throughout the year. To enhance our mix, we are introducing stylized products in large and small sizes, tailored to each market. To contain costs, we have increased productivity, reduced overhead and implemented alternative formulation. In the US, we are expanding our distribution through our local service centers and offering new collections with premium Italian styling to improve our product mix.

We’re expanding our quartz countertop business with innovative new introductions and increasing our participation in the retail kitchen, bath and DIY channel. We’ve integrated Vitromex in Mexico and Elizabeth in Brazil and are enhancing our sales, marketing and operational strategy. In both countries, demand significantly declined last year due to rising interest rates and slowing economic conditions which reduced our results. Combined with our legacy businesses, these acquisitions give us leading positions in Brazil and Mexico. In Europe, gas prices have continued to decline and are improving our competitive position. We are optimizing our recent expansion of premium porcelain slabs in Italy to meet growing demand in both the residential and commercial channels.

In our Flooring Rest of the World business, our improved results in the quarter were driven by lower input cost and productivity gains, offsetting pricing pressure and foreign exchange. The European building product category remains under stress, with consumers remaining cautious and retailers reducing their inventory levels. We are investing in new products for 2024, while implementing tight cost control. We are reenergizing our flagship Quick-Step brand with interactive displays. We are completing the transition to rigid LVT and we have decommissioned our residential flexible line. As material and energy costs decline, we’ve reduced prices across our product categories in response to the competitive market. In insulation, we have recently experienced material increases and are raising our prices accordingly.

Our wood panels performance has declined during the year from typically high pricing to a more competitive environment with excess capacity. We continue to implement restructuring actions and enhance our smaller bolt-on acquisitions in insulation, MDF boards, sheet vinyl, and mezzanine flooring. In Flooring North America, fourth quarter profitability improved significantly over last year with benefits from decreased input costs, restructuring, and productivity gain. Reduced market volumes led to low industry utilization rate and aggressive competition in the marketplace. We are continuing to invest in sales and marketing initiatives to expand our distribution and improve our long-term growth. To enhance our business, we are making capital investments to increase our differentiated features and lower our manufacturing costs.

In each product category, we are introducing innovative new collections, which are being well-accepted. We have already begun installing our new displays with retailers around the country to accelerate the sales of these product launches. We have created the next generation of LVT with our SolidTech premier collection featuring new technology that enhances visuals with higher definition color and texture. We’ve also introduced a new flooring category called PureTech which is PVC-free. It is an alternative to LVT made from renewable polymer core that is waterproof and made with 70% recycled content. The commercial channel outperformed our expectation led by the hospitality sector. We are leveraging our customer relationships to expand our needle punch flooring and trim acquisitions.

With that, I’ll return the call to Jeff for his closing remarks.

Jeff Lorberbaum: Thank you, Chris. As we enter 2024, the industry is at a cyclical low and we expect quarter one seasonality to be more aligned with long-term historical levels. Our businesses are minimizing their expenses, reducing the overhead and restructuring to adapt to the present conditions. We are continuing to invest in innovative products to increase our sales and mix. We are reacting to competitive pressures to optimize our volumes as we pass through the declines in our input costs. We continue to manage our inventory and anticipate temporary shutdowns to align with demand. Our businesses are implementing initiatives to enhance our processes to reduce the impact of inflation. Given these factors, we anticipate our first quarter EPS to be between $1.60 and $1.70, excluding any restructuring charges.

Over the past 18 months, we’ve initiated many actions across the company to improve our cost structure, manage our lower volumes, and integrate our recent acquisitions. We’ve closed four manufacturing facilities and a number of higher-cost production line, consolidated administrative functions and reduced overall headcount. When complete, these actions will collectively decrease our operating costs by approximately $150 million with about half of this already realized. Combined with our actions, improving industry conditions as we emerge from the bottom of the cycle should improve our results in the second half of the year. We anticipate central banks will lower interest rate, expanding home sales, residential remodeling, and commercial projects.

The pace of improvement of the flooring category will be dependent on inflation rates, consumer confidence and the strength of home sales. We believe the US and Latin American markets should improve sooner than Europe given the current geopolitical pressures. Historically, remodeling activity has led the flooring industry out of downturns, followed by new home construction with commercial projects taking longer, given the time to plan and complete. After past housing recessions, our industry has expanded with increased sales and margins for multiple years. Housing remains in short supply across all our geographies and increased remodeling investments will be required to update that aging housing stock. Our restructuring actions, investments in new technology, targeted expansions and recent acquisitions will enable us to further expand our business.

As the world’s largest flooring company, we believe we are uniquely positioned to improve our results as the market recovers. We’ll now be glad to take your questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Susan Maklari with Goldman Sachs. Please go ahead

Susan Maklari: Thank you. Good morning, everyone, and thanks for taking the questions.

Jeff Lorberbaum: Good morning.

Susan Maklari: Jeff, maybe we could start out with, how you think about the cadence and the sequential lift for the business as we move 2024? How should we think about coming into this year at this cyclical low that you talked about? And where we can go to over the next several quarters? Do you still think that there’s the potential for that second half lift that you talked about on the last quarter call?

Jeff Lorberbaum: Let’s start with last year. The interest rates increased throughout the year and our business declined with lower investments in housing and commercial projects. This year, we anticipate the reverse to occur. We are starting with the industry starting out slower and improving with consumer confidence and interest rates throughout the year. The US mortgage rates have declined from their peak and Brazil has already started to lower their rates. We anticipate Europe to lag given geopolitical risks, energy prices, and slower economies in the rest of our markets. We believe the business will strengthen in second half from these improved results from last year. We should also see an improvement in product mix as remodeling grows, we expect an extended period of higher demand as the economy recovers and our investments in new products, cost reductions, and expansion project should benefit our future result.

Susan Maklari: Okay. That’s very helpful. And then maybe digging into that a little bit more. When you think about the different economies globally and what’s going on there relative to the segments of Mohawk segment, how do you think about what that could imply for, say, Flooring North America versus Global Ceramics or Rest of World, anything that you can give us just in terms of the different segments and how you’re thinking about the opportunities there?

Jeff Lorberbaum: Sure. The segments we see — that we think we’re going to see more improvement in Flooring North America and the Ceramic businesses with remodeling in each category leading the way, we think Europe will take longer to improve where they’re going to be pricing pressures, continuing in more in the flooring and panels business in the other categories that we have.

Chris Wellborn: And we’ve kind of seeing in Europe, consumers have traded down given tighter lower budgets and the geopolitical crisis is further stressed in consumer confidence. But as the region recovers, we know we’ll see improvement across our business.

Jeff Lorberbaum: Just to remind everybody in Europe, they still have the higher energy costs, and the regulations make it a less dynamic marketplace, may get through. And then at the same time, their wages have increased more than the rest of the world impacting inflation.

Susan Maklari: Okay, that’s great color. Thank you both, and good luck.

Jeff Lorberbaum: Thank you.

Operator: And our next question today comes from Phil Ng with Jefferies. Please go ahead.

Phil Ng: Hey guys. Certainly, your business has been hard hit with rates being elevated on the R&R side. When it comes down, is the bigger driver we should be looking at is tied to housing turnover or rates coming down just kind of improving consumer confidence that it’s going to drive demand. So just trying to gauge, what are the things that we should look at? And when we do see, and how quickly that could kind of unleash that pent-up demand?

Jeff Lorberbaum: In past cycles, it all starts with consumer sentiment. As it starts improving they start spending money on discretionary spending. And that then impacts the remodeling business, which the consumer as soon as they feel more comfortable about it can walk in the stores and start immediately. So that always starts it. The Central Bank’s lowering interest rates then starts increasing the home resales, which is also a large part of that shows up in remodeling business, but it happens concurrently as you start. Then what happens is, with the lower rates, you have the builders start building more new homes and they start increasing. But just to remind you, they take longer because our products are putting almost right before they sell the home at the end. And then finally the piece that works is the — you start planning commercial projects, but they take a longer time to complete and it works through one after the other.

James Brunk: And so Phil, you also have two key points. One is that in most of our geographies, new homes are really underbuilt so the inventory is low. And then, it’s also an aging inventory so it’s kind of in prime position as we start to come out for remodeling to increase which puts us in a very strong position.

Phil Ng: Okay. And then a follow-up, Jim. You guys have obviously done a lot on the cost front and pivot the portfolio into — with some new products. When we think about the recovery in the back half going to 2025, is there a good way to think about the operating leverage of that business, whether it’s volumes or just top line more broadly from a drop-down standpoint?

James Brunk: Well, a couple of things are important there. So, you’re right that utilization rates, which right now are anywhere between 70% and 80%, differing, of course, based on geography and business, is driving some shutdowns, which certainly impacted us in 2023. As we look at 2024, lower inventory reductions and improving volumes through the year should reduce that impact. And as you look further in terms of demand increasing, incremental margins could be anywhere from 25% to 35% depending on segment and the product category, and also whether you’re in the premium or more in the commodity product line.