Coming up with new companies to research is quite often the most difficult part of what I do. I could take Buffett’s suggestion of starting with the A’s and working my way through all of the publicly listed companies, but this is a bit too inefficient for my liking. Each day, I scour the news for fallen angels and hunt through a variety of websites looking for interesting prospects. One site I frequent is Market Folly, which tracks hedge funds and reproduces many investor letters. These investor letters can be great sources of secondary research and provide useful information about the investment processes of successful money managers.
Last week, Market Folly reproduced the recent investor letter penned by Mark Massey of AltaRock Partners LLC. I recall being impressed with AltaRock’s investing principles (also reproduced on Market Folly) and so I enthusiastically read Massey’s new letter for both greater insight into their approach to analyzing investments and hopefully for some leads on companies to research. I was not disappointed!
I was most interested in reading Massey’s take on Mohawk Industries, Inc (NYSE: MHK), a producer of floor coverings such as tiles, stone, hardwood, and laminates. Massey certainly knows the company well, having tracked MHK for nearly a decade and owning it for a multi year stretch beginning in 2003. He recently bought back in as worries over the housing market have hit the company’s shares hard. I won’t repeat all of Massey’s analysis here but the gist of it is that MHK has a strong competitive advantage thanks to its distribution system, and the company operates in an industry that tends to favour the supplier rather than the customer. Additionally, despite operating in the worst economic climate for this industry since the Great Depression, MHK is still profitable and earning healthy free cash flows which will set it up for a strong rebound as the economy recovers. Simply put, you just can’t kill this company!
I’ll show a few of the regular graphs of the company’s historical performance, and then I’ll get to valuation. Let’s start with the company’s historical returns.
Mohawk Industries, Inc. - Historical Returns, 1995 - 2Q 2011
Here we see a dramatic decline in 2008. Fear not for this was not the result of a massive decline in operating performance. Rather, this decline in returns was due to a one-time impairment of goodwill related to its earlier acquisitions of Dal-Tile and Unilin. Many companies were using the market crash as a chance to take a “big bath” and take overdue charges for past mistakes all at once. Evidently overpaying for these earlier acquisitions, the recession gave MHK the opportunity to write them down to more reasonable levels.
Let’s look at revenues and margins.
Mohawk Industries, Inc - Revenues and Margins, 1995 - 2Q 2011
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