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Cost-Cutting Measures Create Leverage with a Recovery.
Like many others in the industry, Mohawk has undertaken several differenttypes of cost-cutting initiatives over the past several years. From a manufacturing standpoint, Mohawk has consolidated or temporarily shutdown several plants, both in the U.S. and Europe. In addition, the company has rationalized some manufacturing assets that were older andless efficient, such as older extrusion technologies and spinning mills. On the distribution side, where Mohawk had expanded during thehousing upturn, the company has closed some warehousing and distribution facilities and is in the process of combining distribution for itsMohawk and Dal-Tile businesses.As a result of these actions, Mohawk has reduced staffing levels by over 7,000 since early 2008, or roughly 20% of its workforce. In the firstquarter of 2009 alone, Mohawk lowered employment by 2,000 workers, shut down four operations, closed two plants, and reduced itswarehousing space by 1 million square feet.Although difficult to measure while manufacturing capacity continues to be underutilized, the company should benefit from these cost cuttinginitiatives once an upturn begins. Mohawk management indicated on a recent conference call that it believes its cost-cutting initiatives willhave a roughly 1-year payback (the company has taken roughly $46m in charges from 4Q08-2Q09).We can look at the potential for a return to profitability in several ways. First, one way to measure efficiency of cost-cutting measures over time and the potential for future improvements is by examining operating profit per employee. While this may not capture any gains or losses from items such as changing commodity costs, we think over time it can provide a solid picture of the company’s ongoing ability tomanage its workforce and manufacturing capacity.This metric for Mohawk rose fairly steadily from 2001 to 2006, peaking at $23,000 per employee. During the downturn it has dropped downto $13,000 per employee in 2008, a level not experienced since 2000. We expect this to fall further in 2009, to roughly $9,000 per employee.
Incorporating the further 2,000 employee cuts that occurred in 1Q09 – if we assume that Mohawk can return to its peakoperating profit per employee level of $23,000 without expanding its employee base, this would imply operating profits of roughly$660m,
up from $419m reported in 2008 and our $73m estimate ($257m adjusted for one time charges) in 2009. All other costs held equal,this would imply earnings per share of $5.90. Returning to the historical average of $15,000 per employee would imply earnings per share of just under $3.50. We are forecasting 2011 EPS of $2.91 per share.
Operating Profit per Employee($000s)
$0$5$10$15$20$251995 1998 2000 2003 2005 2008
O p e r a t i n g p r o f i t p e r e m p l o y e e
Op. profit/ employee
Source: Company reports and Barclays Capital estimates
Another way to think about potential operating leverage upside in a recovery is to assign a contribution margin to Mohawk’s business, thusproviding an estimate for the level of operating profit recovery that is likely when revenue growth returns. We estimate that for the Mohawksegment fixed costs represent roughly 14-18% of COGS, 17%-19% in the Dal-Tile business and 23%-26% for the Unilin business. Weestimate that roughly 45-50% of the company’s SG&A is fixed. We estimate that this would give the company somewhere between a 25-30% contribution margin. The chart below shows a sensitivity analysis on different revenue growth scenarios assuming a 28% contributionmargin.
We estimate that if revenue growth next year is between 3 and 10%, the company should be able to earn between $2.13and $3.35 per share.
In contrast, if revenues fall by 5% we expect that earnings could be reduced to roughly $0.73 per share. We arecurrently forecasting roughly 4% topline growth and EPS of $2.17 in 2010.
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