Earnings quality check: Mohawk Industries is about as un-sexy a company as you can get. It makes carpeting and other types of flooring.
Sexy or not, it’s stock has been on a tear — up 60 percent over the past year on the back of booming earnings and rising builder stocks. At its current price, the stock is about 73 percent of housing-bubble highs.
But beware: While the numbers are indeed impressive, the quality of the strong earnings leaves something to be desired. (Read More: Beware of Get-Rich Quick IPO.)
The simple math: Profits are rocketing as sales skid — always a red flag on earnings quality.
In this case, earnings per share last quarter soared by 20 percent, but sales fell by a half of a percent — even as price increases announced earlier in the year kicked in. A closer look shows that earnings were boosted by such things as lower bad debt reserves, restructuring charges and rising prepaid expenses.
The non-operational (otherwise known as not sustainable) boost in earnings story has been much the same in recent quarters.
As for the drop in sales: Most of it is coming from the company’s Mohawk carpet division, which accounts for 50 percent of revenue.
In its 10-Q, Mohawk blames “slowing” commercial and residential sales “as well as retailers deferring promotional activities and further inventory reductions in the channel.” (So much for its sales tracking the new home market.) (Read More: Home Builders Don't Have Enough Workers to Meet New Demand.)
Oh, and by the way, while the company guided to a 22 percent earnings per share gain in the current quarter, it also said that input prices will remain high and Europe remains a challenge. (Read More: European Stocks Could Correct Up to 20% - Marc Faber.)
Put another way: With its shares trading at 16-times this year’s estimate, if operations don’t start driving earnings growth pretty soon investors risk being taken to the, uh, mat.
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