March 14, 2012 / 8:03 PM / 6 years ago

TEXT-S&P raises Mohawjk Industries rating to 'BBB-'

Overview	
    -- U.S.-based carpet and floor covering maker Mohawk Industries Inc. 
       has reduced adjusted debt by over 40% since the last housing peak in
2007, 	
improving adjusted leverage to pre-downturn levels of about 2.8x.	
    -- We expect earnings and funds from operations to gradually increase 	
over the next two years because of recent cost reductions and slowly improving 	
market conditions.	
     -- We have raised the corporate credit rating to 'BBB-', reflecting our 	
expectation that the company will continue to maintain credit metrics 	
consistent with the higher rating.	
     -- The stable outlook is based on our expectation that Mohawk will 	
maintain credit metrics at or near current levels despite still weak end 	
markets.	
	
Rating Action	
On March 14, 2012, Standard & Poor's Ratings Services raised its corporate 	
credit and issue-level ratings on Mohawk Industries Inc. by one notch to 	
'BBB-' from 'BB+'. The outlook is stable.	
	
Rationale	
The upgrade reflects our view that Mohawk will maintain and improve credit 	
metrics that are now consistent with a low investment-grade rating. Standard & 	
Poor's economists are projecting housing starts to improve to 730,000 units 	
and for unemployment to tick down to the mid 8% area by the end of 2012. We 	
think these trends will result in gradually increasing demand for Mohawk's 	
floor covering products, particularly as consumers and businesses begin to 	
catch up with deferred carpet, and other flooring, replacements.	
	
Under our operating assumptions, we project Mohawk's sales will increase at 	
about 5% in 2012 and EBITDA could reach $700 million, reducing total adjusted 	
leverage to about 2.5x by the end of this year. Under our operating 	
assumptions, we think Mohawk would produce over $100 million of free cash flow 	
to reduce debt after capital expenditures of about $235 million. 	
	
Furthermore, even if sales growth is less than our assumptions, we think 	
Mohawk will maintain credit measures in a fairly narrow range with total 	
adjusted debt/EBITDA remaining below 3x and funds from operations/debt of 	
about 30%, both of which are consistent with our view of its "intermediate" 	
financial risk (as our criteria define the term).	
	
We think Mohawk's earnings are poised to improve dramatically when housing and 	
repair and remodeling markets begin a more robust recovery, probably in 2013 	
based on our economist's view of 990,000 housing starts by that time. Under 	
this scenario, we think EBITDA could approach or exceed 2008's level of $800 	
million assuming high single-digit percentage sales increases. This could 	
result in leverage declining to 2.0x or below by that time, assuming no debt 	
financed acquisitions take place. 	
	
For the fiscal year ended Dec. 31, 2011, Mohawk's total revenues increased 	
6.1% despite still soft residential construction and remodeling markets. The 	
company's good operating performance is attributable to aggressive cost 	
management and to gradually improving end markets. Commercial markets have 	
experienced a higher level of office refurbishment and consumers are showing 	
more confidence towards home improvements. Mohawk increased adjusted EBITDA 	
3.5% to $672 million despite approx. $200 million of raw material headwinds 	
during the past year. The company did produce over $300 million of operating 	
cash flow for the year and managed to reduce total debt (adjusted for 	
operating leases) by nearly $100 million. As a result, year-end total adjusted 	
debt/EBITDA was 2.8x versus 3.0x in the previous year. 	
	
We expect that Mohawk will pursue acquisitions to grow and to further 	
diversify its business beyond low growth North American markets, which 	
currently constitutes about 82% of revenues. Our projection for 2012 does not 	
take into account any acquisitions, but we would expect that any such activity 	
would be accretive to earnings and would be financed in such a manner that 	
Mohawk leverage would not exceed 4.5x and that leverage would drop to 3x or 	
below in a relatively rapid time frame, given the company's healthy cash 	
flows. 	
	
The ratings on Mohawk Industries Inc. reflect what we view as the company's 	
"satisfactory" business risk  given its strong No. 2 position in the U.S. 	
carpet and floor coverings market, a portfolio of well-recognized brands, 	
vertically integrated operations, multiple distribution channels, and diverse 	
customer base. These strengths are tempered by highly competitive and cyclical 	
markets (subject to housing construction cycles and variable consumer 	
discretionary spending), low operating margins in the carpet business and a 	
majority of its sales from the residential sector. The ratings also reflect 	
our assessment of the company's intermediate financial risk profile driven by 	
its prudent financial policies and reduced leverage. 	
	
Mohawk is a total floor coverings company, providing one-stop shopping to its 	
customers. The company has the No. 2 U.S. position in carpets and rugs behind 	
market leader Shaw (unrated). Mohawk also holds the market leading position in 	
the U.S. in the ceramic tile sector while also possessing an important 	
position in the growing laminate flooring market.	
	
	
Liquidity	
We view Mohawk's liquidity to be "strong" under our criteria. Our liquidity 	
assessment is based on the following factors and assumptions:	
	
     -- We expect the company's liquidity sources (including cash, funds from 	
operations, and availability under credit facilities) over the next 24 months 	
to exceed its uses by more than 1.2x.	
     -- In our analysis, we assumed liquidity of about $1.2 billion over the 	
next 12 months, consisting of cash, funds from operations, and availability 	
under its credit facilities. We estimate total uses in 2012 of approximately 	
$325 million, including about $235 million in capital expenditures.	
     -- Even if EBITDA fell by 30%, we believe sources would exceed uses by 	
1.2x. The company has liquidity in cash and availability under its $900 	
million revolving credit facility due on July 8, 2016. 	
	
Mohawk's credit agreement requires compliance with a 3.75x net debt/EBITDA 	
leverage covenant and a 3.0x interest coverage covenant. As of Dec. 31, 2011, 	
Mohawk maintained significant cushion against both of these covenants. Under 	
our assumptions, we think Mohawk will maintain 30% or more cushion against 	
these requirements at all times. 	
	
We do not expect the company to engage in any meaningful share repurchase 	
activity nor to declare any dividends in the near term. While we do not expect 	
any large acquisitions in the near term, we do expect Mohawk to expand its 	
geographic diversity via acquisitions in the future. Should such activity take 	
place, we expect the acquisition would be accretive to earnings and would be 	
financed in such a manner that Mohawk leverage would decrease to 3x or less in 	
a relatively rapid time frame.	
	
Outlook	
The outlook is stable, reflecting our expectations that Mohawk will maintain 	
and likely improve upon credit measures that are now in line with a low 	
investment-grade rating. With our expectation that U.S. economy and housing 	
markets (both new and remodeling activity) will gradually recover in 2012 and 	
2013, we expect Mohawk's credit measures will remain below adjusted leverage 	
of 3x or less and FFO to debt of about 30%. 	
	
While an upgrade would be considered unlikely in the near term given our view 	
the company's satisfactory business risk profile, we would consider a positive 	
rating action if Mohawk further diversified its geographic presence, improved 	
still-thin operating margins to predownturn levels, and reduced leverage to 	
2.0x or less on a sustained basis.	
	
We could take a negative rating action if extreme raw material volatility or 	
an unexpected decline in demand caused operating earnings to suffer, resulting 	
in sustained leverage exceeding 3.5x. We could also downgrade the ratings if 	
it assumed a more aggressive financial policy by doing large debt financed 	
acquisitions or if it pursued debt financed share repurchases or aggressive 	
expansion, resulting in leverage above the mid 3x range.	
	
Ratings List	
Upgraded; Outlook Stable	
                                        To                 From	
Mohawk Industries Inc.	
 Corporate Credit Rating                BBB-/Stable/--     BB+/Positive/--	
 Senior Unsecured                       BBB-               BB+	
   Recovery Rating                      NR                 4

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