Strategic Exchange: Economists forecast a slight economic dip in 2020 - Dec 2018

By Kemp Harr

The Dodge Construction Outlook for 2019 and the ITR Economics presentation at the NAFCD meeting appear to be in sync about what the next couple of years will look like in the construction/interior finishes business. A deceleration or flatness is predicted in 2019 with a slight downturn in 2020. Dodge goes on to say that the severity of the downturn in 2020 will pivot on the trade war between the United States and China.

The Dodge Construction Outlook, which is published every year in late October, tells us that total U.S. construction starts in 2019 will be $808 billion, which is essentially equal to the $807 billion predicted through the end of 2018. And a deeper look into the construction starts within the various sectors reveals that single-family housing, on pace to grow 6% in 2018, will be flat next year. Multifamily housing, expected to grow 5% in 2018, is anticipated to decline by 6% next year. Commercial buildings, up an expected 2% in 2018, will decline 3% next year. Institutional building is the only exception. That sector was up 1% in 2018 and is expected to increase another 3% in 2019.

The ITR Economic report points to the U.S. Purchasing Managers Index as a leading indicator that the economy started to decline this year. It too predicts a flat 2019 and a slight dip in 2020. According to ITR, the primary drivers of the dip are rising interest rates, inflation due to tariffs and a shortage of contractor labor.

The two big news items in the flooring business in the last month were Armstrong’s decision to sell its wood flooring business and the notable decline of Mohawk’s stock value. Of the two, the story with the most historical significance is the Armstrong one.

ARMSTRONG TO EXIT WOOD FLOORING BUSINESS
Most people know that Armstrong started in the cork business prior to the Civil War and in 1909 started making linoleum flooring. Over the years, Armstrong invested in its brand, and today is one of the best-known flooring brands among consumers. In the last 30 years, it got in and out of the ceramic tile business (American Olean) and carpet business (Evans and Black) and now, finally, the wood flooring business.

Just a few short years ago, when flooring insiders referred to suppliers in the wood flooring business, it was “Armstrong and the seven dwarfs” thanks to its dominant position relative to its competitors, which is very similar to Dal-Tile’s share of the ceramic tile business today.

Armstrong dominance in the wood flooring business culminated in 1998 with the acquisition of Triangle Pacific Corp. when it paid $890 million in stock shares and assumed an additional $260 million in debt. In addition to increasing Armstrong’s wood flooring marketshare to 46%, the acquisition also gave the firm the Bruce, Hartco, Robbins, Premier and Traffic Zone brand names. Prior to the acquisition in 1997, Triangle had $653 million in revenue, compared with Armstrong at $2.2 billion-though 28% of Triangle’s revenue came from its cabinets, and Armstrong’s revenue included its ceiling business.

One has to wonder why the private equity firm American Industrial Partners (AIP) is interested in Armstrong’s wood flooring business. This is the same group that bought Armstrong’s cabinet business in 2012, and they’ve been happy with that deal. This group also made a killing in the sawmill business when it purchased Weyerhaeuser’s lumber business in 2011, and then flipped it three years later for nearly nine times EBITDA to Littlejohn & Co. I haven’t seen Armstrong’s wood flooring balance sheet, but we’ve got to assume their receivables and inventory spanning across six U.S. factories could easily offset half the $100 million price tag.

You might have noticed our news story this month that Shaw Contract is back in the commercial hardwood business, so they are obviously seeing a fresh opportunity in the hardwood flooring segment. Perhaps with fewer players, the product can bring more margin to those that stay in the business.

As an aside, I know the National Wood Flooring Association, which has been pushing to spend money by telling consumers the benefit of real hardwood versus the LVT look-alikes, will be happy. Now Armstrong, which has been voting against this activity, will no longer have a vote.

RECENT DECLINE IN MOHAWK’S STOCK PRICE
I’ve been on the road a lot lately, and hardly a day goes by when someone doesn’t ask me what’s up with the drop in Mohawk’s share value. For those of you who don’t track it, Mohawk’s 52-week range is a high of $286 and a low of $113, and last I checked, they were trading around $125. There are 11 analysts that monitor Mohawk, and from what I can tell by reading their reports at the end of the third quarter, they all got spooked and lowered their price per share expectations for the near term. Some attribute this loss of confidence to EBIT erosion within the Flooring-North American segment; others point to a loss of marketshare overall; and still others say Mohawk is “under indexed” in the fastest growing LVT sector. It is true that demand within the ceramic tile sector has softened this year, and Dal-Tile is, by far, the largest supplier to the U.S. tile market. It’s also true that Mohawk has invested heavily in its IVC operation in Dalton and has had difficulty getting its rigid core LVT production on-line.

Most investors will tell you that Wall Street valuations are not scientific, and it may take a few good quarters before Mohawk recovers from the jitters generated from the results of the last two quarters. One analyst recently told me that Mohawk was never worth $280, but that it is also worth a lot more than where it is today. We all smiled when the Oracle of Omaha, Warren Buffet, validated this industry by buying Shaw Industries. Flooring is the one plane in the cube that we touch and the one that wears out over time-so hopefully it will continue to be a wise investment.

If you have any comments about this month’s column, you can email me at kemp@floorfocus.com.

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