Stifel Reports on Q3 Expectations for the Flooring Industry

St. Louis, MO, October 17, 2016—Analyst Stifel reports on its expectations for the flooring industry in Q3, “We provide a look at the flooring industry in advance of Q3 earnings. As we typically do, we begin our discussion with a look at the macro backdrop on a lagged basis before making some brief comments on each company. We continue to believe Mohawk is a good addition to investors’ portfolios given the company’s strength in hard surface flooring and management’s strong track record, not to mention a possibility of acquisitions given the company’s balance sheet strength and historical pattern of getting more aggressive as leverage drops below 2x.

Our trade contacts indicate that business has slowed modestly into Q3, yet remains in a positive growth mode. We always separate the industry in three primary buckets: Residential Replacement (Retail), Residential New Construction, and Commercial. Our conclusion is that while overall flooring industry sales likely grew approximately 4% in the first half of 2016, that pace decelerated to closer to 3% in Q3 and will likely slow modestly further into Q4. We support that claim with relevant housing data (existing home sales, housing starts) and some commercial data (Dodge Indices) that have slowed in the last few months that would ultimately have an impact on flooring results later in the year and/or into 2017.

The macro backdrop would seem to indicate somewhat of a gap from flooring results currently. We note strength in single family housing and existing home sales during the time period that we would consider relevant to flooring sales for Q3. Consumer sentiment has been quite strong and job growth is adequate, yet we have seen retail flooring sales weaken modestly in Q3. This dynamic is not significantly different from what we have seen in other aspects of our coverage where the headline macro indicators seem to be telling a different story from what we are hearing from trade contacts and company results. Residential construction trends clearly slowed during Q3 compared with the very strong start to 2016. On the margin, the backdrop would be less robust for 2017 although we still believe housing starts are some 20%-25% below what we would deem a balanced result between household formation growth and units of housing.

The stocks have stalled in Q3. Lumber Liquidators and Armstrong Flooring performed well in the first part of the year, while the other equities including Mohawk, The Tile Shop and Interface have been relatively trendless. We believe the perceived threat of rising interest rates, a murky consumer outlook, and slowing residential construction activity have all weighed on the group. Regardless of whether the Federal Reserve Bank moves on interest rates before year end, we don’t fear mortgage rates rising materially as we don’t see how housing, a critical part of the economy, can sustain higher monthly mortgage payments currently. The biggest threat to valuations in flooring stocks is rising rates. The next biggest would be a recession. We don’t see either scenario developing currently.”

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