NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Mohawk Industries, Inc. (NYSE: MHK), including the company's Issuer Default Rating (IDR), at 'BBB-'. The rating actions follows Mohawk's announcement that is has reached a definitive agreement to acquire the IVC Group (IVC) for approximately $1.2 billion through a combination of cash and equity. The Rating Outlook remains Positive.
A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings for Mohawk reflect the company's leading market position in most of its major business segments, strong brand recognition, and end-market diversity. Risks include the cyclicality of the company's end-markets, a relatively weak global economy (especially Europe), and aggressive growth strategy.
IVC ACQUISITION AND RATIONALE
Founded in 1997, IVC is a major producer of sheet vinyl, luxury vinyl tile (LVT) and laminate flooring, with manufacturing operations in Europe and the United Sates. IVC is a major sheet vinyl producer in Europe and the U.S. and is a leading player in the rapidly growing LVT flooring category in Europe. IVC is also in the final stages of completing a new LVT plant in the U.S. IVC had approximately $700 million of sales during 2014 (based on current exchange rates).
Fitch views this transaction as strategically positive for Mohawk. The acquisition further expands Mohawk's standing as a leading global flooring manufacturer and positions the company to be a major participant in the growing LVT category and the expanding fiberglass sheet vinyl business. IVC's laminate flooring products, which are marketed in the mid-price range category, also complement Mohawk's high-end laminate floor offering.
IMPACT ON RATINGS
Mohawk expects to fund the acquisition with roughly $1.075 billion of debt and $127 million of equity. While Fitch views the transaction as strategically positive for Mohawk, the acquisition temporarily weakens the company's credit metrics as a result of higher debt levels. Fitch expects leverage as measured by debt to EBITDA on a pro forma basis will increase to about 2.6x from 2.1x for the LTM period ending Sept. 27, 2014. EBITDA to interest coverage was 13.9x for the LTM period ending Sept. 27, 2014 and is projected to decline to about 10.0x on a pro forma basis.
The Positive Outlook reflects Fitch's expectation that Mohawk's leverage ratio will decline to about 2.1x and interest coverage will settle at or above 10.0x 12 months after the completion of the acquisition.
AGGRESSIVE GROWTH STRATEGY
The company has historically grown its business internally and through acquisitions. During the first half of 2013, Mohawk completed three acquisitions for a total purchase price of roughly $1.81 billion (Marazzi for $1.5 billion; Pergo for $150 million and Spano NV for $160 million). These acquisitions significantly improved the company's market position and also extended Mohawk's customer base into new channels of distribution.
However, Mohawk's credit metrics temporarily weakened due to the debt incurred from these acquisitions but has gradually improved as the company integrated the acquisitions and subsequently reduced debt.
Mohawk has demonstrated in the past that it has the discipline to reduce leverage levels following a major acquisition. Most recently, Mohawk's leverage increased from 2.0x at year-end 2012 to around 3.3x for the LTM period ending June 30, 2013 after the acquisitions of Marazzi, Pergo and Spano. Leverage has gradually declined to 2.3x at year-end 2013 and 2.1x for the Sept. 27, 2014 LTM period as the company fully integrated the acquisitions and reduced debt levels. Additionally, following the Unilin acquisition in 2005, leverage increased from 1.2x at year-end 2004 to 4.3x at the end of 2005. Leverage was reduced to 2.5x at the end of 2006 and to 2.1x at year-end 2007.
While the company had demonstrated discipline in the past, the risk is that Mohawk becomes a serial acquirer and will continually pursue acquisition opportunities that will frequently push its leverage at the higher end (or perhaps above) of its 2.0x-3.0x leverage target. Fitch expects the company will remain disciplined in its growth strategy and will consistently manage its balance sheet towards the lower end of its leverage target.
Mohawk has adequate liquidity and is able to meet its financial obligations, although the company has significant short-term borrowings and debt maturing in the next two years. As of Sept. 27, 2014, Mohawk had $105.6 million of cash, of which $60.1 million was held outside the U.S.
The company also has a $1 billion commercial paper (CP) program that is backed by its $1 billion five-year revolving credit facility that matures in 2018. As of Sept. 27, 2014, Mohawk had $381.4 million of borrowing availability under its revolving credit facility, which takes into account $569.1 million of CP borrowings, $10.4 million of revolver borrowings, and $39.2 million of letters of credit. Fitch expects Mohawk will have continued access to its revolver as the company has sufficient cushion under the facility's financial covenants.
About 50% of the company's debt will mature in the next 15 months. Additionally, Mohawk has $569.1 million of CP borrowings as of Sept. 27, 2014. Mohawk's $500 million securitization facility (fully drawn) matures in December 2015. Fitch expects the company will renew the securitization facility prior to its maturity date. The next debt maturity is in January 2016, when $700 million of senior notes become due. The company has demonstrated its ability to access the capital markets, and Fitch expects Mohawk will refinance part of the notes in advance of its 2016 maturity.
Mohawk generated $19 million of free cash flow (FCF) for the LTM period ending Sept. 27, 2014 compared with $158.7 million (2.2% of revenues) during 2013 and $379.3 million (6.6%) during 2012. Fitch currently expects FCF will be roughly 1% of revenues during 2014, due to higher capital expenditures (capex). Management expects capex will total about $550 million during 2014 or 7% of revenues. By comparison, capex represented 5% of revenues in 2013, 3.6% in 2012 and 4.9% in 2011. The higher capex last year was due to investments to replace high-cost assets (including assets from the three acquisitions closed last year), construction of new plants, and capital investments to support changing product trends in its carpet business. Fitch projects FCF will approximate about 4.5%-5.5% of revenues in the next few years.
EXPECTED CONTINUED IMPROVEMENT IN MOHAWK'S U.S. END-MARKETS
The company markets its products primarily to the U.S. construction industry, with a majority of sales directed to the residential repair and remodel segment and the remainder directed to new residential construction and commercial markets. On a pro forma basis, sales in North America will account for roughly 66% of sales (down from 70% currently).
Fitch expects overall industry construction spending will expand 7% in 2015, driven primarily by continued robust spending in the private sector. Total housing starts are projected to grow 14% while new home sales are forecast to expand 18% in 2015. Existing home sales are projected to rise 5% this year. Home improvement spending is also forecast to increase 6% while private nonresidential construction is expected to improve 6% in 2015.
Currently, management estimates that about 20% of its sales are generated from Western Europe and about 5% from Russia. Fitch estimates that exposure to these regions will increase slightly, with Western Europe and Russia accounting for about 22.7% and 5.4%, respectively, of overall pro forma sales. During the third quarter of 2014, Mohawk's flooring sales in Europe and Russia remained soft. Fitch expects continued weakness in these markets, as Eurozone GDP is only projected to improve 1.1% in 2015 while Russia's GDP is projected to contract 4% this year.
Future ratings and Outlooks will be influenced by broad end-market trends, as well as company specific activity, particularly FCF trends and uses, and liquidity position.
An upgrade of the ratings to 'BBB' may be considered in the next six to 12 months if the company's leverage is trending towards 2.0x (and is expected to be sustained at the 2.0x level) and interest coverage remains above 9x, while maintaining a robust liquidity position.
On the other hand, the Rating Outlook could be stabilized if the recovery in the company's end markets are weaker than Fitch's expectations, leading to EBITDA margins between 11%-12%, debt to EBITDA levels consistently in the 2.5x-3.0x range, and interest coverage of 7.0x-9.0x. The Outlook could also be revised to Stable if the company completes another sizeable acquisition funded by debt, leading to leverage levels consistently in the 2.5x-3.0x range, and interest coverage of 7.0x-9.0x.
Negative rating actions may also be considered if the recovery in the U.S. construction market dissipates and affects volumes, and/or sustained materials and energy cost pressures contract margins, leading to weaker than expected credit metrics, including EBITDA margins below 10%, debt to EBITDA levels consistently above 3.0x and/or interest coverage below 6.0x. Negative rating actions will also be considered if Mohawk completes another sizeable acquisition funded by debt while it is still integrating the IVC acquisition, leading to leverage levels above 3x and/or interest coverage below 6.0x.
Fitch has affirmed the following ratings for Mohawk with a Positive Outlook:
--IDR at 'BBB-';
--Senior unsecured debt at 'BBB-';
--Unsecured revolving credit facility at 'BBB-'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage