Mohawk (NYSE: MHK) Recovery Comes To An Abrupt End

For a while in recent months, things were looking good for investors of flooring manufacturer Mohawk Industries (NYSE: MHK). Despite taking a 60% whack from the coronavirus crash in Q1, shares had been steadily rallying since the lows of March and the outlook was as good as it had been in a long time. Through the start of June, shares more than doubled in value, helped in a large part by a faster than expected economic recovery from the pandemic and a softer than expected impact on home purchases and renovation projects.

It’s been a while since Mohawk was able to call itself a good stock but it did have its moment in the sun back in the day. From 2011 through 2017, shares ran up almost 600%. But it’s been a fairly downhill slope since then, with March’s low putting them down a full 80% from their all-time high.

Better Than Expected Outlook

Still, as was reported back in June, it seemed as if the worst-case scenario was already well baked into the share price and any positive development was going to send the bulls rushing in and the bears scrambling to cover short positions. To this end, at the end of last month Cleveland Research surprised many with an upbeat outlook on Mohawk’s Q2 revenue which they saw coming in much stronger than previously expected.

A forecasted 35% drop in revenue was more likely to be closer to the 15% mark they suggested and investors quickly took notice. It helped that new home sales in May came in 16% higher than expected which fed the theory that the economic impact of the coronavirus wasn’t going to be as bad as first thought. Interestingly though, at the same time towards the end of June, Deutsche Bank downgraded the stock to a Sell.

Red Flags

In hindsight, it looks like they might have known something we didn’t, as there are now much worse things for Mohawk management to be worrying about now than May or June new home sales being better or worse than expected.

On Wednesday of last week, Deutsche raised a red flag about potential fraud allegations coming down the line. Not good. On Thursday, Wells Fargo weighed in and shed some light on a lawsuit that shareholders have known of since January but that was only made public last week. Definitely not good. They reported that a class action by The Public Employees' Retirement System of Mississippi alleges the company engaged in a "fraudulent scheme to fabricate revenues through fictitious sales of products that were not delivered to customers and to conceal from investors the true reasons for the company's ballooning inventory" from the middle of 2017 through the summer of 2019. Shares went into the weekend down a full 30% from their weekly high.

Then on Monday, investors woes were added to after the company announced they had received subpoenas from the SEC, not something a bullish investor ever wants to hear happening to a company he owns stock in. The gist of the class action complaint is that Mohawk tried to make deliveries to customers that were closed and then recognized these as sales, falsely boosted operating margin by overproducing products and valued inventory improperly.

In a note to investors this week, the company said they are well-positioned to ‘vigorously defend’ themselves, “with a strong balance sheet and limited debt. We have recently issued over $1B of long term bonds to strengthen our ability to strategically invest and better position Mohawk for the future. Our operations are improving as countries adapt to COVID-19."

Still, the old saying “there’s no smoke without fire’ comes to mind in this situation and if there’s a shred of truth to the allegations then no one is going to be buying Mohawk stock, or potentially Mohawk products, in the near future. Buyer beware.