Mohawk Group Holdings (NASDAQ:ATER) is up 800% over the last year as investors have fallen in love with the data-driven consumer goods retailer. But even with the meteoric rise in its stock price, the company still looks to have plenty of growth ahead of it.
Let’s look at why so many investors are piling into this small-cap stock.
What does Mohawk Group do?
More than 75% of product searches on Amazon do not include a brand name, according to research from Marketplace Pulse. This means consumers are going to Amazon open to discovering new items, and these days, those items are chosen based on data such as reviews and ratings. This is the market Mohawk Group is hoping to capture.
Mohawk identifies market opportunities based on its e-commerce engine that the company calls AIMEE (the artificial intelligence Mohawk e-commerce engine). It is a collection of rules set forth by its developers to help digest data and identify underserved areas that lack a clear product leader. Often, these areas are focused on basic household items like kitchenware, appliances, or beauty products.
Once AIMEE helps Mohawk Group identify a target market, the company will either acquire a brand that fits the mold or build a product it believes can be a category leader. Once that product is listed, Mohawk is willing to lose money to gain market share. This means pouring investments into marketing and discounting the product in order to boost sales and increase ratings.
After Mohawk’s products have become the clear category leader, it peels back the advertising and discounts and lets the sales come organically.
Mohawk by the numbers
Mohawk Group is now home to 12 different brands selling hundreds of products. Its goal is to promote these products to the point when they’re profitable without the need for further investment. Once products reach this stage, Mohawk expects each product to produce a 10% net margin. This strategy sounds great in theory, but let’s take a look at how it’s really playing out.
|Revenue||$53.6 million||$88.8 million||$144.2 million|
|Net margin (loss)||(43.4%)||(30.8%)||(13.0%)|
Over the last three years, as Mohawk has expanded its product range, revenue has consistently increased, and the company has grown closer and closer to profitability. While growth may be lumpy going forward due to the timing of acquisitions, this trend supports the viability of Mohawk’s strategy.
Even with the incredible revenue growth Mohawk has seen over the last three years, it expects that momentum to continue in 2021. In a Feb. 2 press release, management projected revenue for the current fiscal year would fall in the range of $340 million to $370 million, nearly doubling its expected total for 2020.
But this growth does come at a price. Over the last year, Mohawk’s share count has increased 13% as the company acquired several companies with a combination of cash and stock. That increase doesn’t even include the slew of brands Mohawk recently purchased for more than $100 million. Once these acquisitions are in the books, shareholders should expect to see further share dilution.
While the dilution might concern some shareholders, it can be an excellent avenue for growth if Mohawk Group spends the money wisely. And since it predominantly targets small consumer-goods brands with limited capital, it often pays a pretty low purchase price. For example, in its most recent acquisition, Mohawk acquired an online seller of essential oils called Healing Solutions. In the last 12 months, Healing Solutions generated $65.2 million of revenue and $12.7 million in operating income. Yet Mohawk was able to acquire the business for approximately $48.2 million, or 3.8 times Healing Solutions’ trailing 12-month operating income.
What could go wrong?
There’s plenty to like about Mohawk Group’s business model, but there is one potential concern shareholders should watch closely,
A total of 95% of Mohawk Group’s revenue comes from selling on Amazon. That level of dependence on another business leaves it in a bit of a fragile position. If Amazon were to increase seller fees or restrict selling across its platform, it would be detrimental to Mohawk’s operating model.
While it seems unlikely that Amazon would do anything to harm the sellers that make up its platform, Mohawk can still take steps to alleviate this risk by increasing its sales across other commerce platforms like it’s doing with Shopify and Walmart.
Even while acknowledging this reliance on Amazon, with a market cap under $1 billion, Mohawk Group still strikes me as a promising small-cap growth stock in its early innings.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/03/05/one-small-cap-stock-that-wont-stay-small-for-long/