Free Cash Flow Rules: AmEx, Mohawk

Obviously the red flag here is the uncertainty with how the credit crisis will affect the credit card industry. It's decimated the mortgage industry, as evidenced by the billions in writedowns from Citigroup (C Quote), Merrill Lynch (MER Quote), and company.

I discussed my reasons for Amex's solid long-term prospects in an earlier article [RealMoney access required]. Amex is still generating solid amounts of cash that lend credibility to the business model.

As the company operates a closed-loop network, it can keep an eye on the entire credit process (unlike possible transparency issues between banks and the other credit card processors). In my view, if Amex continues to roll in the dough, shares should be trading at around 12 times FCF or at 2007 levels, around $90 million or twice today's value.

Laying Down the Cash

Value investors love to seek out bargains in distressed industries. One such opportunity exists with Mohawk Industries (MHK Quote). Mohawk produces and sells floor-covering products for residential and commercial customers. It's the "residential" side of the business that has weakened and taken the stock price for a ride.

Mohawk and Shaw Carpet, a unit of Berkshire Hathaway (BRK Quote), have a duopoly over the carpet and flooring industry. The two command over 60% of the flooring market. At $66 a share, the market value of Mohawk is $4.6 billion. Over the three years during 2005-2007, free cash flow was $314 million, $615 million, and $710 million, respectively. So far in 2008, free cash flow has been $215 million, but that was with a $200 million charge to working capital in the first quarter.

So what's this cash worth? Let's make some quick, yet conservative assumptions. Considering the phenomenal growth rate in free cash flow over the past three years, let's assume that 2008 free cash flow comes in at $500 million, $210 million less than 2007 (we'll assume a transition year).