Goodyear Tire GT
September 10, 2009 - 2:34pm EST by
rookie964
2009 2010
Price: 17.24 EPS $0.00 $3.00
Shares Out. (in M): 462 P/E N/A 6.0x
Market Cap (in $M): 4,100 P/FCF N/A 7.0x
Net Debt (in $M): 3,100 EBIT 600 1,400
TEV ($): 8,100 TEV/EBIT 13.5x 6.0x

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Description

 At first glance, Goodyear Tire does not look attractive: it is highly levered, has a substantial underfunded pension and does not appear cheap based on current earnings. That said, I believe the Goodyear Tire to be a highly attractive investment opportunity with significant upside driven by near-term catalysts.  Unlike many companies that are currently being bid up in today's environment on the perception of "normalized earnings" in 2011 or 2012, I believe Goodyear's to be on the cusp of a significant spike in profitability to over $3.00 in earnings over the coming 12 months.  Also important, is the fact that this investment is not dependent on improving economic conditions.  

 Key Investment Points:

            -1) significant replacement cycle of passenger tires over the next 12-18 months

            -2) massive margin expansion due to raw material declines combined with sticky pricing

            -3) $2.5B cost reduction program with $700mm of savings running through the P&L this year

            -4) commercial OE business running 50% below normalized levels and set to increase substantially in 2010

            -5) long term trend towards high performance tires which provides substantial margin expansion despite modest unit growth

            -6) potential import tariff that would eliminate the entire Chinese tire industry from shipping into to the US

 Key Stats:

  • - Market Share: Goodyear Tire is global tire manufacturer with about a 15% market share (US share is 23%).
  • - Geographic Distribution: 45% North America, 36% EU & Mid East, 10% Lat Am, and 9% AsiaPac

 Mix of Business (Sales):

  • - 75%/25% tied to Replacement/OE
  • - 75%/25% tied to Passenger Tire/Truck Tire

 Normalized Earnings

Goodyear has gone through a multi-year period of transition, improving its geographical footprint, closing high cost capacity, and restructuring its labor contracts.  We believe a good way to think about the earnings power of the business is to look at the company's performance right before the collapse in the macro economy.  From Q4 2007 through Q3 2008, Goodyear managed to earn well over $2.00 per share in the face of declining volumes and an unprecedented rise in raw materials.  As we fast forward to today, the company has managed to further rationalize its cost structure and now in a position to post significant earnings growth as deferred replacement tires eventually flow through the volumes. 

 Investment Thesis:

  • - Significant Replacement Cycle: (Replacement Sales v Miles Driven) - Historically, miles driven has been the best measure of replacement demand. Miles driven in the US first turned negative in November 2007 and continued its decline through 2008 falling by just under 4%. While tire units seemed to track miles driven closely through the first 9 months of 2008, the collapse in the economy in the fourth quarter resulted in a complete de-linking of replacement tires v miles driven. In the last nine months, replacement demand is down 13% v miles driven -1% to -2%. There are two key factors here. 1) GT is current operating roughly 20% below normalized units and 2) We believe there is pent up demand of 15-20mm tires that will need to be replaced in time (consumer has to catch up). We believe it is possible to see a 25% spike in US replacement tires as consumers upgrade their tires. It is worth noting that the US miles turned positive in April (was negative since 12/07) and has continued this trend through June (up 1.9%).

 

US PASSENGER TIRES:

 

 

 

 

 

Replmt.

% Growth

Miles Driven

% Growth

Jul-08

 

            16,053

-3.5%

             257,000

-3.8%

Aug-08

 

            16,773

-8.5%

             255,700

-5.8%

Sep-08

 

            17,081

-2.7%

             235,300

-4.5%

Oct-08

 

            15,891

-15.0%

             251,722

-3.8%

Nov-08

 

            14,806

-15.6%

             230,403

-5.3%

Dec-08

 

            14,238

-15.5%

             237,152

-1.6%

Jan-09

 

            13,286

-12.0%

             222,400

-3.5%

Feb-09

 

            12,226

-20.8%

             215,800

2.7%

Mar-09

 

            15,437

-7.1%

             245,090

-1.2%

Apr-09

 

            14,355

-16.6%

             249,502

0.6%

May-09

 

            15,661

-6.6%

             257,311

0.0%

Jun-09

 

            16,376

-8.9%

             256,686

1.6%

 

 

  • - Massive Margin Expansion from Raw Materials Decline: While most manufacturing companies began to experience raw material relief at the end of 2008 and into early 2009, Goodyear Tire actually realized peak raw materials in the first quarter of 2009. Because of lag effect, the enormous drop we have seen in key raw materials (polybutadiene, natural rubber, carbon black, and steel) will start to flow through COGS beginning in the third quarter and accelerating into 2010. Based on current spot prices, GT will likely realize close to $4.00-$5.00 in earnings per share from raw material savings over the next year. Now the key risk here is that tire pricing collapses, something I do not believe is likely occur. While pricing will likely compress moderately, there have been no signs of weakening as of yet (Michelin, in the Q&A of 1st half results, noted they expected price/mix to be up YoY in Q4). Additionally, a tire is not a pure commodity product. The consumers' purchasing decision is not made solely on price, but variation of safety, technology, brand recognition, etc.

RAW MATERIALS

 

 

 

 

 

 

 

 

Carbon Black

% Growth

Natural Rubber

% Growth

Synthetic Rubber

% Growth

Aug-08

 

              135.0

60.7%

                 135.4

31.3%

                     156.5

68.3%

Sep-08

 

              140.0

66.7%

                 142.0

36.9%

                     165.0

79.3%

Oct-08

 

              124.0

44.2%

                 148.5

49.4%

                     169.0

83.7%

Nov-08

 

              121.0

37.5%

                 147.4

46.5%

                     144.0

54.8%

Dec-08

 

                94.0

8.0%

                 127.3

23.6%

                       97.0

3.2%

Jan-09

 

                84.0

3.7%

                 120.0

11.8%

                       80.0

-16.7%

Feb-09

 

                84.0

3.7%

                   97.5

-10.6%

                       75.0

-23.5%

Mar-09

 

                84.0

2.4%

                   87.9

-26.6%

                       72.0

-28.7%

Apr-09

 

                84.0

-3.4%

                   79.3

-35.2%

                       72.0

-35.1%

May-09

 

                79.0

-16.0%

                   74.0

-42.4%

                       74.0

-40.3%

Jun-09

 

                79.0

-23.3%

                   75.9

-41.6%

                       78.0

-43.7%

Jul-09

 

                77.0

-43.0%

                   74.9

-43.2%

                       92.0

-37.8%

 

 

 

 

 

 

 

 

 

  • - Substantial Cost Savings: Goodyear has gone to great lengths to improve its cost structure over the last number of years. To date, mgt has taken $2.1B of costs out of the business through the shutdown of 25mm units of production, lower cost sourcing, back-office consolidation, labor reduction, etc. Additionally, mgt is on track to realizing over $350mm over the next two quarter or roughly $700mm for the full year. In 2007, many investors owned this stock on the restructuring thesis alone. While it was hard to calibrate mgt's ability to take costs out of the business a year ago, it is now quite evident in the numbers that these savings have been very much realized. It is for this reason that when volumes do return, I believe the leverage to the upside will be significantly greater than the market expects (Most investors are not aware of the improvements in the cost structure as it has been distorted by a complete collapse in volumes & earnings).

 

  • - L-T Trend Toward High Performance Tire: While the economic contraction has likely put on hold the strong growth in high performance tires (HVA), the long term trend will resume when the economy rebounds. The auto manufacturers continue to gravitate towards larger radius tires, driving the shift towards high performance demand over time. Goodyear's leverage to this trend is enormous, generating an incremental $10-$20/tire, quite material for a company that did $6/EBIT per tire in 2008. This trend (mix) has been a major driver of the business the last few years and has not shown any real signs of slowing. If you look at price/mix disclosed over the last few years you will see the tailwind this provides.

 

  • - Truck Volumes Below Normalized: Goodyear's truck business has collapsed in the past six months (new units down over 50% YoY in the US & 75% in Europe). While I do not expect a return to the peak builds seen in 2006, 2010 should increase substantially from current levels. PCAR has guided to close to 20% unit growth for new US builds in 2010. The US fleet age is at the highest level in over a decade and current deliveries are roughly 50% of the 10 year average. It is also worth mentioning that purchase deferrals have been quite evident in the replacement for trucks tires as well. Industry contacts have noted that truck owners have been replacing worn-out tires by removing tires from idle trucks. As volume comes back and fleet utilization increases, these tires will need to be replaced prior to getting on the road.

 

 

 

2006

2007

2008

2009

2010

 

 

 

 

 

NA Trucks:

 

 

 

 

 

 

 

Hist Average:

 

 

Class 8 Builds

 

     376,448

     212,391

     205,237

     105,000

     125,000

 

Class 8

 

     234,709

 

     % Growth (YoY)

 

11.0%

-43.6%

-3.4%

-48.8%

19.0%

 

     09 Build v Average

-55.3%

 

Class 5-7 Builds

 

     274,707

     206,213

     157,561

       86,652

     113,718

 

Class 5-7

 

     207,968

 

     % Growth (YoY)

 

8.6%

-24.9%

-23.6%

-45.0%

31.2%

 

     09 Build v Average

-58.3%

 

 

  • - Chinese Tariffs: At the end of June, the International Trade Commission has recommended that the Obama administration institute a 55% tariff on Chinese made tires (45% in year 2 and 35% year 3). While it is unclear whether the new president will impose the recommended tariff, such an action would result in the removal of Chinese tires in its entirety from the market (20% of US mkt). To the extent this were to occur (decision expected Sept 17), I believe US tire companies will respond by raising prices.

 Additional Datapoints:

  • - Today, the Obama administration recommended a substantial tariff on steel pipe imports from China. This is a significant event that does not appear to be garnering much press. Considering this complaint was filed by the same labor union (USW) as the tire complaint, I believe it makes a statement that this administration is following through on its promise to protect American jobs (good read through to tire decision).
  • - Michelin reports monthly figures on its website with a lag. While the company has only posted July numbers thus far, all segments showed a dramatic improvement in volumes v Q2. In fact, Michelin showed year over year growth in the NA replacement market (3.4% v decline of 10% for Q2). To the extent GT is experiencing a similar trend, the company will likely beat on volumes in Q3.
  • - Cash for clunkers in the third quarter should provide a material boost to volumes in Q3. While ASPs are lower than the replacement side of the business, it is fair to assume this should help earnings by $25/tire.
  • - Dollar devaluation will help earnings on the margin (EU & LatAm), especially in Q4 when we comp against the spike in the USD last year.

 Q3 & Upcoming Earnings:

I believe the company is likely to beat Q3 earnings materially.  While I am happy to provide more color, you can easily get to consensus simply by adjusting Q2 results for the swing in raw materials (YoY benefit is around $.75/share alone).  Other benefits will be 1) lower inflationary costs (diesel & gas are large inputs and down significantly YoY), 2) smaller decline in volumes YoY, 3) significantly lower unabsorbed overhead costs (200mm in Q2 and likely $125mm in Q3), 4) $175mm of cost savings YoY, and 5) positive price/mix.  As we move into 2010, the street has either modeled 1) raw material declines incorrectly or 2) a significant decline in pricing due to competitive pressures.

 

 

 

 

 

Catalyst

1. Earnings beats (Q3 & 2010)

2. Obama's decision on Chinese import tariff's (next week)

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