2023-04-10 12:04:06 ET
Summary
- Goodyear has seen a -62% stock decline over the past 5 years.
- The tire industry is expected to grow at a slow, 2-3% CAGR through 2030, while competition intensifies.
- The list of challenges for Goodyear includes low profitability, little geographical diversification, alarming debt levels and mediocre forward expectations.
Thesis
After a strong hit caused by the Covid-19 pandemic, the tire industry has recovered to a large extent. The mature industry houses many global brand names including The Goodyear Tire & Rubber Company ( GT ), the largest American manufacturer, that has been showing signs of struggle for a few years now. In this analysis, I explore the tire industry's prospects and characteristics while raising some more specific concerns regarding the company's past and forward financial performance.
Stock Price Declining
The past 5 years have been especially challenging for the company and its shareholders alike. The stock has retreated more than 60% since 2018 amid profitability struggles and has been hit even harder since the beginning of 2022.
Over the past year Goodyear has exhibited elevated levels of volatility, while recording a large -19.49% decline. Currently, GT trades at $10.33 ($2.93B market cap), -34% from 52-week highs and pays no dividend.
The Company
Goodyear is an iconic American brand with its name synonymous to tire manufacturing. Founded in 1898, Goodyear has established itself as a leading manufacturer in the tire industry around the world. Its portfolio of brands also includes Avon Tyres, Dunlop, Cooper Tires and others. Apart from vehicle tires, the company also manufactures and sells some rubber-related chemicals. Goodyear maintains 57 manufacturing facilities in 23 countries across the globe. Today, it remains as the market leader in North America, with over $20B in annual revenue.
Consumers' View
Goodyear is mostly highly-regarded by consumers and automotive experts, in terms of quality, performance and affordability. However, the company seems to lack its larger competitors (Michelin, Continental and others) in many reviews. CarTalk.com ranks Goodyear at no.5 among its competitors for 2023, while Cartreatments.com ranks the company 7th. Automoblog.net gives Goodyear its best ranking position at no.2. It is important to note, that in all rankings mentioned Michelin captures the number one position when it comes to consumer and expert preference.
A Slow-Growth Industry
The global tire market is fragmented, with a number of major players providing intense competition. Manufacturers from many different countries fight for market share while chasing innovative solutions and quality advancements. The Michelin group, a French manufacturer is considered the global market leader, while the top 5 list fill companies like Bridgestone (Japan), Continental (Germany), Pirelli (Italy) and Goodyear (U.S.). Advertising costs are high and among other channels manufacturers choose to promote their products in different racing events around the world, promoting their performance and durability.
The global tire market is very mature and volumes are expected to increase at a small 2-3% CAGR for the foreseeable future. The few factors driving growth include expanded safety awareness, technological advancements and new product launches. Rising automotive production will also be able to sustain this small growth over the mid-term. The larger and fastest growing region for the industry is Asia-Pacific (4.5% CAGR through 2030).
While the tire industry is included within the consumer discretionary sector many view tire purchases as a mandatory spending item and believe that the industry is far more defensive in nature. In my view, there is truth to both perspectives. While at some point, tires must be replaced, consumers can delay purchases by many months when they have lower disposable income available or when expectations regarding the economy worsen. This can result in sale slowdowns across the industry, leading to decreased profitability.
A Number of Financial and Other Challenges
Focus on Slow-Growth Markets: While the company's American roots have helped Goodyear familiarize itself with consumers in North America, where the company leads in market share, overseas it lacks in market penetration. Approximately 61% of sales originate from North America and only 12% from the Asia-Pacific region, the industry's fastest growing market. A diversion of geographic focus towards emerging markets is needed if the company aims to grasp future sales growth, inside an overall slow-growth industry.
Worsening Profitability : Despite an overall growth in sales the company struggles to deliver strong profitability results. While sales increased by 18.8% in 2022 to reach $20.8B, the cost of goods sold increased even more, by 23.8%, climbing to $16.95B. The company's gross margin of 18.6% is rather narrow and has decreased over the past 5 years. SG&A expenses have also increased, although at lower rates. Goodyear's 1.0% net margin is also especially thin.
Market-cycle sensitive: As I mentioned in a previous segment the tire industry exhibits both defensive and discretionary attributes. Commercial customers' spending on tires is more stable due to their need to adhere to safety regulations and maintain operational efficiency for professional vehicles. Approximately 63% of Goodyear's sales, however, are retail-oriented (only 20% commercial), which makes the business more sensitive to economic cycles. Given the current macroeconomic outlook this can be viewed as an added risk.
Mediocre Expectations Going Forward: In the Outlook section of the company's 10-K report, management mentions an expected increase in raw materials cost of $200M for 2023. Challenges for vehicle manufacturing are also expected to persist, at least for the better part of 2023, hurting OE tire sales. Labor and energy costs also constitute headwinds. In addition, management sees a reduction in manufacturing volume for the beginning of the year. Analysts expect low-single digit sales growth and strong fluctuations in EPS over the next couple of years.
Alarming Debt Levels: Long-term debt and finance lease obligations stand at the alarmingly high levels of $7.2B (more than 2x the company's market cap). These extensive leverage levels could potentially place the company's solvency and long-term survival in question. Interest Expenses also take a toll on profitability, amounting to $450M in 2022, compared to $324M in 2020.
The Low Valuation Might Deceive
At an initial glance, Goodyear's valuation multiples might appear attractive. The company trades at a 9.7x forward non-GAAP P/E, which is rather cheap compared to sector averages. However, on a GAAP basis a 14.5x ratio can probably be considered expensive given the company's financial struggles. The very low P/S ratio that the company exhibits (forward 0.14x) is not a reliable valuation indicator in this case, as the company is barely profitable and sales growth is also expected to be low going forward. Overall, the company's alarming debt levels and profitability struggles indicate that Goodyear is not especially cheaply valued after all in my view.
Final Thoughts
After all things are considered, the headwinds Goodyear faces, at least over the mid-term, appear too strong. Alarming debt levels and low profitability make the stock a precarious choice in a macroeconomic environment where weakened consumer spending can stall sales growth. For these reasons, and despite an initially appealing valuation, I would rate GT as cautious hold, while highlighting the more speculative nature of the stock.
For further details see:
Goodyear Tire: A Number Of Challenges To Consider