2023-11-16 12:22:47 ET
Summary
- Goodyear Tire & Rubber has announced a transformation plan aimed at cutting costs and unloading non-core assets.
- The company plans to optimize its Chemical, Dunlop, and Off-the-Road assets, potentially through spinoffs or asset sales.
- These initiatives, if successful, will drastically increase the firm's profitability and, in turn, its share price.
As an investor, I'm not one to piggyback off of the investment decisions of others. But every so often, an idea will come across my desk that is impossible to pass up. That is what transpired in May of this year when an activist investor called Elliott Investment Management came out with a presentation that demonstrated that shares of Goodyear Tire & Rubber (GT) could be worth as much as $32 apiece. I found myself skeptical considering that shares were only trading at $11. But after digging into the analysis, I wrote an article discussing how this was an entirely realistic assessment of the company's potential.
At the end of the day, I ended up rating Goodyear Tire & Rubber a 'strong buy'. At the time, I did not make an investment. But after seeing shares pull back from their initial spike in reaction to the news, I started a position and have added to it. Fast forward to today, and the company now accounts for 9.8% of the assets in my portfolio, making it the fifth largest holding of the nine that I have. But now, I have a reason to be even more optimistic. And that's because, on November 15, the management team at the firm came out with a new update that indicates that the future for the company and its investors should be very bright indeed.
The picture just got a lot better
All too often, the management teams at companies that become the target of activist investors either ignore the changes that the investors want or they actively push back against them. In some cases, this makes a great deal of sense. But in others, particularly where all parties involved stand to benefit financially, it is illogical. Fortunately for investors in Goodyear Tire & Rubber, the team in charge of the company appears to have a good sense of where things should be going.
On November 6, management made public the fact that they would be updating shareholders regarding a strategic review process that the company began earlier this year at the urging of Elliott Investment Management. That data finally came out on November 15 when Goodyear Tire & Rubber made clear that, in addition to changing up its leadership team, it would also be initiating a transformation plan aimed at cutting costs and unloading certain non-core assets.
Goodyear Tire & Rubber Company
After supposedly looking at all of the assets that the company has, it decided that its efforts moving forward would be on optimizing three different ones. These are its Chemical, Dunlop, and Off-the-Road assets. The first of these, the Chemical business, is the largest, accounting for roughly $1 billion in annual revenue. Even though it may seem odd for a tire company to be involved in the chemical space, it actually makes a lot of sense when you dig down into the numbers. Chemicals are required in significant quantities in order to produce tires. And as of the end of the company's 2022 fiscal year, the firm had four different chemical plants located throughout the Americas. The company also engages in the sale of third-party chemical products for its customers.
When it comes to tires, there is no denying that the Dunlop brand is one of the most famous out there. Management claims that overall revenue associated with those operations is around $0.7 billion. This matches the $0.7 billion in sales for the Off-the-Road operations that basically involve the sale of off the road tires. Now, to be perfectly clear, management has not said exactly what they intend to do with these assets. Instead, they stated that they are conducting a further strategic review regarding them. However, I would argue that they are far enough along into the process to be very near a decision. I say this because they expect any moves that they make to result in gross proceeds of greater than $2 billion. A spinoff or asset sale outright is likely, with the latter being the most probable. The reason why I say that asset sales are more likely is because, geographically speaking, these are very disparate assets. The Chemical business might be focused on the Americas, but Dunlop's primary exposure is to Europe. Meanwhile, the Off-the-Road operations mostly involve the Asia Pacific region. It wouldn't make much sense to spin off such different assets into a separate enterprise.
Goodyear Tire & Rubber Company
This is only part of the company's strategy. They also are working to drastically improve the segment operating margins of the firm as a whole, with the goal of increasing the segment operating margin from 5% to 10% between the end of this year and the end of 2025. This is projected to save around $1.3 billion in annual expenses for the company. But these costs don't come easy. The firm will have to spend around $1.1 billion on restructuring expenses, though it is worth noting that this figure includes $400 million that was previously announced as part of an asset rationalization push by the company.
This margin expansion will likely focus on a few key areas. For instance, the company plans to focus more on its pricing and on rationalizing its line of products. It wants to position itself appropriately, with the Goodyear brand becoming known as a premium product and the Cooper brand fitting under the mid-tier category. Culling anything lower than that on the totem pole is definitely something that management is looking at. The firm in general wants to address all low margin aspects of itself. Those parts that can be fixed will be. But anything else the firm will look to sell or exit. At the same time, management is also going to be looking at increasing market opportunities that could help to expand revenue. All combined, these particular initiatives are expected to bring in around $300 million in annual savings.
Goodyear Tire & Rubber Company
The larger chunk, $1 billion in all, we'll focus on consolidating the company's massive physical footprint. It is worth noting that the plan to cut away certain low margin products will help on this side of the cost savings table as well since it will make it easier for the company to reduce complexity and to improve the efficiency levels at its plants. The reset of the company to focus on doing business a different way than it has previously is expected to renew certain purchasing opportunities. And on top of this, management is looking at other ways to reduce costs by making improvements in the supply chain and by adopting other technologies such as those that allow virtual research and development prototyping, higher levels of automation, and even that include the incorporation of artificial intelligence.
Goodyear Tire & Rubber Company
When everything is said and done, the asset sales and other initiatives that the company is pushing for, combined with profit growth, should help to reduce the firm's net leverage ratio from around 4.0 to between 2.0 and 2.5. Based on my own estimates, the $1.5 billion in total debt reduction that the company is pushing for should translate to net debt declining from $7.66 billion today to $6.16 billion by the time everything is said and done at the end of 2025. The net leverage ratio change will be aided significantly by the fact that the firm is expecting EBITDA by the end of 2025 to be around $2.7 billion on an annualized basis. That's up from the $1.8 billion forecasted for that metric this year. No estimates were given when it came to adjusted operating cash flow. Management did say with they expect adjusted free cash flow to be. But they did not give an indication of capital expenditures. So if we assume that the company prioritizes the debt that's coming due soonest and we assume 821% corporate tax rate with depreciation depletion and amortization levels that should match with the company is seeing today, we should expect operating cash flow by 2025 of around $2 billion.
*Figures above, other than percentages, are trading multiples
If this comes to fruition, the impact for shareholders could be significant. Right now, the company is trading at a price to adjusted operating cash flow multiple of 7.50. Achieving the targets set by the firm would bring this down to 1.99. Using the EV to EBITDA approach, the company is currently trading at a multiple of 6.56. Achieving its targets would bring this down to 3.82. If we fast forward to the end of 2025, and if we assume that the fair value of the company at that time implies the same trading multiples as what we have today, then the EV to EBITDA approach would imply upside of 185.9%, while the price to operating cash flow approach would imply upside of 276.9%. That translates to a per share price of between $40.14 and $52.91.
Takeaway
Based on the data provided right now, I am even more optimistic about Goodyear Tire & Rubber than I was previously. It is true that the company could fail to recognize material synergies. But that is something we will have to wait and see about. Even if the firm can capture half of the savings and other opportunities forecasted by management at this time, the end result could be quite bullish for shareholders. Given these factors, I have decided to keep the company rated a 'strong buy' and I will likely be adding to my position moving forward.
For further details see:
Goodyear Tire & Rubber Is Drastically Undervalued After Management's Bold Move