2023-04-11 11:35:47 ET
Summary
- The company was ranked #3 in the global tire industry. The company has improved its market position to ranked #2 by revenues in America through the acquisition.
- The uncertainty of the macro environment and the recent negative outlook revision from S&P continued to depress the valuation of the stock.
- The company has improved its ranking but its stock is still traded at a deep discount to its peers.
- The company's outstanding capability to generate cash flow amid the 2008 financial crisis and the 2020 COVID disaster is a strong testament to its resilience in recession.
- For long-term investors, the strategy is to buy more when this name goes lower due to the macro pressure.
Investment Thesis
The Goodyear Tire & Rubber Company (GT) was ranked #3 in the global tire industry. Our analysis below showed that the company has improved its market position to ranked #2 by revenues in America through the acquisition of Cooper Tire. The tire industry is highly competitive and is projected to enter into a recession in 2023. The uncertainty of the macro environment and the recent negative outlook revision from S&P continued to depress the valuation of the stock.
We like the company's strong market position and its strategy to compete in the industry. The company has improved its ranking but its stock is still traded at a deep discount to its peers. The company's outstanding capability to generate cash flow amid the 2008 financial crisis and the 2020 COVID disaster is a strong testament to its resilience in recession. We rate this stock Buy. For long-term investors, the strategy is to buy more when this name goes lower due to the macro pressure.
Company Profile
The Goodyear Tire & Rubber Company is one of the world's leading manufacturers of tires, with one of the most recognizable brand names in the world and operations in most regions of the world. The company has a broad global footprint with 57 manufacturing facilities in 23 countries, including the United States. It operates through three operating segments representing our regional tire businesses: Americas; Europe, Middle East, and Africa; and Asia Pacific.
Key Takeaways from Q4 2022 Earnings:
In Q4 2022, its sales increased by 6.3% to $5,374 million from $5,054 million, decelerating from 7.6% in Q3 2022.
In Q4 2022, its gross margin decreased by 540 bps to 16.1%, from 21.5%, due to increases in raw materials, transportation, energy, and wage costs, partially offset by a Price/Mix lift.
In Q4 2022, its SG&A% decreased by 180 bps to 13%, from 14.8%, due to synergy saving from the acquisition of Cooper Tire.
As of the end of Q4 2022, its inventories increased by 27.2% to $4,571 million, from $3,594 million.
The company provided the outlook for 2023 in its 10-K.
We expect our raw material costs to increase by approximately $200 million in 2023 compared to 2022, including the impact of the stronger U.S. dollar and higher transportation and supplier costs. This net increase includes higher raw material costs of approximately $300 million and $100 million in the first and second quarters of 2023, respectively, and lower raw material costs of approximately $200 million in the second half of the year. We anticipate price and product mix improvements to more than offset raw material cost increases in the first quarter of 2023 by approximately $100 million.
In addition to higher raw material costs, we expect the impact of other inflationary cost pressures to persist, particularly with respect to transportation, labor, and energy costs. We expect the negative impact from non-raw material inflation in the first quarter of 2023 will be approximately $175 million compared with the first quarter of 2022.
We also anticipate our first quarter 2023 results will be negatively impacted by our reduced production levels in the fourth quarter of 2022 of approximately 3.5 million tire units. We also plan to reduce our production levels in the first quarter of 2023 by the same number of units as the fourth quarter of 2022, which will impact our second quarter of 2023 results.
For the full year of 2023, we expect working capital to be a source of operating cash flows of approximately $100 million. We anticipate our capital expenditures will be approximately $1.0 billion. Our capital expenditures in 2023 will be focused on projects to modernize certain of our manufacturing facilities and expand others to address anticipated future demand.
We have the following comments:
- The company is expected a weak environment in 2023 and will cut production levels further in Q12023. It suggests further gross margin pressure ahead given the company still operated at a high inventory level.
- The company is expected to continue to face an inflation headwind in 2023 and the synergy cost saving is unlikely to offset the pressure. Operating margin and free cash flow margin can go lower in 2023.
Company Fundamental
The company's principal products are new tires for most applications. 86% of its sales in 2022, 85% in 2021, and 84% in 2020 were for tire units. Sales of chemical products to unaffiliated customers were 3% of its consolidated sales in 2022, 2021, and 2020 (5%, 6%, and 5% of America's total sales in 2022, 2021, and 2020, respectively).
The percentages of each segment's sales attributable to tire units during the periods indicated were:
Tire unit sale breakdown by geography (Company's filing)
Tire unit sales for each segment during the periods indicated were:
Tire unit sale breakdown by geography (Company's filing)
The company has significantly increased its market share in the Americas and Asia after the acquisition of Cooper Tire in 2021.
Its replacement and OE tire unit sales during the periods indicated were:
Tire unit sale breakdown by segments (Company's filing)
Its consumer and commercial net sales were $13,163 million and $4,205 million in 2022, respectively. Its consumer and commercial net sales were $11,118 million and $3,702 million in 2021, respectively.
Its consumer and commercial unit sales in 2022 were 169.0 million and 13.6 million, respectively. Its consumer and commercial unit sales in 2021 were 154.2 million and 13.1 million, respectively.
Industry
Peer comparison
The company has two major competitors: Bridgestone (based in Japan) and Michelin (based in France).
Based on Michelin's presentation, the top 3 players account for 34.6% of the total global tire market in 2021.
Market share breakdown (Michelin's report)
Below is the financials comparison based on companies 2022 financials.
At a glance, the company ranked at the bottom in terms of total sales and profitability.
Financials of its peers (Companies' reports, LEL Investment)
*Euro/USD=1.08, USD/JPY=133.6
However, after the acquisition of Cooper Tire in 2021, the company's revenues in America surpassed Michelin in 2022.
Financials of its peers-America (Companies' reports, LEL Investment)
*Euro/USD=1.08, USD/JPY=133.6 (Please see reports of Bridgestone and Michelin )
Based on Michelin's report, we estimated the company has a 20% market share in America. North America and South America grew 10% in Original Equipment ("OE") segment in 2022, outperforming the global average. South America grew 11% in the Replacement segment in 2022, leading globally.
Industry development
In 2022, and especially in the first half, tire markets were extensively impacted by a multitude of disruptions, including automaker component procurement difficulties, complications in the global supply chain (particularly in transportation), the resurgence of the health crisis in China, and the outbreak of war in Ukraine. All these factors and more helped to drive high volatility in sell-in demand throughout the year, even if some sources of strain eased in the second half.
OE tire unit sales (Michelin's report) Replacement tire unit sales (Michelin's report)
The company generated 73% revenue in America in 2022. The improvement of its market position through the acquisition is beneficial to the company long term.
Valuation and Catalysts
The company's valuation multiples are relatively low from the sector median or its 5-year average based on Seeking Alpha's metrics.
Valuation multiples (Seeking Alpha)
If we compared it with Bridgestone and Michelin, the company traded at 0.19x P/S and 3.05x P/EBIT, almost half of where its peers at.
Valuation metrics of its peers (Companies' report, LEL Investment)
DCF valuation
We make the following assumptions based on the company's financials and current market conditions:
- No growth in 2023
- 20% WACC
- 3% terminal growth rate
- 7.5% free cash flow margin
- Net debt 6,683 million (Q4 2022)
- Outstanding shares 284 million (Q4 2022)
Applying the DCF method, we can arrive at an equity value of $2,791 million ($9.8 per share), which implies a 7% decline from the current stock price.
With the sensitivity test below, we can see that the stock is undervalued only if its free cash flow margin increases above 8% or WACC drops below 15%.
Sensitivity Test (LEL Investment)
*negative return below -100% due to negative equity value as a result of high net debt.
Catalysts
In our opinion, the company traded at discount to its peers and its 5-year average for the reasons such as inflation concerns and industry headwind in 2023.
Also, the S&P recently revised the company's outlook to negative, reflecting downward margin pressure. Continued decrease in margin can trigger the stock to reprice by as much as -70% in our DCF model.
The DCF model predicts a significant upside for the stock, nevertheless, if the company can demonstrate improvement in margins or a decrease in WACC as a result of either a reduction in the fed rate or a recessionary environment.
Although short-term margin pressure continued, we are still not very pessimistic about the company. The company was able to increase prices in 2022 to offset its raw material costs pressure. This demonstrated its pricing power to consumers. Also, the company is expected to incur another $250 million in synergy cost savings from the acquisition. Moreover, by strengthening its market position in America over the long term, the company is likely to boost its margin.
Risks
Bankruptcy risks
On Feb 14, 2023, S&P revised the company's credit outlook to Negative to reflect its weak cash flow and margins ahead.
The negative outlook reflects our expectation that credit metrics will remain weaker than previously expected and the risk that they could weaken further should consumer demand for the Goodyear's products materially fall over the next 12 months. Goodyear's fourth-quarter performance was significantly weaker, primarily in Europe. The replacement market was especially weak (down 13.7% for Goodyear in Europe) and margins fell significantly due to a worse mix (less high-margin winter tires), higher input costs (especially energy), and higher unabsorbed overhead costs. The lower margins combined with a greater-than-expected working capital investment which we attribute to lower European sales volumes led to significantly negative free cash flow in 2022 of over $500 million. While leverage of 4.2x at the end of 2022 remains within our expectations for the current rating, FOCF to debt remained below 5% for both 2021 and 2022, which is a downside trigger for the rating. For 2023, we expect debt to EBITDA to be about 4.5x, and FOCF to debt should improve to 3%-5% as working capital investments reverse to some degree.
As of the end of 2022, the company had total credit arrangements of $11,806 million available of which $4,035 million were unused.
The company has a relatively spread-out debt amortization schedule for the next 5 years.
Obligation Amortization Schedule (Company's filing)
Although there is a risk of solvency for the company if the recession in the industry or inflation pressure persists longer than expected, we think the company still has ample liquidity in the next 2 years.
The company survived in 2008 financial crisis and the 2020 COVID crisis.
The company generated 1.1 billion in cash from operations in 2020 when it operated at a loss of 1254 million.
The company generated 1.3 billion in operating cash flow in 2009 when it incurred a net loss of $364 million.
The company's branded quality product portfolios make its inventories more like a source of cash than illiquid assets.
We think this best proves its strong capability to clean inventories in a recession environment. This gives investors confidence to hold the stock.
2009 cash flow statement (Company's filing)
Summary
Overall, we like the company's strong market position and its strategy to compete in the industry. The company has improved its ranking but its stock is still traded at a deep discount to its peers. The company's outstanding capability to generate cash flow amid the 2008 financial crisis and the 2020 COVID disaster is a strong testament to its resilience in recession. We rate this stock Buy.
In the short term, the stock might trade sideways as the market waits for earnings before making a move. For long-term investors, we think the current level is appropriate for entry. Investors should only buy more when this name goes lower due to the macro pressure.
For further details see:
The Goodyear Tire Has Survived Many Bad Years