Wednesday, September 11, 2013

Goodyear Shifts Gears

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U.S. car sales continue to surge. In August, they jumped 17% from a year ago, to a seasonally adjusted 16.1 million cars and trucks, a level that hasn’t been seen since 2007, before the financial crisis and recession.

Rising car sales are being supported by continued low interest rates and declining unemployment. And the trend looks set to continue: the average car on U.S. roads is now 11.4 years old—a new record, according to August figures from Polk Research.

At the same time, rising wealth in emerging markets continues to expand the middle class in those countries. According to estimates from the Brookings Institution, for example, Asia will be home to 64% of the global middle class by 2030, up from 30% today, while 22% of this group will reside in Europe and the U.S., down from about 50%.

Rates of vehicle ownership remain low in those countries. According to figures from the World Bank, there are just 18 vehicles per 1,000 people in India (not including motorcycles) and 58 per 1,000 in China. Compare that to the United States, with 797. Brazil comes in at 209.

Many Options for Investors

There are a number of ways for investors to profit from the rising auto sales. The obvious approach is to buy shares of major automakers like General Motors (NYSE: GM), Ford (NYSE: F) or Nissan (OTC: NSANY). (We took a close look at Nissan in a September 3 Investing Daily article. Click here to read the full piece.)

Another option is to invest in component makers like Magna International (NYSE: MGA), which makes a range of automotive components, including chassis, seats and electronics.

Tire manufacturing is another sector that benefits from rising levels of car ownership. According to 2012 figures from global market research firm Lucintel, the global tire market is expected to reach an estimated $187 billion in 2017, with a compound annualized growth rate of 4% over the five years between 2012 and 2017.

Goodyear Tire & Rubber Co. (NasdaqGS: GT) is the No. 1 tire maker in North America and Latin America, and No. 2 in Europe. Globally, it sits in third spot by sales, behind Japan’s Bridgestone and Michelin of France. In addition to Goodyear, the company makes tires under the Dunlop, Kelly, Fulda, Lee, Sava and Debica banners. It operates 52 plants in 22 countries around the world.  

Akron-based Goodyear traces its roots back to 1898, when founder Frank Seiberling bought the company’s first plant for $3,500 using money he had borrowed from his brother-in-law. Its business also goes beyond car and truck tires: the company also makes rubber-related chemicals for industrial applications and operates commercial truck service and tire retreading centers, as well as 1,400 tire and auto service outlets.

Goodyear also makes tires for aircraft—another market with bright prospects. More on that below.

Latest Earnings Fuel Optimism

In many ways, Goodyear’s results have mirrored those of the global auto industry. In 2012, it saw higher sales to automakers, but replacement tire sales, which comprise a large part of the overall tire market, remained depressed as the weak economy prompted drivers to hold off on buying new tires for their older cars. Like the overall auto industry, Goodyear has also been weighed down by ongoing weakness in Europe.

Sales declined 7.8% in 2012, to $20.9 billion from $22.8 billion in 2011. Net income fell to $0.74 a share from $1.26.

However, in the company’s second quarter earnings report, which it released on July 30, CEO Richard Kramer said he is seeing signs of sales volumes stabilizing.

During the quarter, Goodyear’s revenue declined 5.0%, to $4.9 billion from $5.2 billion a year ago. Tire unit volumes rose 1%, but that was more than offset by other factors, such as lower sales in other tire-related businesses and unfavorable currency exchange rates. Even with the decline, Goodyear’s revenue topped the Street’s forecast of $4.88 billion.

Net income more than doubled, to a record $181 million, or $0.67 a share from $85 million, or $0.33. Excluding special items, Goodyear earned $0.76 a share, up from $0.57 a year ago and ahead of the consensus forecast of $0.48.

Lower raw material expenses and cost cuts were major factors behind Goodyear’s improved profits. “We reported $177 million of reduced raw material costs during the quarter,” said CEO Richard Kramer in the post-earnings conference call.

Turning the Corner in Europe?

The company saw profit gains across all its divisions. In North America, revenue fell 10%, but operating income gained 8.5%, helped by lower costs.

Latin America also showed strength, with sales gaining 5.6% and operating income surging 41.4%. Europe, the Middle East and Africa was also a surprising bright spot. Revenue in the region declined 1%, but tire sales volumes rose 1%. Operating income soared to $51 million from just $19 million a year ago. The Asia-Pacific region’s operating profits rose 28.2%, despite lower revenue there, as well.

“We anticipate volume growth in the second half of 2013 compared to last year, with a 3% to 5% increase in the third quarter, driven by continued improvement in emerging markets and slow but steady recovery in mature markets,” said Kramer. The company also said that it expects full-year operating income of about $1.5 billion, at the high end of its previously announced forecast of $1.4 billion to $1.5 billion.

Aviation Tires Are a Growth Area

As mentioned, the company is also a leading maker of aviation tires, having made its first airplane tire back in 1909, just six years after the Wright Brothers made their first flight. Today, Goodyear makes tires for commercial and military aircraft, as well as spacecraft.

This business’s sales should gain along with global aircraft demand. As Investing Daily managing director John Persinos reported in a December 17 article, $4.5 trillion worth of new passenger jets are expected to be sold over the next two decades. Two-thirds of those planes will be headed for the Asia-Pacific region, as rising wealth in the area drives up demand for air travel.

Goodyear shares have risen sharply so far in 2013, including significant jumps in the wake of the latest earnings report and on news of rival Cooper Tire & Rubber Co. (NYSE: CTB) being taken over by India’s Apollo Tyres.

To be certain, Goodyear faces a number of risks. The tire business is highly competitive, and the stock is volatile, with a beta rating of 2.26 (meaning that it is more than twice as volatile as the overall market). The company’s long-term debt is also high, at $6.3 billion—above its $5.2-billion market cap—though it does hold $2.6 billion of cash on its balance sheet, up from $2.3 billion a year ago. Goodyear also remains heavily reliant on replacement tires and needs a recovery in that market.

On the positive side of the ledger, Goodyear’s sales should stabilize as auto sales continue to rebound in the U.S. and emerging markets. Replacement tire demand should also pick up in the longer term, in light of the fact that consumers have been putting off purchases for much longer than usual.

The stock’s trailing-twelve-month p/e ratio is 17.0, but it trades at just 8.6 times the average analyst earnings estimate of $2.46 a share for this year. Analysts estimate that Goodyear’s earnings could rise to $2.73 a share in 2014.

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