Tim Boyle
Goodyear Tire & Rubber Co (NASDAQ:GT) has endured a torrid 2022 so far in terms of its share price performance, down 49.31% YTD versus 19.46% for the S&P 500 overall. It’s had an incredibly challenging past couple of years, due in large part to the pandemic, and many of the problems this has caused are a long way from abating. However, when you begin to look under the hood, it becomes clear that we are looking at a well-capitalised, well-run company here, with a stellar brand reputation and some fantastic growth prospects. I feel that the current $11.04 is an incredible price at which to get into the share. Although not without risk, I am confident in issuing a strong buy recommendation for the stock at current prices.
The global pandemic and subsequent lockdowns were certainly no cakewalk for tire companies, as I’m sure you can imagine. With swathes of people globally confined to close quarters, both the demand for new cars, along with the low level of driving carried out by individuals compared to pre-lockdown levels (the vehicle miles travelled figure reduced by 430 billion miles in 2020 in the US alone), meant that demand for tires significantly dried up. Add to this the widely publicised car production shortages we’ve witnessed, along with the rise of the Great Resignation movement which has had significant implications for GT in particular (in terms of staffing issues), and you’re looking at a company which suffered a vicious onslaught to its fundamentals that quite rightly would have warranted a downgrade to the valuation investors were to place on it at as the pandemic was unfolding. This was reflected strongly in the financial numbers, with a net loss of $1.2bn in the year 2020.
However, 2021 was a fantastic fiscal year for the company, which is a true testament to the company’s potential, particularly given the fact that many of these trends are still in force to this day – indeed, GT was even hit with an idiosyncratic headwind in the form of severe winter storms affecting some of their US locations, causing losses to the tune of an estimated $44 million in 2021.
I’m of the view that all of this coming to a head at a time when we’ve hit a general market malaise has led to a significantly over-done selling of GT to a price far below what the company’s long term growth trends and current position would reasonably warrant.
Let’s take a look at some of the more prominent growth trends among these, so we can get a clearer picture of the fundamentals of the company:
Cooper Tires Acquisition
Midway through 2021, GT announced the completion of the acquisition of Cooper Tire & Rubber Company for $2.8bn, which it claims will engender huge synergistic benefits.
Synergies are a much-maligned topic when it comes to investment analysis and management science. Accusations range from companies being over-optimistic as to the incipient synergies they believe that a combining of companies will bring about, to the more nefarious assertion that management are doing it so that they can preside over a bigger (and thus more prestigious) company, boosting their credentials, while actually destroying economic value in the process.
On analysis of this particular transaction, I view the acquisition of Cooper to be one of those comparatively rare cases where the synergistic potential is patently clear. Many people may think of vehicle tires as an almost commoditised entity, with little to differentiate between competitors. However, this is not at all the case. The Goodyear brand is known for quality and performance, whereas Cooper is targeted more at a mid-market level. Cooper, being the fifth largest brand of tire in the US, is a large player in the mid-market SUV and light truck space, whereas Goodyear is more of a premium offering. Thus, this partnership makes perfect sense, as not only are the two units unlikely to be stepping on each other’s toes in terms of sales, but they will also benefit from being able to sell the other’s tires from their locations/distribution centres. This brings us neatly onto our next growth driver:
China
China has recently made up a significant part of Goodyear’s sales, and the acquisition of Cooper nearly doubles Goodyear’s presence there. There is also the presence of the aforementioned benefit of being able to sell the Cooper tires through its own incumbent distribution network in the country. Sales of late in the region have predictably fallen as a percentage of the company’s overall sales relative to previous years, yet the APAC region, of which China is a huge part, still represented 12% of overall sales in Q1 of 2022. This came despite the barbaric lockdown measures, car manufacturing slowdowns, and incredibly weak GDP growth figures relative to recent history that the country has faced of late. GT’s operating margin has been higher in the APAC region than in its other primary markets (7.7% in 2021, vs 6% in EMEA, and 6.4% in the Americas.) Assuming that China emerges out of its current malaise and continues on the pre-pandemic path of a seemingly ever-growing accession to the middle class of its citizens, the upside potential is huge in the coming years and represents a huge growth prospect that GT is poised to take advantage of. This is also bolstered by China’s forecast widespread adoption of electric vehicles, to which Goodyear tires are particularly well-suited:
Electrification
The strength of GT as a company in the electric vehicle (EV) space means they are fantastically well positioned to meet EV consumer original equipment (OE) demands. This is where the tires are used on new models (rather than the piecemeal type of business that replacement tires signifies), and can mean extremely lucrative contracts for the firm. Goodyear received a 60% win rate on EV deals as at the end of last year, and is one of the main players in the area – an area where it looks very useful to gain an early foothold in so as to stay at the bleeding edge in order to cater for new developments in the market as and when they arise. EVs demand different capabilities from tires than legacy vehicles do – the cars are heavier for starters, so the tires need to accommodate this – ceteris paribus, a tire used by an EV will wear out quicker than one used on a normal car. There is a need for efficiency in order to improve the range of the EVs – not necessarily such a big concern for traditional vehicles – as well as a need for a quieter tire as the lower volume of electric vehicles makes the tire’s sound more obvious. In addition to this, the regenerative braking technology used in most electric vehicles demands further functionality for EVs that was not an issue beforehand. Growth in EVs is huge – 59% of all new vehicles sold are forecast to be electric by 2035.
A famous adage posits that it’s better to be selling the pickaxes than mining for gold, and Peter Lynch extends this analogy well in One Up On Wall Street by comparing Microsoft to the pickaxe sellers, providing the software instead of the low-margin “boxes” that the likes of Dell and HP viciously competed away margins on. This is analogous to tires, which can be used across vehicle brands – Goodyear, who have started fantastically in this space, will look to profit in this fashion as and when EV explodes, and new players come and go.
Other Growth Areas
GT has invested in many other potential growth areas, some of which are already bearing fruit. In 2020 it launched AndGo, a service which connects mobility companies to service providers for things such as tire maintenance, cleaning, oil changing, etc. This can be used to market their own providers to such companies – many of which have vast fleets of vehicles. After launching, the company saw a five-fold increase in service maintenance jobs in 2021. Another related technology they have recently introduced comes in the guise of SightLine, an intelligent tire solution which monitors tires’ conditions and need for maintenance, and which also proposes to drive traffic (no pun intended) to in-house maintenance. A smattering of recent partnerships, and some interesting investments with their venture fund (including in AmpUp, an EV charging company), also point to other prospective growth areas, which all work to further demonstrate the significant upside potential GT has to offer.
Finances and Risks
Despite sustaining a heavy net loss of $1.2bn in 2020, GT regained ground considerably in 2021 for a net income of $764m. It has a relatively solid debt to equity ratio of 1.4 – this was formerly higher, but it has worked hard to bring down its debt levels recently. Its TTM P/E ratio of 3.7 seems incredibly low to me given its risk characteristics and clear growth prospects. Along with threat of competition and the potential for an incipient global recession that many are now predicting, one of the main risk characteristics that stands out with GT is the secular trend of individuals driving less miles, especially as new lifestyles emerge, such as that which remote working now affords to people.
However, I feel that nothing but risk has been priced into GT. True, it has been the subject of an incredibly vicissitudinous couple of years, but has fought back well to turn a significant profit last year, and has some great growth prospects as shown. The PE is down more than 7-fold since this time last year, despite improving performance. I think this is more likely the product of an overselling in a general market malaise, rather than a re-rating of such an order of magnitude.
Summary
In summary, I believe that GT is a fantastic buy at its current prices. It has carried out what looks to be a great and truly synergistic acquisition recently in the shape of Cooper Tire, and is making all the right moves when it comes to the EV wave. I believe such a stellar name would do well to be included as a small allocation to the discretionary part of one’s portfolio, to enjoy gains as the market recognises its potential, and re-rates the stock to a more realistic level.
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