Goodyear Tire & Rubber has been outracing its own share price. Since 2007, the year before the world economy went kablooey, company revenue has fallen by about $4 billion to an estimated $15.3 billion this year. That’s because management has walked away from low-value business to pursue profits ahead of volume. Earnings per share are expected to approach $4 this year, up from $1.66 in 2007. Goodyear shares peaked at over $36 that year. They recently sold for $32.18. At that level, about eight times earnings, they’re 57% cheaper than the Standard & Poor’s 500 index.
Key concerns about the stock (ticker: GT) seem overstated and more than priced in. Some investors might view the company as a short-term beneficiary of low oil prices, and thus at risk of a rebound in crude. But while lower materials costs have helped results, companywide efficiency gains have been a bigger driver. A possible peak in North American light-vehicle sales is also a concern, but Goodyear makes more on tire replacements than on new vehicles. A boom in big tires could attract more competition. Then again, new entrants could have a difficult time matching Goodyear’s ability to keep today’s dizzying menu of tire types and sizes in stock at dealers, and its new online system to streamline the buying process.
“Getting tires is not like getting your iPhone upgraded,” Goodyear Chief Executive Richard Kramer told Barron’slast week. “But we’ve got a connected business model that makes the process easier for consumers.”
There’s also an enthusiastic share buyer on the horizon: Goodyear itself. The company appears poised to generate $5 billion in free cash cumulatively through 2020. That compares with a recent stock market value of $8.4 billion. Over the past two years, most of the company’s free cash flow has gone toward debt and pension payments. From here, it could spend nearly all of it on share repurchases and dividends. The dividend yield is only 1.3% now; expect payments to rise quickly in coming years. Look for shares to inflate to a more appropriate level, too. Goodyear could hit $40 in a year for a gain of 25%.
BASED IN AKRON, OHIO, Goodyear began production in 1898—of bicycle and carriage tires, horseshoe pads, and poker chips. It rolled out tires for Henry Ford’s Model T in 1907; developed synthetic rubber tires in 1937; and pushed into radial designs in the 1960s, when it made its billionth tire. Along the way, it had a hand in blimps, tank tracks, and Corsair fighter planes, too. Today, Goodyear holds about a 10% share of the worldwide tire market, putting it third behind overseas rivals Michelin (ML.France) and Bridgestone (5108.Japan). Last year, operating income grew 18% and topped $2 billion for the first time in Goodyear’s history. It would have grown 27% if not for currency head winds. Management aims to get to $3 billion in operating income by 2020.
Part of the growth will come from a continued shift to larger tires, including in the U.S., where Goodyear leads in tires for new vehicles. Demand for 17-inch and larger models has more than doubled since 2010, and management expects it to double again by 2020—much faster growth than the rest of the market.
Partly, that reflects strong sales of pickup trucks, sport utility vehicles, and crossovers, but it’s also about looks. Many cars now come with the option of upgrading to larger wheel sizes. Broadly, larger tires bring in about $25 apiece in gross profit, compared with just $9 for smaller ones, Goodyear estimates. It gets better: As customers buy more cars with larger wheels, they create a lucrative base of future replacement demand. Replacement tires of 17 inches and larger bring in about $32 in gross profit apiece. Goodyear gets 70% of its revenue from replacement tires.
Last month, Barron’s recommended shares of CarMax (KMX), based in part on signs of a coming boom in used-car sales (“CarMax: Ready to Step on the Gas,” Nov. 19). A surge in new-car leases in recent years is now giving way to a flood of off-lease vehicles coming up for sale. Goodyear is poised to benefit from the same market shift.
THE COMPANY’S NEW online ordering service at Goodyear.com lets customers buy tires, have them delivered to a garage, and make an appointment for installation. That’s a play for younger drivers, but it’s also an effort to simplify tire-buying in an era of what CEO Kramer calls SKU-proliferation, a reference to stock-keeping units used to identify different products. Buyers can choose tires for fuel efficiency, sport handling, off-road driving, seasonal driving, and more.
Additional wheel sizes adds another layer of complexity. For Goodyear, that complexity serves as a barrier to entry for smaller players who compete mainly on cost.
Material costs have been rising. Tires can be made from rubber, oil, synthetics, and steel, among other things. An index of these tracked by Morgan Stanley peaked at 216 in 2011, bottomed at 53 early this year, and recently topped 80. But Goodyear’s operating margins have improved by more than seven percentage points over the past five years, and the company says less than one point of that has come from savings on materials. Most has come from a cost-cutting drive and a shift to higher-value tires.
Last quarter, Goodyear lowered its guidance for full-year operating income to a range of $2 billion to $2.025 billion, from its earlier range of $2.1 billion to $2.2 billion. Management blamed that on weak truck-tire orders. Dealers have been destocking ahead of expected new tariffs on Chinese truck tires, which could hit retroactively.
Wall Street was disappointed because the company had reiterated the higher guidance only a month earlier at an upbeat presentation to investors. Shares lost 9% in a day. They’re now down 1% for the year, even though earnings per share are seen growing 18%.
“Tires never grow in a straight line,” says Kramer. “Nothing has changed our long-term strategy or outlook.” JPMorgan recently named Goodyear a top value pick for 2017, with a price target of $43. Its analyst on the stock, Ryan Brinkman, expects the commercial-vehicle tire weakness to begin to reverse as soon as the first half of next year.
LIKE MANY U.S. industrial businesses, Goodyear has benefited from a Trump bump, but in its case, the stock gain merely offset its earnings-day selloff. That’s a buying opportunity. A rise to $40 in a year would leave the stock at only about nine times earnings. Also, Goodyear’s tax rate is expected to hover around 30% in coming years, meaning it could get a modest benefit from a widely expected cut in the corporate tax rate.
Speaking of the president-elect, investors buying shares today of U.S. manufacturers with overseas plants should estimate their Twitter risk. Goodyear is opening a new factory in Mexico next year, where it has not had a manufacturing presence in 15 years. The plant will serve Mexico, Brazil, and other countries throughout the Americas, the company says, which could include the U.S. But the company has a third of its global workforce in the U.S. and says it isn’t moving any U.S. jobs to Mexico.
