Tire Manufacturers Finally Ready to Roll

Drop in rubber prices, increase in shipping just what industry needs

   
Tire Manufacturers Finally Ready to Roll

Given the way Cooper Tire & Rubber (NYSE:CTB) and Goodyear (NYSE:GT) shares have been acting over the past 12 months, it’s pretty clear investors have been pessimistic on the tire industry. Funny thing, though … while these two stocks have posted lackluster returns since this time a year ago, the companies themselves have continued to do better.

Is it possible the market got it wrong, and more than that, is it possible each of these outfits could continue to grow the top and bottom lines? In a word, yeah.

The Pessimistic Case

The mid-2011 implosion and lingering lethargy of these two tire stocks isn’t hard to understand. Although stocks were technically in a bull market and economy was growing last year, echoes of 2010’s trucking woes still were ringing in investors’ ears.

Remember, 2010 was a worst-case scenario for Goodyear and Cooper. The economic rebound was tepid, so much so that dozens of major trucking companies like Yellow Roadway (NASDAQ:YRCW) and Arrow — along with thousands of smaller ones — were on the road to bankruptcy. Between not enough demand and rising fuel prices, shipping was a miserable business to be in.

What’s that got to do with tires? The shipping industry is the tire industry’s biggest customer. If the shipping business is drying up, then so is the tire business.

But wait — it gets worse.

As if things weren’t rough enough in mid-2010, rubber prices also were skyrocketing at the time, up 94% in 2009, and halfway to 2010’s 74% price increase. Cooper, Goodyear, and all the rest of the tire makers were able to pass some of that higher cost on to customers, but not all of it. And let’s not forget, the total number of tire customers still was shrinking at the time. Earnings in 2010 were almost as bad for both companies as they were in 2009. So, when battle-fatigued investors saw hints of more economic weakness against a backdrop of strong gas prices in mid-2011, the knee-jerk response was to dump the tire manufacturers.

We saw it happen again in early 2012. Things are very different now than they were in 2010, however, and considerably different than they were in 2011.

From Good to Even Better

Say what you want, but the facts say the tire business is getting better. Cooper struggled a bit in 2011, with per-share earnings falling from 2010’s $2.50 to $1.36. This year’s total is expected to be better, however, reaching $2.23 per share. Goodyear rocked and rolled last year though, cranking up the bottom line from a loss of 95 cents per share in 2009 to a gain of 50 cents in 2010 to a record $1.91 per share last year. Both companies already are on pace for a great 2012 too.

What happened? For starters, demand is better because shippers are busier. In fact, the American Trucker’s Association tonnage (shipped goods) index is now above prior peak levels from the 2002-2005 growth cycle, and was still trending higher as of the last look.

It’s not the bulk of the reason for the tire industry’s current earnings growth, though. For that, you can thank plummeting rubber prices.

The Perfect Storm

There’s a massive raw rubber glut in place right now, so much so that rubber futures contracts are down 14% since the end of April. U.S. prices are about 50% lower than the early February peak. The same price trend is evident in China, which has been the biggest buyer of tires for the past couple of years. The country’s 134,000-ton rubber deficit for the first half of the year is forecasted to become a 402,000-ton surplus in the second. As a result, rubber prices in China — already low — have fallen 20% from their peak earlier in the year, and are expected to slide another 20% by the end of the year. It all means lower expenses for tire companies.

Yes, demand for tires also is waning a bit, but the benefit of lower input costs is a heck of a lot bigger than the downside of weaker tire demand. For perspective, Deutsche Bank’s Rod Lache estimates that for each 1% decline in raw materials costs, Goodyear’s full-year earnings for 2012 improves by 26%. The same basic model has to apply to Cooper as well.

But given how Cooper Tires and Goodyear Tire & Rubber raised tire prices when rubber prices were skyrocketing, won’t they push prices lower again now that input costs have faded? Not likely. Goodyear actually raised prices 6% across the board in April. Yokohama (PINK:YORUF), Toyo, and Bridgestone (PINK:BRDCY) have all also cranked up prices this year, despite the fact that rubber prices started to slide lower last year. Translation: Higher margins.

If anything, this is a perfect storm for Goodyear and Cooper, and by extension, a perfect storm for shareholders. And, with Goodyear’s forward-looking P/E of 4.8 and Cooper Tires’ 6.7, there’s plenty of value packed into the stocks’ prices.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2012/06/tire-manufacturers-finally-ready-to-roll/.

©2014 InvestorPlace Media, LLC

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