Sure, Goodyear (NASDAQ:GT) may have a blimp as its marketing prop, but don't mistake that as a sign that its stock is flying high. On the contrary: Goodyear is so burdened with debt, that the company may be celebrating this Christmas in a funeral home. That is, unless, either private equity comes to the rescue or the company does a secondary offering, raises some much-needed cash and pays off hungry creditors. Let's review Goodyear's dire predicament:
Description: Goodyear is a global manufacturer of tires and rubber products. It markets several lines of power transmission belts, hoses and other rubber products for the transportation industry and various industrial and chemical markets. In addition, it operates commercial truck service, tire retreading, and auto service center outlets where the company offers its products for retail sale. Goodyear has 80,000 employees, posted $20 billion in sales last year and currently supports a $2.3 billion market cap.
Thesis: Goodyear finds itself in the middle of a "must restructure or die" scenario. Without sufficient cash flow from US operations, Goodyear could end up going under because of its high debt levels (debt/total capitalization ratio is 70%, way above our 50% preference threshold).
Having mutilated its brand, the company is now attempting to turn things around in the US, which is its largest and worst-performing segment. Management plans to do this by selling non-core business assets, instigating new product launches, tightening distribution, and marketing more effectively. So far, sales have picked up, although a large chunk of that has come from one-time gains. Tire sales is a low margin, cutthroat business (GT's net margins are at a 700 bps discount to S&P's); besides the abrasive competitive milieu, Goodyear must also deal with the bane of looming pension payouts. Goodyear claims 40% of the market for original equipment tires, but because rivalry is thick, price wars ensue among tire companies, leaving customers with high buying power. Lastly, Goodyear is currently fighting some legal messes whose outcomes remain unknown.
Risks: The possibility that Goodyear will have trouble covering interest expenses over the next year is likely; additionally, a secondary offering (whose proceeds will presumably be used to retire debt) will dilute current shareholders and make any future earnings streams less meaningful. Moreover, we're vexed by how little stock insiders at Goodyear own, less than 1% of the 177M shares outstanding. Without stock-based motivation, a successful restructuring appears less likely and the risk/reward becomes far less attractive. Others agree: the short interest ratio on GT shares is 12%, an increase from the previous month.
Valuation: Because of its debt load, tarnished brand image, and questionable management motivation levels, Goodyear stock is trading at a basement level valuation. On a price/sales ratio, Goodyear trades at a discount to both its industry and the S&P; on a forward PEG basis, GT trades at a 55% discount to its estimated 16% EPS growth for 2007 (9.2 forward multiple/16). Nonetheless, investors must take into consideration the firm’s highly leveraged capital structure. Our back-of-the-envelope DCF valuation model (using an aggressive 13% cost of capital) yields a price target of $11, representing a 15% haircut from Friday's closing price. We think holding onto this stock is like lighting a cigarette in a dynamite factory -- you might live, but it's still not a smart move.
GT 1-yr chart: