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Bull markets that feel "long in the tooth" annoy me. I like to buy stocks when everybody else is running scared. Perhaps "like" is the wrong description. I practice buying stocks when it is most uncomfortable: when prices have been falling and seem to have no signs of recovering. I know I can't pick a bottom, but I know when everyone is emotional, good companies sell for far too little.

Unfortunately, now is not that time, and I'm having a hard time being enthusiastic about opening any position. One stock however, has crossed my screener that seems to be an extraordinary deal. Cooper Tire & Rubber Co. (NYSE:CTB) has had a fairly robust rise in value since November. Valuations appear to justify significant increases in stock price from today's levels in the mid $24s. But is this really a great buy, or is the market flashing a yellow caution light?

The Surface Arguments: Pro and Con

The arguments for buying CTB are fundamental and quantitative in nature. For the most part, I don't chart. I examine valuation through a standard discount free cash flow analysis, ratio analysis, enterprise earnings, and defensive earnings. I look at past and current financial statements to look for accounting inconsistencies and business weaknesses.

As with any company, especially those presenting a possible "value," there are risks and caveats. In this case, we know right off the bat that Cooper Tire faces lawsuits regarding negligence in tire rollovers. Cooper Tire's 10Ks highlight the fact that lawsuits are common in this industry, and that they maintain a rolling reserve to settle litigation. Whether the legal troubles that Cooper faces are routine or not, we should consider the additional uncertainty in our final assessment of value.

Discount Free Cash Flow

The first step I take before delving further into a company is to establish a baseline valuation. I personally base my equity valuation on a discount free cash flow analysis (DCF). As many of the variables in a free cash flow analysis are estimates, I prefer to stay fairly conservative and use buffers on both growth rates and the resulting "fair value."

I've discussed DCF in previous articles, and if you are interested in greater details on my techniques, please feel free to scan my earlier analysis of companies.

First, if we are knowledgeable enough about the company's operations, competitors, and the overall industry, we could build a Proforma spreadsheet and develop growth estimates on our own. Unfortunately, I do not have the knowledge base, nor do the few thousand dollars I'm likely to invest in Cooper Tire warrant such a detailed look. I am forced to piggyback off analyst growth estimates.

If I go to yahoo finance and look at analyst estimates, I can get a look at both analyst growth estimates for the upcoming years, and I can look at how close analysts came in recent years to meeting their earnings estimates. Below is a copy of the chart from yahoo finance, detailing future growth estimates. I also included a chart from streetinsider.com with two years' worth of earnings per share vs. consensus estimates. Yahoo's records only reflected one year.

Growth Est

CTB

Industry

Sector

S&P 500

Current Qtr.

94.10%

41.20%

114.50%

12.40%

Next Qtr.

21.30%

8.30%

55.30%

16.80%

This Year

0.30%

1.00%

15.30%

8.30%

Next Year

5.30%

26.50%

26.30%

12.60%

Past 5 Years (per annum)

54.66%

N/A

N/A

N/A

Next 5 Years (per annum)

7.10%

17.88%

34.72%

9.33%

Price/Earnings (avg. for comparison categories)

7.26

7.73

19.02

19.09

PEG Ratio (avg. for comparison categories)

1.02

0.68

1.35

2

Date

Qtr

EPS

Cons.

Surprise

Revs

Cons.

% Since

2/25/2013

Q412

$1.15

$0.85

$0.30

$1.04B

$1.03B

-0.037

11/2/2012

Q312

$1.17

$0.86

$0.31

$1.05B

$1.11B

0.214

8/9/2012

Q212

$0.82

$0.50

$0.32

$1.06B

$1.04B

0.351

5/2/2012

Q112

$0.34

$0.31

$0.03

$984.26M

$998.96M

0.615

2/27/2012

Q411

$0.51

$0.39

$0.12

$1.05B

$1.02B

0.562

10/31/2011

Q311

$0.27

$0.29

-$0.02

$1.05B

$1.01B

0.707

8/4/2011

Q211

$0.18

$0.41

-$0.23

$922M

$979.9M

1.147

4/26/2011

Q111

$0.25

$0.22

$0.03

$906M

$909.18M

-0.087

There is a fair amount of information that can be gleaned from these charts. First, growth estimates are not extraordinarily high, given significant recent growth. In addition, growth estimates are lower than both industry and market projections (market, in this case, being defined as S&P 500). Obviously, analysts predict a pullback for Cooper Tire, and we will need to determine why.

The growth estimates aren't necessarily bad news. Drastic drops in growth rates may have chased investors off, but the company IS still growing, and if we are able to pay a deep discount price for cashflow, we should take it, even if growth in earnings is slow.

Furthermore, a quick look at analysts' earnings estimates in the past show that they have consistently undershot true earnings. Analysts seem to have been overly pessimistic in the past, and, barring further revelations, it is fairly reasonable to assume earnings may be somewhat better than expected in the future. If stock prices are depressed due to the significant drop in growth rate estimates, investors should benefit from likely future earnings surprises.

In order to determine what is driving analyst growth estimates, I turned to a couple of reports published by S&P and Ford Equity Research. Standard and Poore's April 20, CTB Stock Report had little to say regarding Cooper Tire's future prospects:, but Ford Equity Research (April 19), stated:

Ford's earnings momentum measures the acceleration or deceleration in trailing 12 month operating earnings per share growth. The downward curvature of the plotted points in the graph on the right indicates that while Cooper Tire & Rubber Co.'s earnings have increased from $1.69 to an estimated $3.73 over the past 5 quarters, they have shown strong deceleration in quarterly growth rates when adjusted for the volatility of earnings. This is an indication of weakness that could lead to declining earnings.

Fair enough. But there are a number of factors, which could lead such projections to be pessimistic. Decreasing commodity costs, 2012 labor dispute settlements (see here), expansion into the Chinese market through CTB's 51% ownership of Cooper Chengshan, and increasing domestic demand should bolster revenues and reduce costs this year. Any faltering in the economy would negate these benefits of course. However, to stay conservative, we will assume that Ford has accounted for all these factors, and proceed with analysts' estimates.

Often, I'll shave 10% to 25% off of analysts estimates, based on past performance, and my overall assessment of the industry. In this instance, however, analyst opinions were typically below results. I will round down to the nearest percentage, and call that a significant moat.

I will use 11% as my required rate of return (discount rate), and I'll use 3% as a horizon growth rate. People tend to have a lot of heartburn with my horizon growth rate. I don't try to estimate growth outside of five years, and simply use what is roughly a long-term inflation average. I'm perfectly open to constructive criticism on this rationale, or any others within this article.

Financial statement numbers are from Morningstar.com. As stated above, I've rounded down analyst growth rate guesstimates, resulting in 5% growth for 2013, and 7% for the following five years. Perpetual growth, after year five, is estimated at 3%.

Actual

Income Statement ($ millions)

2012

Net Sales

4,201

Cost Of Goods Sold

3,547

Selling, general & administrative

257

Depreciation

0

Operating profit

397

Balance sheet ($ millions)

Cash

352

Inventory

562

Accounts receivable

415

Total operating current assets

1,329

Net PP&E

929

Total operating assets

2,258

Accounts payable

380

Accrued expenses (and leases/notes payable/misc)

222

Total operating current liabilities

602

Free Cash Flow Calculations ($ millions)

Operating Income

397

Tax on Operating Income

135

NOPAT

262

Net Operating WC

727

Net Operating Long Term Assets

929

Total Net Operating Assets

1,656

Investment in net operating assets

51

Free Cash Flow

211

free cash flow

211

growth rate in free cash flow

WACC/ or required rate of return

0.11

Horizon value

3%

Value of operations

$3,237

Value of investments

0

Total value of firm

3,237

value of all preferred stock

-

Value of equity

3,236.7

Number of shares (millions)

63.16

Estimated Share Price

$ 51.25

Growth rate

7.00%

Value Moat

25.00%

Buy Under price!

$38.43

Using analysts' growth rates (and a horizon growth rate of 3%), I come up with a fair value of $51.25. Accounting for an additional 25% safety moat (we have to assume things will go wrong with our investment hypothesis, and we want the odds to still be in our favor), we come up with a buy under $38.43. At these prices, this stock looks like a steal! So load up our retirement fund and call it a day? Not just yet. Anytime the market seems to give us a gift so shiny it's glowing, we need to stop and get our oven mitts to try to avoid getting burned. We will need to read through the annual statements to try to find some clue as to why these shares are so cheap. But first, we can squeeze a little more information out of the analysis we've already done. In order to do so, we will tweak our DCF analysis, to see what kind of assumptions would make today's CTB price a "fair price." I can alter the growth rate, or I can alter my required rate of return. Everything else is based on numbers provided by Cooper Tire, and can be presumed to be accurate.

By changing my required rate of return, I find I can "calculate" a fair value DFC of today's market prices with a required rate of return of 19%. If I instead hold required rate of return constant, then it appears investors expect an earnings shrinkage of 11.5%. Either the market considers current cash flows to be suspect, and therefore requires larger returns to compensate for the uncertainty, or it expects drastic earnings issues in the near future.

Subsurface Valuation

One problem with relying on DCF analysis alone is that we get no sense of how likely our estimated growth rate is to be sustained. Will healthy competition eat away at market share faster than expected? Will the company fritter away profits on "investments" that prove to be non value additive. Are company financial statements reliable, or are they employing accounting gimmicks destined to bite the unwary investor down the road. We can't know the future, but we can look at recent company behavior, and try to determine how effective the company has been in some of these areas.

Enterprise Earnings

I've used enterprise earnings in the past to demonstrate that intangible investments were not yielding the profitability that bulls were arguing for Amazon.com (see article here). Now I want to run the analysis to determine whether investments in advertising and R&D are yielding profits. The method I use is detailed in Hewitt Heiserman Jr.'s excellent book, "It's Earnings that Count." Mr. Heiserman details the creation of the "enterprising income statement," which strives to account for the value that intangible investments bring to the company.

Detailing this method would warrant an article unto itself. Furthermore, I feel it would be a disservice to Mr. Heiserman to disclose the specifics of his methodology, given that he is selling books describing that very thing. However, here is the general idea.

Mr. Heiserman argues that investors who rely on a company's investment in R&D, patents, advertising etc., to produce value must have a way to measure the value created by those investments. GAAP accounting requires companies to expense intangibles such as R&D and advertising, rather than depreciate it, as one would do with expenditures on tangible assets. Furthermore, he argues that GAAP accounting treats shareholder equity as a free source of financing. His "Enterprise Income Statement," one of several "income statements" in the book, treats intangibles as depreciable assets, while attempting to account for the cost of issuing equity.

The calculations result in an "enterprise earning per share" where we can view capitalized intangibles in the same light as debt and equity. The more money earned per dollar spent on intangibles, the more efficient the company. With this information, we can see trends in Cooper's enterprise EPS to see whether the business is becoming more or less efficient. Those of you still reading should note that I have only capitalized advertising and R&D costs found in the 10Ks. Cooper's 10Ks explain that it already capitalizes other intangibles, which is a pretty aggressive accounting strategy.

Intangibles Net Income

2007

2008

2009

2010

2011

2012

Revenue

2932.60

2881.80

2779.00

3361.00

3927.20

4200.80

Cost of Sales

2461.70

2649.90

2203.50

2784.00

3404.60

3371.80

Selling, marketing and admin

177.50

185.10

214.00

211.70

201.00

257.30

Other expense

0.00

0.00

0.00

0.00

0.00

0.00

Intangibles reversal

-64.74

-71.16

-65.99

-69.98

-78.99

-100.56

Intangibles

0.00

71.08

69.68

70.88

70.17

77.33

Interest expense

245.38

233.27

194.65

177.87

205.80

247.97

imputed interest operating leases

-0.43

-0.43

-0.93

-0.88

-0.83

-0.78

taxes

15.80

-30.30

0.20

20.10

-135.50

116.00

total expenses

2835.21

3037.47

2615.11

3193.68

3666.26

3969.07

Profit

97.39

-155.67

163.89

167.32

260.94

231.73

Per-share "earnings"

$1.55

-$2.64

$2.70

$2.67

$4.14

$3.67

enterprise P/E ratio

9.25

-6.25

2.29

7.60

5.78

3.92

With results in hand, we can see that enterprise earnings, at least for the past four years, are positive. Furthermore, if we convert the "earnings" to P/E, (I used opening prices from the following year), we find that, for the past three years, Cooper's enterprise earnings are becoming cheaper to acquire.

Defensive Earnings

Another method Mr. Heiserman advocates is the use of a "defensive earnings statement." Now we are attempting to ascertain whether the company can self fund its operations. Since GAAP accounting rules do not expense fixed and working capital investments, it can be hard to determine whether the company is producing earnings above and beyond such investment. By subtracting such costs from our operating income, we can come up with a third measurement to judge value from.

2007

2008

2009

2010

2011

2012

operating income

134.4

-216.6

156.3

188.4

163.3

397

Investment Fixed Cap

155.4

65.2

106.1

157.7

275

134.9

Working Capital

1.6

-172.7

-20.5

164

146.8

63.5

Taxes

15.8

-30.3

0.2

20.1

-135.5

116

Profit

-38.4

-78.8

70.5

-153.4

-123

82.6

EPS

-$0.61

-$1.34

$1.16

-$2.45

-$1.95

$1.31

P/E

-23.45

-12.35

5.32

-8.29

-12.26

11.00

In this case, Cooper Tire's earnings history does not look so rosy. Four out of six years yielded negative results when accounting for capital expenditures. It is slightly encouraging that the most recent year, was resoundingly positive, but this evaluation casts some doubt into my mind that our DCF model reflects all risk inherent in this company.

Ratio Analysis

Ratios give us a simple way to compare financials between one company and its competitors to get a sense of financial health and competitiveness. Ideally, one company would be compared with another in an almost identical market. In this case, Cooper's two biggest competitors, Bridgestone and Michelin Tires are not traded on the U.S. boards. So I have compared Cooper to Goodyear Tire Company (NASDAQ:GT) as well as the industry average. All numbers were pulled from reuters.com.

Ratio

CTB

Industry

GT

P/E Ratio (NYSE:TTM)

7.05

11.84

15.34

Price to Book (MRQ)

2.05

1.88

85.79

Price to Tangible Book (MRQ)

2.64

1.9

--

Price to Free Cash Flow

7

5.04

--

Dividend Yield

1.71

0.51

--

Dividend Yield - 5 Year Avg.

2.36

0.69

0

Dividend 5 Year Growth Rate

0

10.18

--

Sales - 5 Yr. Growth Rate

7.45

10.21

1.34

EPS - 5 Yr. Growth Rate

19.04

40.9

4.83

Quick Ratio (MRQ)

1.36

1.05

1.1

Current Ratio (MRQ)

2.21

1.51

1.69

LT Debt to Equity (MRQ)

44.37

64.24

1,176.68

Total Debt to Equity (MRQ)

49.01

89.26

1,227.80

Net Profit Margin

6.01

10.68

1.28

Receivable Turnover

9.96

6.39

6.2

Inventory Turnover

6.9

5.37

4.62

Return on Assets

9.51

7.4

1.47

Return on Assets - 5 Yr. Avg.

4.78

4.36

0.13

Return on Investment

13.52

10.26

2.31

Return on Investment - 5 Yr. Avg.

7.23

5.44

0.2

Return on Equity

33

19.13

110.28

Return on Equity - 5 Yr. Avg.

18.81

10.54

-4.09

Pitting ratios side by side, we can see that Cooper Tire outperforms Goodyear in almost every way. In terms of value, Cooper Tire's Price to Earnings, Price to Book Value, and Price to free cash flow all are superior to Goodyear. However, Cooper Tire seems to be a little expensive when compared to industry averages when considering book value and free cash flow.

We can evaluate profitability by looking at ROA, ROI, and ROE. Cooper Tire outperforms both the industry and Goodyear in all areas (one notable exception being ROE , which lags Goodyear significantly). Even more intriguing, if we look at Cooper Tire's leverage usage (See d/e or LT Debt/Equity), we see that they are accomplishing higher ROEs than the industry and, for the most part, Goodyear with significantly less debt. All of this data points to an efficient use of resources when compared to competitors.

Speaking of debt, debt-to-equity ratios show that the company is using debt to reduce tax obligations, while still maintaining a healthy balance sheet. For short-term concerns, we can look to Quick and Current ratios, which measure liquidity and solvency (higher numbers are better), and we can see that the entire industry, Goodyear included, appears healthy (over 1.0). Again, Cooper leads, demonstrating its ability to meet short-term obligations is somewhat better than its peers.

One final point I'd like to take from the ratio analysis is on the subject of dividends. Many people prefer owning positions with dividends, and I'm in that camp. We can see that Cooper Tire's dividend yield exceeds both industry standard, and its competition. We also see a big fat 0 in the dividend growth rate column. The dividend makes this somewhat more attractive for those of us who are still investing for total yield, but if growing dividend streams is your sole concern, this company probably isn't going to be attractive to you.

Common Size Balance sheet and Income Statement

At this point, I'd like to take a closer look at Cooper Tire's financial statements themselves and see if we can find any clues as to whether the company has any hidden skeletons, or simply whether it has any growing weaknesses. To do so, I employ a quantitative technique known as Common-size Analysis. I first learned of this technique in a Master's class, from a book entitled Financial Shenanigans, by Howard Schilit. For those of you interested in doing this type of analysis on a regular basis, I highly recommend getting the most recent edition of this book. The checklists of "shenanigans" within the book come in handy when evaluating financial statements.

Common-Size analysis is an attempt to look at a company's balance sheet and income statement in relation to total assets and total sales, respectively. The first portion of common-size analysis is vertical analysis, where all balance sheet items are expressed as a percentage of total assets and all income statement items as a percentage of net sales.

ctb

Year

2008

2009

2010

2011

2012

TTM

Month

12

12

12

12

12

Prior 4 Quarters

2008/12

2009/12

2010/12

2011/12

2012/12

0

Income Statement

Revenues

Revenue

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

COGS

91.95%

79.29%

82.83%

86.69%

80.27%

80.26%

Gross Profit

8.05%

20.71%

17.16%

13.31%

19.73%

19.74%

Operating Expenses

SG&A

6.42%

7.70%

6.30%

5.12%

6.13%

6.12%

R&D

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Other

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Operating Income

-7.52%

5.62%

5.61%

4.16%

9.45%

9.45%

Other Income and Expense

Net Int Inc & Other

1.43%

1.47%

0.85%

0.74%

0.68%

0.68%

Earnings Before Taxes

-8.95%

4.16%

4.75%

3.41%

8.77%

8.77%

Income Taxes

-1.05%

0.01%

0.60%

-3.45%

2.76%

2.76%

Earnings After Taxes

-7.61%

4.15%

4.16%

6.86%

6.01%

6.01%

Acctg Changes

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Disc Operations

0.00%

-1.14%

0.72%

0.00%

0.00%

0.00%

Ext Items

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Net Income

Net Income

-7.61%

1.86%

4.18%

6.45%

5.25%

5.24%

Net Income %

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Diluted EPS, Cont Ops$

-0.13%

0.05%

0.06%

0.10%

0.08%

0.08%

Diluted EPS$

-0.13%

0.03%

0.07%

0.10%

0.08%

0.08%

Shares

Balance Sheet

Assets

Cash and Equiv

12.12%

20.33%

17.93%

9.34%

12.56%

12.56%

Short-Term Investments

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Accts Rec

15.57%

17.47%

20.98%

19.97%

16.72%

14.83%

Inventory

20.56%

14.21%

16.78%

18.61%

20.06%

20.06%

Other Current Assets

2.85%

1.88%

2.44%

2.62%

2.41%

4.30%

Total Current Assets

51.11%

53.89%

58.13%

50.54%

51.75%

51.75%

Net PP&E

44.12%

40.52%

36.97%

38.75%

33.18%

33.18%

Intangibles

0.97%

0.88%

0.75%

0.70%

5.35%

5.35%

Other Long-Term Assets

3.79%

4.71%

4.15%

10.02%

9.72%

9.72%

Total Assets

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

Liabilities & Equity

Accts Payable

12.17%

14.30%

16.68%

13.56%

13.56%

13.56%

Short-Term Debt

7.23%

0.74%

0.26%

0.85%

0.08%

0.08%

Taxes Payable

0.00%

0.00%

0.00%

0.00%

0.00%

0.00%

Accrued Liabilities

0.00%

0.00%

0.00%

0.00%

0.00%

7.92%

Other Short-Term Liabilities

15.23%

15.25%

13.18%

11.62%

9.74%

1.82%

Total Current Liabilities

34.63%

30.30%

30.11%

26.03%

23.39%

23.39%

Long-Term Debt

15.94%

15.76%

13.91%

13.17%

12.00%

12.00%

Other Long-Term Liabilities

35.03%

37.50%

35.99%

37.69%

37.57%

37.57%

Total Liabilities

85.60%

83.56%

80.01%

76.90%

72.95%

72.95%

Total Equity

14.40%

16.44%

19.99%

23.10%

27.05%

27.05%

Total Liabilities & Equity

100.00%

100.00%

100.00%

100.00%

100.00%

100.00%

Cash Flow from Operations

-167.2

444.6

174.7

125.5

454.2

Net Income

-219.4

51.8

140.4

253.5

220.4

52.2

392.8

34.3

-128

233.8

Vertical analysis has revealed a few issues that I have concern with. First, we notice in the time period from 2008-2009, Gross margins grew by 257% in relation to total revenues. What happened to Cost of Goods Sold in 2009 that enabled Cooper Tire to increase their gross margins to such an extent?

According to Cooper Tire's 2010 amended 10K, raw material costs in 2008 were at record highs, but a drop in raw material costs yielded $411.1 million in savings for 2009. Looking at 2007 and before, I see Gross margins in the 16 to 17% range, so this answer is fairly credible to me. Unfortunately, this isn't the only issue I see.

A look at PP&E over the entire time period (2008-2012), we see a gradual drop from 44% of total assets to 33% of total assets. We have to keep in mind two things. First, the numbers I used throughout the spreadsheet were Net PP&E not gross PP&E, so the numbers don't directly reflect a decrease in investment. In fact, we know that the company is investing in fixed capital (see defensive earnings worksheet), and that this investment doesn't seem to have a down trend over the past few years. But if Net PP&E is decreasing, and there is no trend in amounts invested in fixed capital, then the company change must be coming primarily from depreciation expense. It appears to me that Cooper Tire was once more heavily invested in infrastructure than it is at this time. At some point, Cooper Tire is going to have to reinvest in capital, and when that happens, earnings will most likely drop.

From 2010 to 2011 cash, as a percentage of total assets, fell by nearly half (8.59%). According to the 2011 10K, Cooper Tire purchased remaining ownership interest in Cooper Kunshan, which cost it $117 million. This could account for up to 4.7% of the difference between 2010 and 2011. A one-time expenditure of this level combined with higher costs could account for the difference. Still, precipitous cash drops bear watching, and we should watch for further drops in the future.

Finally, and perhaps most disturbingly, we see a drastic drop in Cash Flow from Operations between 2009 and 2011. Worse still, Net income increases over this period of time, to the point that Net Income is higher than CFFO in 2011. Seeing CFFO rise above net income is alarming because it can be a symptom of channel stuffing. Channel stuffing exists when a company attempts to boost earnings by pushing inventory to its retailers it knows they cannot sell. Of course, retailers end up sending inventory back up the distribution chain, which ultimately is reflected in the numbers.

In this case, Cooper Tire has an independent accounting firm auditing its financial statements. I have a hard time believing Ernst & Young LLP would miss anything as blatant as channel stuffing. Perhaps I lack imagination, but something more mundane and less illegal is probably going on here.

Nevertheless, seeing Net Income jump over CFFO in the recent past IS a warning sign that something is unhealthy in the cash cycle. This is a red flag for me, and may explain why the market has discounted the stock so heavily.

Horizontal Analysis

A second method of analysis Mr. Schilit recommends is horizontal analysis. Horizontal analysis looks at percentage change for each financial statement item from year to year. This allows us to better visualize relationships between revenues and expenses, as well as highlight areas where one of those relationships has changed. When the relationship between two entries change, we can dig deeper to find the cause.

CTB

Year

2008

2009

2010

2011

2012

Month

12

12

12

12

12

2008/12

2009/12

2010/12

2011/12

2012/12

Income Statement

Revenues

Revenue

98.27%

96.43%

120.94%

116.85%

106.97%

COGS

107.65%

83.15%

126.34%

122.29%

99.04%

Gross Profit

49.26%

248.12%

100.26%

90.59%

158.63%

Operating Expenses

SG&A

104.28%

115.61%

98.93%

94.95%

128.01%

R&D

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Operating Income

-161.16%

-72.16%

120.54%

86.68%

243.11%

Other Income and Expense

Net Int Inc & Other

223.91%

99.03%

70.10%

102.10%

97.60%

Earnings Before Taxes

-222.24%

-44.80%

138.35%

83.92%

274.79%

Income Taxes

-191.77%

-0.66%

10050.00%

-674.13%

-85.61%

Earnings After Taxes

-240.04%

-52.55%

121.25%

192.85%

93.62%

Acctg Changes

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Disc Operations

5.88%

-31700.00%

-76.03%

0.00%

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Ext Items

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Net Income

Net Income

-183.44%

-23.61%

271.04%

180.56%

86.94%

Net Income %

Diluted EPS, Cont Ops$

Diluted EPS$

Shares

94.10%

102.88%

103.13%

100.64%

100.32%

Balance Sheet

Assets

Cash and Equiv

71.61%

172.39%

96.81%

56.53%

150.53%

Short-Term Investments

0.00%

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Accts Rec

89.63%

115.37%

131.80%

103.25%

93.79%

Inventory

137.92%

71.03%

129.62%

120.32%

120.73%

Other Current Assets

43.28%

67.58%

142.89%

116.34%

103.21%

Total Current Assets

87.76%

108.39%

118.41%

94.31%

114.69%

Net PP&E

90.88%

94.42%

100.16%

113.69%

95.89%

Intangibles

71.07%

92.96%

93.51%

100.58%

862.07%

Other Long-Term Assets

88.88%

127.74%

96.57%

262.03%

108.66%

Total Assets

88.94%

102.81%

109.77%

108.48%

112.00%

Liabilities & Equity

Accts Payable

85.34%

120.84%

128.00%

88.22%

112.00%

Short-Term Debt

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10.49%

38.06%

359.32%

10.85%

Taxes Payable

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Accrued Liabilities

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Other Short-Term Liabilities

128.98%

102.99%

94.85%

95.62%

93.91%

Total Current Liabilities

132.86%

89.94%

109.12%

93.76%

100.63%

Long-Term Debt

70.10%

101.63%

96.89%

102.74%

102.00%

Other Long-Term Liabilities

141.00%

110.08%

105.33%

113.62%

111.63%

Total Liabilities

116.23%

100.35%

105.11%

104.26%

106.26%

Total Equity

37.12%

117.41%

133.45%

125.39%

131.12%

Total Liabilities & Equity

88.94%

102.81%

109.77%

108.48%

112.00%

Horizontal analysis reveals even more potential pitfalls. Starting in 2009, we see both accounts receivables and inventory growing faster than sales. The fact that receivables are growing faster than sales is disturbing because, like our CFFO findings above, it indicates there may be some problems in the cash cycle. Perhaps company credit policy is too loose. Unfortunately, I was unable to find anything in the 10Ks from 2008 to 2012 that explains the change.

Inventory growth is another concern as it shows that the company is producing more tires than it can sell. Building inventory costs the company in storage, and eventually, obsolete merchandise. By the way, inventory growing faster than sales can be a sign that obsolete inventory is not being written off, but maintained on the balance sheet as an asset. Again, we can assume that Ernst & Young are doing its job, and nothing of the sort is taking place. Either way, inventory growth over several years is not a desirable trait.

The year 2010 saw a couple of other accounting anomalies that bother me. First, other current assets grew faster than sales in 2010. In addition, SG&A grew slower than sales from 2010 and 2011.

Other current assets could be restricted cash, or investments or anything else the company deems "like cash," but is not cash, securities, receivables, inventory, or prepaid assets. Fortunately, Cooper Tire spells out what constitutes other current assets in the 10K (2010 10K pg. 43 note 3). The change increase comes entirely from "Income tax recoverable," which jumped nearly $19 million dollars.

SG&A grew slower than sales, which can be a sign of company capitalizing operating costs improperly (as is other current asset growth when it's faster than sales). However, Cooper Tire has already pointed out that raw material costs dropped over this time period, which could easily explain why SG&A and sales are deviating.

SUMMARY

When I first started this article, I thought I would be making a slam dunk case for purchasing CTB. I put a lot of weight on DCF analysis, and finding a company that is selling for half of my estimated fair value is an enticing proposition. But such discounts should make us cautious. EMH proponents would tell us that such opportunities never exist. I have not found that to be true. But I have found that cases should be extremely rare. You will find legitimate valuation distortions most often in times of panic, either market-wide, or overblown bad news within the company itself.

Still, I thought Cooper Tire might be sufficiently boring enough to have been ignored by investors, who are busy poring dollars into Netflix (NASDAQ:NFLX), Amazon.com (NASDAQ:AMZN), and LinkedIn (NYSE:LNKD). Every once in a while I've found great deals in companies that simply do not garner enough attention from investors. They languish for a while, until enough people searching for value find them, and the word spreads.

I am not convinced that this is the case here. I think there is room to make money here. Just because I couldn't find satisfactory answers to some of my accounting concerns (see net income exceeding CFFO), doesn't mean satisfactory answers don't exist. I'm fully willing to admit that the probability that my lack of understanding exceeds the probability of any sketchy behavior taking place on the part of the company. However, with so many questions, it's hard for me to take my DCF valuation, even with its built in buffer, as a reliable indicator of value.

If I decide to invest in Cooper Tire, I need to be compensated for additional risk. Rather than demanding an 11% return, I will be looking for at least a 15% return. Rerunning my DCF analysis discounting at 15%, yields a buy under price at $25.27 with a fair value price $33.69.

I've already sold 2 22.50 puts (May 18 expiration), foolishly doing so before I completed my analysis. I am still confident that this trade will yield favorable results. However, before I commit additional funds, I need to find solid answers to the questions posed by the vertical and horizontal analysis.

I'd be very interested in hearing readers thoughts regarding the points made in this article. Maybe I'm missing some mitigating circumstances that make this company a great buy. If so, please feel free to comment.

Thank you for taking the time to read my article.

Source: Cooper Tire & Rubber Co.: Should Investors Load Up Or Tread Carefully?

Additional disclosure: I am long this position through short put contracts.