Shares of wheel and tire maker Titan International (NYSE:TWI) continue to tumble, trading at $18.09 as of this writing (at 1:30 EDT), down 18.5 percent from Thursday's close. The catalyst for the fall was apparently remarks from CEO Maurice Taylor about the tire market quoted in a press release concerning a potential investment by the company in Russia.
Indeed, Taylor's comments began rather ominously, as he wrote that:
I have stated over and over that all the talk of tire shortages has been false. Well, in the past couple months, millions of dollars in tires have been dropped into the aftermarket from the OEMs in the farm and construction industries and also the mining companies, who had built up inventories greater than a year and are now releasing these tires. This will affect every tire manufacturer worldwide.
In other words, Titan customers -- equipment makers such as Deere & Company (NYSE:DE) and CNH Global (NYSE:CNH) -- have surplus inventory of Titan off-road tires and are selling them at a loss to clear them. Clearly, the presence of significant numbers of new tires available at a substantial discount not just to their current price, but the cost of manufacture provides a substantial headwind to Titan and other competitors such as Carlisle Companies (NYSE:CSL).
Investor and analyst reaction was swift and fierce, as the stock plunged and at least four analysts downgraded Titan stock, a serious number given that Reuters lists only six analysts covering the stock.
But there are a number of reasons to believe that Titan's fall is overwrought, and the pessimism toward Taylor's comments overdone. The first comes from the release itself, as the second half of the CEO's commentary showed a more positive long-term outlook:
The entire volume of tires will have an aftermarket effect for a few months before things get back to normal. We feel that this is a bump in the road as we have experienced this in the past...The selling price of all our products is going down because our material cost has been dropping. The guidelines that I gave in December of 2012 will be adjusted downward, but I need to find out approximately how much the mining companies will be lowering their inventories.
The "guidelines" from December to which Taylor refers were guidance for 2013, in which Titan announced its goals as $2.4-$2.7 billion in revenue (up 40 percent year-over-year at the midpoint, in large part to due to the acquisition of Titan Europe in Q4) and $340-$400 million in EBITDA. So while revenues may fall toward -- or below -- the bottom half of Taylor's guided range, lower raw material costs will boost gross margin and perhaps keep earnings from falling as far as feared. Even at the low end of the EBITDA range, pre-tax earnings will be roughly $240 million. Assuming depreciation and amortization rise in line with revenue growth to $70 million, and interest expense rises modestly to $30 million, pre-tax income would still hold at $240 million; net income would come in no less than $140 million, or roughly $2.10 per share. That would put TWI's P/E ratio below 9.
It is true that in the wake of Taylor's updated remarks on the tire market, analysts took a more bearish approach to the numbers; Jefferies cut its FY13 estimates to $1.75 per share, with the FY14 number going from $2.75 to $2.25 per share. Jefferies cut the shares from "Buy" to "Hold"; equivalent moves also came from Feltl & Co., William Blair, and Janney Montgomery Scott.
But, at current levels, Titan still offers a FY13 P/E just over 10, and an FY14 P/E of 8 based on Jefferies' numbers. And much of the analysts' concerns would appear to be baked in:
|Feltl & Co.||$22.00||21.6%|
* -- from TWI price of $18.09 at 1:30 EDT
In other words, the herd of analysts downgrading the stock still, on average, are projecting double-digit gains for TWI shares over the next 12 months.
To be fair, the cyclical nature of TWI's business will usually give the stock a lower valuation. Indeed shares of DE and CNH, Titan's two largest customers (accounting for 19% and 10% of net sales in 2012, respectively, according to Titan's 10-K) offer earnings multiples in the same range. But at the same time, Titan offers growth opportunities not seen at either Deere or CNH. As Taylor noted in his December guidance, the company has grown revenue from $866 million in 2010 to $1.82 billion in 2012, with the company's goal (at the time) to reach a $4-$4.5 billion run rate by 2015, through organic growth and acquisitions. If the dumping of OEM tires into the aftermarket is truly a short-term issue, that $4 billion goal may be delayed. But with a drop of over 20 percent in the share price in barely a week's time, that delay would seem to be more than priced in. With Titan's market cap headed toward $1 billion -- and its enterprise value below $1.5 billion -- reaching the $4 billion target in sales would seem highly likely to result in a share price up nicely from current levels.
The question, of course, is: is the aftermarket dumping truly, as Taylor said, "a bump in the road," or is it the first sign of structural, longer-term weakness in the farm, mining, and construction segments which will cause Titan to see dramatically lower revenue and margins? Right now, the rest of the market -- excluding Titan analysts -- appears rather sanguine about the equipment market itself:
CNH data by YCharts
If analysts of CNH and DE felt that Titan's issues were truly evidence of a long-term problem in the equipment industry, it seems likely that their shares would have fallen in sympathy with Titan's fall. Yet that is not the case.
TWI's fall has moved shares toward levels not seen in over eighteen months, and near a long-term support level around $18 (previously hit in late 2011 and October 2012). Both times, the cyclical stock rebounded strongly off support, and once the current carnage ends, it seems likely TWI will see another bounce. Taylor's comments should cause TWI shareholders some concern; but they hardly seem to justify what is now a nearly twenty percent plunge in less than a full session (the Titan release went out at 2:46 pm on Friday afternoon). Even those analysts concerned by the news are projecting gains from current levels; analysts and investors at the companies supposedly instigating the dumping appear to be relatively unconcerned. All told, it would appear that Titan shares have simply fallen too far too fast, providing an opportunity for investors -- or even traders -- once the bottom is reached.