Shares of Goodyear Tire & Rubber (GT) fell hard on Monday after the tire manufacturer received a downgrade from analysts at Deutsche Bank.
Investors used Deutsche's research report as a reason to take some profits off the table. This comes after shares have seen a great run-up over the past half year. Even though analysts warn for uncertain medium term margins, I think the sell-off might be overdone.
The correction allows for a nice entry point for the long term given the solid long -term prospects as outlined by Goodyear.
Deutsche Bank's Warning
Analysts at Deutsche Bank are downgrading Goodyear Tire from "Buy" to "Neutral" while lowering the price target by three dollars to $26 per share.
Analyst Rod Lache thinks the margin outlook might be more uncertain on the back of new tire capacity being announced, and record levels of capital expenditures within the industry.
On the back of increased supply and investment requirements the bank is now revisiting the global tire industry supply/demand analysis. Mid-term margins, two or three year's down the road, may not be as clear as they have been in recent times.
The intermediate term uncertainty caused Deutsche to be more cautious on Goodyear's prospects, even though shares remain attractive on near-term estimates.
Goodyear is scheduled to release its third quarter results next week, on the 29th of October. The company ended its second quarter with $2.56 billion in cash and equivalents. The company operates with $6.53 billion in total debt, for a net debt position of around $4 billion.
Sales for the first six months of 2013 came in at $9.75 billion, down 8.8% on the year before. Note that earnings more than doubled to $221 million thanks to a relative solid second quarter.
At this pace annual revenues could come in around $19-$20 billion. Annual revenues are seen around $500-$600 million for the year.
Trading around $21 per share the market values Goodyear Tire at around $5.4 billion. This values the company at 0.3 times annual revenues and roughly 10 times earnings.
Goodyear recently announced its intentions to re-initiate a quarterly dividend of $0.05 per share, for an annual dividend yield of 0.9%.
Some Historical Perspective
Long-term investors have seen quite some movement over the past decade. Shares steadily rose to highs in their mid-thirties by 2007 after which shares fell to lows around $3-$4 in 2009. Shares have seen a modest recovery, as the recovery accelerated from levels of just $12 in April to current levels at $21 per share. This is after shares recently touched upon $23 per share in recent times.
Between 2009 and 2012, Goodyear Tire has increased its annual revenues by a cumulative 29% to $21.0 billion, although revenues are set to fall again in 2013. After reporting losses in 2009 and 2010, Goodyear has returned to profitability over the past two years.
Ever since the release of its second quarter results, Goodyear's shares have risen some 25%. A fair portion of these returns have been driven by Goodyear's capital allocation plan, announced in September.
As part of the plan, Goodyear reinstated a quarterly dividend of $0.05 per share. The company furthermore announced a $100 million share repurchase program, sufficient to retire nearly 2% of its shares outstanding.
Perhaps even more important than returning cash to shareholders, Goodyear reconfirmed the outlook for 2013 and announced ambitious targets for the years following. It is these projections for which Deutsche Bank now sees some uncertainties.
Goodyear sees full year operating income of around $1.5 billion for 2013, expected to grow by 10-15% through 2016. At the midpoint of the growth range, operating earnings should grow toward $2.1-$2.2 billion in three year's time. This is quite an achievement for a firm operating in this razor-thin industry. More importantly, the increased future cash flows allows for Goodyear to deleverage its balance sheet while increasing cash flows to shareholders at the same time.
Trading around 10 times earnings, and despite uncertainties about medium term margin developments, shares of Goodyear might be worth it. This is even after the solid momentum witnessed so far this year. Ongoing operational improvements, as guided through 2016, should continue to provide a floor under the current valuation, even though Deutsche Bank sees some uncertainties.