Cooper Tire: Kicking the Tires for Value

Mar.18.11 | About: Cooper Tire (CTB)

Cooper Tire (NYSE:CTB) is the 9th largest global tire manufacturer and 4th largest in the U.S. Their strategic focus is on light vehicle replacement tires in N. America, w/ 13% market share.

CTB also has a rapidly growing international and radial medium truck tire sales, 29% of 2010 revenues. Cooper has three plants in the U.S., four foreign plants are located in Mexico, China and England.

The tire industry is capital intensive with raw material input costs for natural rubber and synthetic rubber accounting for half of CoGS.

Financials: For the seven quarters through Dec. 31, 2010, CTB sales growth averaged 6.9% (per period).

Accounts Receivable and days-sales-outstanding improved in Q4, with DSO's coming in at 47.9 days vs. 53.7 in the prior quarter and three days less than the 50.6 day average. Considering CTB's international growth, these collection cycles are impressive.

Similarly, inventory appears well managed with Q4 coming in at 42.1% of sales, lower than the 45.3% average of all periods reviewed.

Cash-Flow: Operating cash-flow (OCF), as a percentage of sales ended 2010 at 183.8% of sales slightly lower than the balance sheet cash flow reading of 200.6% (of sales).
Cooper Tire Dual Cash Flow RatiosClick to enlarge
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Although balance sheet activity has often played a larger role in supporting earnings, the improving trend in OCF (seen below) is what catches our eye the most.

One primary advantage of the dual cash-flow method (a component in our model) is the ability to identify the participation of cash and non-cash assets to their level of support in earnings. Companies with better earnings quality typically display rising levels of OCF and falling BSCF.
Operating Cash-flow Spreads for CTBClick to enlarge
(Click to enlarge)

CTB's operating cash levels have not yet bested BSCF, but management is clearly focused on generating higher levels of cash-flow from its paying customers as being most beneficial to a foundation of earnings.

In capital intensive businesses like this, an investor should find some comfort that shareholders are being represented by the actions of a management team. Selling tires may sound simplistic and the need obvious, but macro issues aside, labor contracts, safety litigation and commodity prices, together, can also be a headwind for tire manufacturers.

Accruals: We believe management has done a good job of minimizing the use of accrual (non-cash) accounting items to build their earnings statement. As you can see below, the accrual ratio spiked in Q1 '10 and again in Q3 '10, but has otherwise remained neutral (near 0), or negative, which is bullish for earnings quality.
CTB Accruals and Capital ProductivityClick to enlarge
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Forward issues: Pension costs for 2011 will be about $10 million higher, due primarily to a lower discount rate. The company also believes its effective tax rate will be in the 20% to 30% range due to improved profitability, no NOLs and expired tax agreements in certain regions.

Off-setting these obligations may come from tax planning strategies and / or accelerated depreciation opportunities. Although Cooper management has historically been consistent with its strategic results, investors will want to keep an eye on future levels of accrual accounting for clues to earnings quality.

Capital Productivity/Revenue Metrics: CTB has also been very focused on its capital structure in recent years. Debt-to-Assets have been reduced from 29% in Q2 '09 to 20.5% in the recent Q4 '10. Operating capital utilization (per dollar of sales) also improved in Q4 (above). Cost-of-sales was the only decline in our study.

Summary: CTB has broad distribution channels and diverse penetration in the replacement tire market. We believe input costs and raw materials to be the predominate issue going forward.

The company has also lowered labor unit costs in recent years, net income per employee improving dramatically.

Earning's Quality: B+

Estimated Fair-Value: $27.06

The stock has outperformed both the S&P 500 and competitor Goodyear Tire (NYSE:GT) over the past year. Current beta is a thick 2.32 and the associated volatility is clearly obvious in a chart.

That said, the shares do look to be undervalued at current levels. A pullback to the $22 area might be a decent entry point for partial positions; $21 or under for full positions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Link to report on our website.