The Long Case for Goodyear Tire & Rubber

In a recent edition of Value Investor Insight, GoldenTree Asset Management's Adam Tuckman described why he sees big upside in The Goodyear Tire & Rubber Company (GT).

Describe the potential you see in Goodyear.

Adam Tuckman: Goodyear has done a lot to restructure its business, but because the benefits have yet to show up in the numbers, the market is kind of ignoring it. With Michelin and Bridgestone, it’s one of the largest players in the global tire business, with roughly half its sales in North America and the rest outside. Importantly, about 80% of revenues come from selling replacement tires,which have far better margins than the original-equipment [OE] business and which is much less volatile in a recession. They run the OE business basically at breakeven, to have an edge when people replace their tires and 50% of the time go with the original brand.

Isn’t selling tires kind of a lousy business?

AT: There’s clearly a commodity, cyclical element to it. Where tire makers do differentiate themselves is in the part of the market they play in. Goodyear has now officially exited the low-end, private-label part of the business, which is the most volatile and sensitive to recession. In the higher-performance areas of the market, where margins are higher and they’re adding manufacturing capacity, brands like Goodyear’s do make some difference. With respect to the cycle, we think we’re actually below the trend line. Even if the economy gets into trouble, we see that being offset by pent-up demand from all the people who have been deferring tire purchases in the last few years. With lower-cost Asian manufacturers increasing their footprint in the global tire business, we’ve tried to understand what would prevent them from becoming players in the mid- to high-end of the market. The main thing is the OE relationships the big-three tire makers have; when development of a car or truck is finished, they work closely with the OE manufacturer to improve things like ride quality, noise and vibration. The low-cost Asian manufacturers are still years away from having the technological sophistication to do that well. They also don’t yet have the ability to retread tires, which is very important on the truck side. Another thing we’ve seen in the last 18 to 24 months is more rational industry pricing behavior. Oil is a key raw material in making tires, so there have been a dozen or so pricing increases over that time to pass along rising oil costs. Even low-end makers have been raising prices.

How is Goodyear restructuring itself?

AT: They have made a variety of struc-tural changes through difficult union negotiations – particularly in North America, where it’s most needed – with regard to wages, improving productivity, closing facilities, reducing headcount and addressing healthcare and pension costs. For example, they’ve already created the type of separate health-insurance fund that the UAW and GM have just agreed to, which got done at 80% of the original plan’s cost and is already being funded. Most of these changes are contractual, so it’s not a guess what the benefits will be, it’s just that the effects will take some time to flow through the financials.

As that happens, what upside do you see for the shares, now around $30.50?

AT: Given the improvement in margins we expect, you’re paying only 8.5x our estimate of 2009 earnings, which is when you’ll see the full run-rate benefits of the company’s restructuring efforts. We think that valuation, the cost-savings efforts and the resilience of the replacement-tire business protect us fairly well on the downside. We see no reason the shares shouldn't eventually earn the 12x multiple at which they’ve historically traded, which would yield a share price on 2009 estimated EPS of more than $43.