Goodyear bolsters its lineup with Cooper Tires
The deal joins the third-biggest tire manufacturer globally (No. 1 in the U.S.) with the 13th-biggest global player and fifth-largest tire manufacturer in the U.S. It immediately adds scale to Goodyear’s operations. The combination will add Goodyear’s 30 global plants to Cooper’s eight and allow the combined company to start generating costs savings through rationalizing operations in common and reducing logistics and procurement costs.
However, the investment thesis is not just a consolidation play to cut costs; the deal expands Goodyear’s presence in a couple of key end markets. The tire market consists of the original equipment manufacturer (OEM) market and the replacement tire market. The OEM market follows vehicle production rates, so it can be cyclical, while the replacement market follows vehicle miles driven and tends to provide low but reliable growth.
The combined company will generate 80% of its unit sales from the replacement market, improving Goodyear’s position in two key areas.
- Cooper is strong in the U.S. replacement tire market and will solidify Goodyear’s position in the U.S.’ stable auto parts replacement market.
- Cooper is relatively stronger in the China OEM market, so that the deal will strengthen Goodyear in a significant growth area in the OEM world.
As such, Goodyear will gain strength in its core replacement market in the U.S. and more exposure to light vehicle production in China.
The numbers add up
Digging into the deal’s details shows it will build scale and significantly expand Goodyear’s profit and free cash flow (FCF) earnings margin. The key details:
- One-time working capital cost savings of $250 million
- Run-rate cost synergies of $165 million within two years of the deal
Based on 2019 figures, the combined company will have $17.5 billion in sales with an operating margin of 5.7% and FCF of $525 million. Those numbers are larger than Goodyear’s stand-alone 2019 figure of $14.7 billion in sales. Still, since Cooper generated higher earnings and FCF margins, the combined 2019 operating margin will be higher than Goodyear’s 5.6% operating margin and FCF of $437 million in 2019.
In addition, if Goodyear successfully cuts annual costs by $165 million, then (based on 2019 figures) the combined company would have generated a 6.7% operating margin with $690 million in FCF and a 3.9% FCF margin.
Playing around with the numbers produces some attractive-looking valuations for Goodyear. For example, the tire market is recovering strongly from the pandemic hit in 2020 (see chart below), and analysts estimate Goodyear will post $16.6 billion in sales in 2021 and $18.3 billion in 2022.
Based on the 3.94% FCF margin calculated above, Goodyear could be generating north of $710 million in FCF in 2022, giving the stock a price-to-FCF multiple of just 7.2 in 2022. That’s an excellent multiple, especially if light vehicle production embarks on a multiyear recovery in 2021.
The Cooper Tires deal makes sense and will improve Goodyear’s operating metrics in the coming years. However, there’s a real chance that the company could fall behind in its plans. It’s no secret that the reopening of the global economy has come with a host of supply chain and logistics problems. As such, light vehicle production forecasts have been pared back due to semiconductor and other shortages, which means Goodyear’s OEM sales could disappoint.
In addition, Goodyear’s critical raw material costs (synthetic and natural rubber, carbon black, chemicals, textiles, and steel wire) are influenced by oil prices and steel movements. Both have risen in 2021 as the economic recovery gathers steam, pulling demand up, but supply chain issues persist. This could hurt margins for Goodyear.
Goodyear in a few years
Investors will have to be willing to close their eyes and ears to at least a quarter or two of potentially negative news regarding supply chain difficulties and raw material price rises. That said, history suggests these issues will probably be ironed out over time. It’s also worth noting that Goodyear’s price boosts and sales mix exceeded the increase in raw materials prices by $130 million in the second quarter.
All told, despite near-term headwinds, Goodyear looks attractive for long-term investors.
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