A New Bounce in Its Step

01/11/2010 10:56 am EST

Focus: STOCKS

Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says the worst is over for a North American-based tire maker, which should profit from a recovering economy.

Cooper Tire & Rubber (NYSE: CTB) produces replacement tires for cars and light trucks. It generates about two-thirds of its revenues in North America. It distributes tires through independent retailers, three company-owned retailers, wholesale distributors, and regional and national automotive product retailers and tire chains.

Remaining revenues come from international operations. Its UK-based manufacturing facilities make replacement tires for passenger cars, light trucks, racing cars, and motorcycles for the European market.

Facilities in China produce bias ply and radial tires for passenger cars, light and medium trucks, and off-road vehicles. Tires made in China are primarily exported to North America and Europe.

Financial results in 2008 were impacted by the economic downturn and rising gasoline prices, which resulted in fewer miles driven and reduced demand for replacement tires. Higher costs for raw materials also squeezed profit margins. Net sales fell 1.7% year over year to $2.88 billion. The company reported an adjusted operating loss of $108.9 million.

In the meantime, raw material costs have eased and the Chinese government’s efforts to stimulate the economy have strengthened demand in that country. The replacement tire market in North America is stabilizing.

Despite lower pricing and an unfavorable product mix, net sales in [the third quarter] rose 1.1% year-over-year to $802.8 million. Sales in North America fell 2% to $574 million, but shipments increased 2%. International sales climbed 4% to $297 million, as a 13% decline in unit sales in Europe was offset by a 28% surge in Asia.

Sharply lower commodity prices helped the company generate $84.1 million in adjusted operating earnings. This compares to a $47-million loss during the same period a year ago. Net income was a better-than-expected $46.8 million, or 77 cents per share.

[But] CTB is not yet entirely out of the woods. Recovery could stall if the American economy fails to improve or if China’s impressive growth begins to slow. Raw material prices could go even higher and crimp profits. Finally, a recent tariff imposed by the US government on tires imported from China will make it more difficult for CTB to compete on price.

Despite such risks, demand in North America should stabilize further as drivers eventually return to normal patterns. Low inventory levels in the US also work in CTB’s favor. Automobile ownership rates in China are rising rapidly, and demand in that country should keep growing. In response to higher tariffs, the company will shift production and ship more tires made in China to Europe and other destinations.

Improved capacity utilization at its remaining US plants should yield incremental profits that will help offset margin pressure stemming from higher raw material costs. CTB’s improved financial condition (net debt fell from $367.8 million at the beginning of 2009 to $171.5 million at the end of the third quarter) gives it the flexibility to respond quickly to potential growth opportunities that may materialize. (The stock closed below $21 Friday—Editor.)

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