Expect a “Bounce” in this Stock
02/21/2013 7:45 am EST
Taesik Yoon of Forbes Investor believes the issues generating investor fear in this large-cap stock are at least partially overblown, and so its recent turnaround is not so surprising.
Goodyear Tire & Rubber's (GT) stock fell 10.4% after reporting disappointing third-quarter results in late October. What is unusual, however, is seeing the stock trading 26% higher just a few months later-especially when there hasn't been any major change to the company's business outlook or overall industry conditions.
So why the surge? Perhaps investors are looking past GT's near-term challenges, which include softer European demand and lower overall volumes, and are focused more on the company's prospects over the longer term, when industry volume should return to more normal levels. They may also be anticipating the additional benefits to the bottom line expected in 2013 from GT's ongoing aggressive cost-reduction initiatives.
Analysts still project earnings in the current year to grow 40% from what GT likely realized in 2012. But even with the stock's recent gain, shares trade at just six times forward earnings-less than half their average historical forward multiple of 13.
When you consider this compelling valuation, it's not difficult to see why shares have rallied so much since its last earnings report-and why they have the potential to keep on rallying.
Through 53 manufacturing facilities in 22 countries, GT makes tires for automobiles, trucks, buses, aircraft, motorcycles, farm implements, earthmoving and mining equipment, industrial equipment, and various other applications. GT is also a leading global operator of commercial truck service and tire retreading centers. Furthermore, the company runs approximately 1,400 tire and auto service center outlets.
Net sales in the third quarter of 2012 fell by a greater-than expected 13.2% year-over-year, to $5.26 billion-due primarily to a 12% decline in tire volume and unfavorable foreign exchange rates. This was partially offset by higher pricing and a more favorable product mix. Sales fell in all regions.
Near-term demand for GT's tires is likely to remain under pressure. Fourth-quarter guidance for a further decline in tire volume of 3% to 5% suggests as much.
The difficult market environment in Europe could persist for the next several quarters. Additionally, some investors may be concerned by how the expiration of tariffs on Chinese-made tire imports last September will impact sales in North America in 2013.
While we acknowledge that GT's prospects over the short term may be limited, we believe the stock's exceedingly low valuation does not fully reflect the company's prospects over the longer term. This is especially true for its North American operations, where operational improvements, product wins, and other sound decisions more than likely resulted in operating income in excess of $450 million in 2012-a full year ahead of schedule.
Amazingly, this was achieved in a market characterized by channel destocking. This suggests that channel inventories are now likely at low levels. When combined with the persistent increase in US miles driven, GT believes sales in North America will see significant upside once industry volumes return to more normal levels.
We are also not too concerned by the tariff expiration, as GT has largely exited the lower margin market segment served by these imports. Furthermore, GT remains on track to exceed its three-year $1 billion cost savings plan. We expect profit margins to rebound and contribute to what we think will be meaningful year-over-year growth in earnings per share.
Given the low valuation GT's stock currently trades at, it's clear that investors have their doubts. But we believe GT stands a good chance of proving these doubters wrong.