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Goodyear Tire and Rubber - Look Mom, No Rails

March 21, 2011 | About:
wax

wax

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I like Warren Buffett. I think he is a very shrewd investor and an uncommonly astute business person. Do I think he is the be all end all when it comes to investing? Sorry, no.

What irritates me is his blatant self-promotion. Sure everyone in business has to promote what they do, but when they do so by leaving stuff out, well, it just grates on me.

From the Berkshire Hathaway 2010 Shareholder Letter..."Both of us are enthusiastic [Mr. Buffett and Mr. Munger] about BNSF’s future because railroads have major cost and environmental advantages over trucking, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs. Concurrently, our country gains because of reduced greenhouse emissions and a much smaller need for imported oil. When traffic travels by rail, society benefits."

What Mr. Buffett failed to mention is that Berkshire Hathaway owns a trucking company, McLane, which Berkshire purchased from Wal-Mart Stores, Inc. (WMT). This, at least to me, sort of skews the relevance of Berkshire wanting to be a "green" company that benefits society. Raspberries to you Mr. B!!

In the end, the stuff that Mr. Buffett moves on his new train set, can't walk to it's final destination. To get there requires a truck, a big truck, usually one with 18 wheels, which made me realize that I don't see trains broken down on the side of the railroad track, but I often see trucks broken down on the side of the road, and most of the time the reason they are there is because one of those 18 tires has become what the truckers call...an alligator.

What surprised me as I started poking around for information to use in this article was that one of the leading roadside service companies in the world, was a company that I used to hear about regularly growing up, The Goodyear Tire and Rubber Company, (GT). Curious, I thought, why not?

Basis

Financial information presented in this report for The Goodyear Tire and Rubber Company, is based on the company's most recent SEC Form 10-K filing for year ending December 31, 2010, as filed with the Securities and Exchange Commission on February 10, 2011.

What They Do

The company is an Ohio corporation organized in 1898, and today is one of the world's leading manufacturers of tires, engaging in operations in most regions of the world. The company develops, manufactures, markets and distributes tires for most applications. The company also manufactures and markets rubber-related chemicals for various applications, manufacturing its products in 56 facilities in 22 countries, including the United States.

Goodyear has marketing operations in almost every country in the world, employing approximately 72,000 world-wide full-time and temporary associates. In addition, the company is also one of the world’s largest operators of commercial truck service and tire retreading centers operating approximately 1,500 tire and auto service center outlets where their products are sold at retail and where they provide automotive repair and other services.

Short-Term Investment

The stock closed recently at $14.82, with Resistance at $15.45, a 4% increase from the recent close, First Support at $13.35, a 10% decline from the recent close, and Second Support at $11.54, a 22% decline from the recent close. Should the stock price fall beyond second support, the next support level is the 52 week low of $9.10, a 39% decline from its recent price.

The stock price has been trending upward since bouncing off of its December lows, recently running through days of slightly higher highs and slightly higher lows, events that may bode well for the longer-term investor along with the short-term investor.

While we are not short-term investors, it just seems to us that there isn't any reason to put take a short-term position with more immediate downside risk, 10%, than upside reward, 4%. As a result, we are not currently interested in a short-term position.

Long-Term (5 Year Hold) Investment

With Debt at more than three times EBITDA, we were not really to excited as we began our cursory review of the company's financial metrics, only to end up...pleasantly surprised.

The company's Current Ratio at 1.5, Quick Ratio at 0.9, and Cash Ratio at 0.4, while not what we consider investment quality, were not really too bad.

Additional bright spots we noticed was the company's Inventory Turnover at just shy of 5 times a year, and that the company's Receivables were actually collected before their bills were paid, with Receivables outstanding an average of 53 days and Payables outstanding an average of 77 days.

Things like this lead us to conclude that management understands the needs of the company's customers as well as what is happening in the economies the company serves.

While the company generated Free Cash Flow during FY10 of $3.97 per share, a 26% year over year increase, net Debt also increased year over year by almost 5%, a potential trend that we would like to see reversed going forward.

Overall, we felt that the company's financial statements were in fairly decent shape.

Growth

We are value investors, attempting to determine the value of an entire company based on its most recent audited financial information. As such, we simply refuse to pay for earnings growth and make no inclusion of it in our valuation estimates.

However, we realize that many investors care a great deal about earnings growth and base their investment decisions on the spread between year over year earnings growth and the current PE.

In the case of Goodyear, the company was able to grow year over year earnings by 56%, ending FY10 with earnings of $3.66 per share. With a current PE of 4, the spread between earnings growth and the PE is 14, meaning that when for a growth investor, fair value for the stock is about $51.

Valuation

Based on our review of the company's latest annual financial information, we think a Reasonable Value Estimate for the company is between $27-$30 per share, and based on that valuation have set an initial Buy Target at $16.50, an initial First Sell Target at $32, and an initial Close Target at $34.

Considering a recent close of under $15, the potential for growth, an estimated Merger and Acquisition payback of less than 5 years (assuming EBITDA remains the same), and Free Cash Flow of almost $4, we believe taking a position at this time is prudent, and have added the company to the Wax Ink Portfolio.

Final Thoughts

Okay so Mr. Buffett is touting his genius at his purchase of Burlington Northern Santa Fe. Obviously, based on the information in his shareholder letter, it was a very prudent move and simply reinforces why he is such a formidable investor. But with that said, what about the rest of us, what about the little folks, the investors with a few extra dollars to invest, what do we do?

Perhaps for us, we should practice something I believe Mr. Buffett has done all his investing life. Perhaps we should spend more time seeing what isn't there.

Instead of becoming enamored with the money Berkshire made in FY10 thanks to their train set purchase, we should ask ourselves simply, does that make sense?, our maybe we should ask how does it end?, or what comes next?, or something along those lines.

In the case of the Berkshire letter to shareholders, whether intentioned or not, it made me feel as if trucks that haul freight were simply not going to be needed in the future because trains would be doing the job so much more efficiently. What a load!(pun intended)

Sure rail can move the most amount of freight per gallon of fuel used, but it simply can't finish. I don't think I have ever seen a train unloading items at a Target or a Wal-Mart store, and I know trains don't deliver supplies to my local grocery store. But miracle of miracles, the shelves still manage to get restocked! How can that be with no train tracks?

It's questions like those that many of us as small time equity investors simply fail to ask ourselves, and because we don't, we miss out on what may become great longer-term investments.

So Mr. Buffett enjoy being able to blow the horn of your new engines as they pass through America, you certainly earned the right. As for me, I think I'll just stick to investing in companies that complete the job your trains can only begin.

Wax

Disclaimer

We have a long-term position in The Goodyear Tire and Rubber Company. We have received no compensation to write about a specific stock, sector, or theme.

About the author:

wax
Wax Ink is a baseline equity research company not licensed or registered with any government agency

Visit wax's Website


Rating: 3.4/5 (14 votes)

Comments

roke6362
Roke6362 - 3 years ago
I did some quick research of GT, and found its earnings power value to be around $28/share. However, its debt-to-equity is $6.7-$1.

If you add back in depreciation to its plant and equipment, the reproduction value is around $22/share.

The real indicator of value (or lack of) for me was that, over the past 10 years, for every $1 of capex GT spent, it generated $0.59 in cash flow. There are only 3 years in the past 10 in which they even generated a positive ROA.

I don't know for sure, but being associated with the auto industry, at least part of its labor is probably unionized. Which is why (in part) they are moving production to foreign countries.

This one would not be a company I would want to own. Then again, what do I know.

David Tepper took a position in it.

Good luck.

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