It isn’t too hard to argue that one of the most severely impacted industries in 2020 as a result of coronavirus has been the auto industry. As of the beginning of October, auto sales are down across all major U.S. car brands by an average of nearly -17%. That shouldn’t come as much of a surprise, considering that for most of the spring shutdown mandates and shelter-in-place orders brought global economic activity to a standstill. Through the summer, there were some indications that segments of the economy may be recovering as restrictions began to ease, including a report in June that saw new auto sales actually increase; but a new wave of infections across the U.S. and in Europe as we move into the colder months of the year seems to cast doubt on whether that economic increase can be sustained.
The ironic thing about the Auto industry is that, as measured by the NASDAQ Global Auto Index ETF (CARZ), stock market activity would seem to suggest that the industry is in great shape. After hitting a bear market low a little below $20 in March, the stock rebounded to a 52-week high at nearly $42 just about a week ago. The ETF is tied primarily to the stocks of automakers themselves, which the market has generally been treating pretty well since March; it is also being boosted by the massive run-up in price of Tesla Inc. (TSLA), which is up more than 300% from its own March low point below $100. Rather than any useful recovery in the automotive Industry, I think the rally is benefitting, at least in part by shifting media focus on clean energy and the attractiveness of electronic vehicles, especially to the Millennial demographic.
On a macroeconomic level, the industry has been challenged, not only by reduced demand driven by the health crisis, but also by oil prices, which have been holding in the mid-$30 to $45 per barrel price range since June. Some analysts saw the commodity’s plunge into the teens in the early part of the pandemic as an indication that auto components makers like Goodyear Tire & Rubber (GT) might be able to moderate demand declines with cost savings from depressed petroleum prices. While oil is significantly below its pre-pandemic levels, however it has risen enough to decrease the validity of that estimate.
The Auto Components industry is a segment of the industry that I like to pay attention to, because I think it provides a barometer for the prospects of the auto industry on a broad basis beyond merely auto sales, which are usually skewed towards new autos. The companies in this industry provide OEM (Original Equipment Manufacturer) goods and services, which applies to new sales, as well as for replacements, and most of the smart companies in the industry try to maintain a healthy balance between their OEM and replacement businesses. GT is a company in the industry that I’ve followed for a while, and that makes up just two publicly trade tire manufacturers in the United States. It can be said GT is an American icon, too, because Goodyear is a tire brand that is immediately recognized. The company has struggled for the past few years as new auto sales have generally declined, and the truth is that COVID-19 has only made things more difficult; however their latest earnings report has provided some interesting indications that the company’s fundamental profile might be starting to improve in useful ways. When you add to that the fact that the stock is trading at a major discount to its useful valuation metrics, this might be a stock that is worth considering as a long-term, value-based opportunity. Let’s dive in.
Fundamental and Value Profile
The Goodyear Tire & Rubber Company is a manufacturer of tires. The Company operates through three segments. The Americas segment develops, manufactures, distributes and sells tires and related products and services in North, Central and South America, and sells tires to various export markets. The Americas segment manufactures and sells tires for automobiles, trucks, buses, earthmoving, mining and industrial equipment, aircraft and for various other applications. The Europe, the Middle East and Africa (EMEA) segment develops, manufactures, distributes and sells tires for automobiles, trucks, buses, aircraft, motorcycles, and earthmoving, mining and industrial equipment throughout EMEA under the Goodyear, Dunlop, Debica, Sava and Fulda brands. The Asia Pacific segment develops, manufactures, distributes and sells tires for automobiles, trucks, aircraft, farm, and earthmoving, mining and industrial equipment throughout the Asia Pacific region, and sells tires to various export markets. GT’s current market cap is $2.0 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined -848%, while sales dropped about -41%. The picture isn’t better in the last quarter, with earnings dropping -211% and sales declining by nearly -30%. GT is a company that historically operates with a narrow margin profile, but that saw that profile drop into negative territory in late 2019 and deteriorate even more through most of this year. That said, the company might be turning a corner, which is a bit of a surprise given the ongoing health crisis. In the last quarter, Net Income as a percentage of Revenues was -0.06% versus -13.8% in the last twelve months.
Free Cash Flow: GT’s free cash flow measurement is a significant source of strength in the company’s fundamental profile. Over the last twelve months, Free Cash Flow was $421 million, marking an increase from -$44 million in the previous quarter, and near to its healthy level at the beginning of 2020, which Free Cash Flow was $449 million. That’s a good sign that the improvement in Net Income, which is still negative, could be more than just a temporary phenomenon.
Debt to Equity: GT has a debt/equity ratio of 189. That is a bit high, but this is actually a pretty typical pattern for most companies in the Auto Components industry, and isn’t alarming by itself. That said, GT’s liquidity, which was very healthy just a few years ago (more than $2 billion at the beginning of 2015) has been consistently declining since that point. As of the last quarter, the company had a little over $1 billion in cash and liquid assets against about $5.7 billion in long-term. Their balance sheet indicates that they should be able to maintain their debt service without too much difficulty, with cash reserves that remain generally healthy, but have admittedly been under pressure from the company’s negative operating margins. If that pattern continues, liquidity will become a major concern; however if Net Income continues to improve in the quarters ahead, the balance sheet should strengthen even more.
Dividend: GT suspended their dividend early this year, with no indication of when it would be resumed.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $24 per share. That means the stock is very overvalued, with major upside from its current price, which is currently below $9.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s downward trend to its bear market low around $4 in March. It also provides the baseline for the Fibonacci retracement lines on the right side of the chart. The stock managed to rally nicely into the last week of October to a peak at around $11 and a little above the 50% retracement line before dropping back below $9 in the last week or so. Immediate resistance is around $9, in line with the 38.2% Fibonacci retracement line, with support around $7.50. A push above $9 should give the stock room to retest that recent $11 peak, while a drop below $7.50 could see the stock fall to about $6.50 before finding new support.
Near-term Keys: GT’s value proposition certainly is very tempting, but I think that the company’s current negative Net Income pattern is a concern, despite its improvement in the last quarter. If there are additional signs the company’s fundamentals are improving – such as a shift to positive Net Income, or an increase in the stock’s Book Value, which has declined significantly from earlier in the year, then I think the bargain proposition will become very hard to ignore. If you prefer to focus on short-term strategies, you could use a push above $9 as a signal to buy the stock or work with call options, with $11 acting as a good initial profit target. A drop below $7.50 could be a signal to consider shorting the stock or working with put options, with the stock’s next support at around $6 providing a reasonable profit target on a bearish trade.