Is CTB priced right for value?

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Trade tensions, which have persisted for well over a year, have worked to amp up market tension at different periods throughout the year. The prospect for trade compromise helped the market rally strongly from the beginning of this year until mid-July, when the Fed’s more modest-than-expected interest rate cut, along with the cold reality that trade compromise was not viable in the near future has set the market back and retreating off of its latest all-time high. The last time this happened was at the beginning of the final quarter of 2018, when trade tensions were among the primary forces that prompted the market to sell off and test bear market level drawdowns.

Despite the hard edge trade and tariffs are putting on most conversations about the global economy, along with the ability to the U.S. to continue standing apart from the rest of the world as the lone source of growth, the stock market remains up nicely year to date. While the past month has shaved almost 5% off of the S&P 500, it is still up nearly 14% since the beginning of 2019. The same story applies to most sectors, and also to a large number of industries. One industry that has struggled, however, is autos. Tariffs and trade uncertainty have worked strongly against this industry; as measured by the NASDAQ Global Auto Index Fund ETF (CARZ), the industry is down almost -6% year to date, and has lost even more momentum in the last month, retreating by about -10.5%.

Autos have been shown to be particularly sensitive to trade issues. I don’t think that’s too surprising when you consider the reality that there really isn’t a major automaker that makes or sells their products exclusively in their own country. GM or Ford cars naturally use components manufactured all over the world, and so do Toyotas, Hondas, VW’s, BMW’s, and so on. Most of these companies use manufacturing facilities all over the world to produce vehicles for a specific market rather than shipping finished goods all over the world, and they all sell in each other’s home market. That’s why trade is such a big issue in this segment of the economy – and it isn’t just about the U.S. and China. Despite relative calm for the last several months between the U.S., Europe, and Mexico, tariffs still exist between the U.S. and those economies and have yet to be completely resolved. Those relationships may not be as acrimonious, but it does still exist, along with China as a headwind, and together it looks like they continue to weigh on the prospects of the auto industry for the foreseeable future.

Cooper Tire and Rubber Co. (CTB) is one of only two U.S. producers of rubber tires, along with Goodyear Tire and Rubber Co. (GT). As the smaller of the two, CTB operates in a more narrow niche, focusing on the replacement side of the business as opposed to selling tires for installation in new vehicles out of the factory. Both stocks have struggled year to date, and are showing signs that tariffs have negatively impacted their respective businesses. That may comes as a bit of a surprise since the company has a relatively limited scope of business exposure to China; however it does operate two of its segments in Europe and Latin America, and the company’s latest earnings report did refer to trade as a negative draw against their results. As a result, the stock has dropped more than -23% in the last month alone. Is the fundamental picture as bad as it might sound? Depending on the answer to that question, the stock’s current price could represent a new, interesting opportunity, or just another big risk to take under current conditions.

Fundamental and Value Profile

Cooper Tire & Rubber Company is a manufacturer and marketer of replacement tires. The Company specializes in the design, manufacture, marketing and sales of passenger car, light truck, medium truck, motorcycle, and racing tires. The Company operates through four segments: North America, Latin America, Europe, and Asia. The North America segment comprises its operations in the United States and Canada. The Americas Tire Operations segment manufactures and markets passenger car and light truck tires, for sale in the United States replacement markets. The Latin America segment comprises its operations in Mexico, Central America, and South America. The European segment has operations in the United Kingdom and the Republic of Serbia. Its the United Kingdom entity manufactures and markets passenger car, light truck, motorcycle and racing tires and tire retread material. As of December 31, 2016, the Company operated nine manufacturing facilities and 20 distribution centers in 10 countries. CTB’s current market cap is $1.2 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined a little over -40%, while revenues declined by -2.76%. In the last quarter, earnings dropped -18%, while sales improved by a little less than 10%. The company’s margin profile over the last twelve months is very narrow, at 2.46%, and shrank in the last quarter to 1.29%.

Free Cash Flow: CTB’s free cash flow is minimal, at about $33 million over the last twelve month. It is worth noting that CTB’s Free Cash Flow is improving; earlier this year it was $27 million, and negative at the end of the first quarter of 2018 at -$58.4 million. Its current level translates to a low Free Cash Flow Yield of 2.77%.

Debt to Equity: CTB has a debt/equity ratio of .15. This is a very conservative number. The company’s balance sheet demonstrates better liquidity and debt management than you might expect given the earnings and Net Income pattern as cash and liquid assets in the last quarter were about $112 million while long-term debt was almost $188 million.

Dividend: CTB pays an annual dividend of $.42 per share, which translates to a dividend yield of about 1.24% at the stock’s current price.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for CTB is $24.99 per share. That number also translates to a Price/Book ratio of .94 at the stock’s current price. Their historical average Price/Book ratio is 1.88. That suggests the stock is trading right now at a discount of 100%. It is also trading almost 145% below its historical Price/Cash Flow ratio; together, these measurements translate to a long-term target price between $47 and $57 per share.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above marks the last two year of price activity. The red diagonal isn’t particularly useful in identifying the stock’s current trend; however it does serve as a useful baseline for the Fibonacci retracement line shown on the right hand side of the chart. CTB’s downward trend has gained a lot of strength since mid-July, pushing the stock from around $31 to its current level a little below $24. It is near to multiyear lows, which are around $22.50, and the stock’s current momentum implies that a test of that low is likely. If it breaks below that expected support, it could drop to somewhere between $18 and $19 before finding new support. If it can form a pivot low and rally off of support, resistance is probably around $25 based of pivot levels seen a little over a year ago, and then $28 from that point.

Near-term Keys: The stock’s value metrics might make the stock seem like a tempting opportunity right now. The truth is that the fundamental picture is better than I expected, with the company showing some resilience based on its free cash flow and its mostly solid balance sheet. That said, the erosion of profitability as indicated by its shrinking Net Income is chipping away at its liquidity and cash, which I think is a reflection of the effect of tariffs and trade. This is a small company that operates with a conservative management approach that has helped it weather the storm so far, but the longer the storm rages, the more battered it is likely to get. If you prefer to look for a short-term trade, the best probabilities lie on the short side. If the stock drops below $22.50, consider shorting the stock or using put options with a price target at around $18 to exit a bearish trade. A bullish short-term trade is extremely speculative, but if the stock can rally off of support between its current price and $22.50, it could move higher, to around $25 or possibly $28.

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