Goodyear Tire & Rubber Co. (GT, Financial) has been posting declining revenue per share and erratic earnings per share for over a decade now. Value investors have been looking for a bargain in this tire replacement stock for years, focusing on strong fundamentals and consistently high market share, but a good company does not always make a good investment, and Mr. Market is not likely to favor a stock that cannot grow its revenue and create value for shareholders.
Enter activist investing firm Elliott Management, which believes it can flip the script and turn Goodyear into a shareholder-friendly stock. The firm, which claims to own a 10% economic interest in Goodyear, sent a letter and presentation to its board of directors on Thursday, saying that its “strong brand” and “leading global position” could position it to more than double its share price if the company takes certain actions recommended by Elliott Management.
Goodyear’s stock price spiked nearly 20% on the vote of confidence. However, will this recovery be sustainable when any turnaround plans could take years to successfully implement? Let’s take a look.
Why Goodyear’s stock has struggled
Recently, Goodyear has been talking about cost inflation and macroeconomic uncertainty as key headwinds. Like many others, the company was also negatively affected due to Covid-related supply chain issues in 2020. However, that does not explain the long-term revenue per share decline.
The share count does not offer an explanation either. While the company has been a net issuer of shares in recent years, it had been steadily buying back shares from 2014 to 2019.
Looking through the company’s historical earnings reports, in 2013, it attributed the top-line drop to lower third-party chemical sales and unfavorable foreign exchange rates. For the next few years, the blame was mostly placed on unfavorable foreign exchange rates, until 2017, when tire volumes began to slip.
The suspension of the dividend has not endeared shareholders either. In April 2020, the company announced it would be suspending its dividend, and it has yet to reinstate it. This gives bargain hunters little incentive to acquire shares as part of a turnaround bet or a “wait and see” approach.
Growing business, shrinking shareholder value
After a period of volume stagnation coupled with foreign exchange headwinds slowly eating away at revenue, Goodyear has returned to growth with its June 2021 acquisition of key competitor Cooper, which catapulted it from third place in the global tire market to second place, ahead of Japan-based competitor Bridgestone (BRDCF, Financial) but behind France’s Michelin (MGDDY, Financial).
Goodyear’s cash-and-stock acquisition of Cooper was valued at $2.8 billion in total, which is more than half of Goodyear’s $4 billion market cap as of this writing. It is a high price to pay even for more market share, and it may be part of the reason why Goodyear has not tried to reinstate its dividend just yet. The company’s interest coverage ratio has fallen to critically low levels at 1.86. It hopes to achieve as much as $250 million in cost savings from the acquisition, which could help mitigate debt issues. The higher debt expenses have contributed to keeping weighted average cost of capital higher than return on invested capital in most years. This means that, on average, Goodyear is destroying shareholder value.
Elliott Management’s take
According to Elliott Management’s letter to Goodyear, “We believe the Company’s poor stock performance is a direct result of its significant margin erosion, suboptimal go-to-market strategy and unfocused brand strategy, which have collectively led to a loss of investor confidence.”
In order to address these problems, the activist firm suggested Goodyear appoint five new directors, look for more ways to monetize its network of store locations and form an operational committee to manage operations better and improve margins.
All in all, Elliott Management claims this could add as much as $21 to Goodyear’s share price on top of the $11.72 per share it traded at the day before.
How Goodyear stacks up against competitors
To get an idea of whether Goodyear’s operational headwinds are unique to it or whether they are industry-wide, let’s take a look at its key competitors, Bridgestone and Michelin.
As we can see in the chart below, Bridgestone and Michelin have maintained slow but steady earnings per share growth and have nearly recovered to pre-pandemic levels. Goodyear, on the other hand, has more volatile earnings with higher highs and lower lows. Out of the three, it was the only one to report a bottom-line loss in the fourth quarter of 2022.
When it comes to revenue per share, Bridgestone and Michelin have remained fairly steady over the past decade, which may be due in part to lower foreign exchange headwinds or better currency hedging strategies.
In terms of valuation, all three appear to be at a similar level after Goodyear’s 20% spike on Thursday. Goodyear has a sky-high price-earnings ratio of 711 at the moment due to its bottom line turning negative in some quarters, but its forward price-earnings ratio is 11.67 compared to Bridgestone’s price-earnings ratio of 12.87 and Michelin’s 10.54.
Takeaway
When we look at Goodyear in the context of its history and its main competitors, it seems like the company has the potential to stabilize its business if it plays its cards right. The Cooper acquisition should hopefully give it a more advantageous competitive position, but the company desperately needs to get its debt and currency exchange headwinds under control.
Will Goodyear work with Elliott Management to get its operational costs under control? Can it manage its debt and currency exchange better? Given the state of the company’s balance sheet, it does not look wise to try and reinstate the dividend until it can achieve steady earnings growth, which will likely take a few years in a best-case scenario. Given macroeconomic uncertainty, I think there is plenty of time to sit on the sidelines and see how things develop.
