Tuesday, May 8, 2018

Cooper Tire

Cooper Tire (CTB) makes tires for vehicles. The industry is going through a difficult period, with recent sales below expectations, causing promotional pricing that further compounds the problem. Because it is a high fixed-cost industry (manufacturing), revenue shortfalls like those experienced right now cause big changes on the bottom line. For example, this year's headline Q1 profit was down 54% from last year's on just a 6.5% decline in sales.

As production cuts take effect and the channels work through their inventory, I'd expect the price wars to eventually end and for margins to get back to normal. This is an industry with barriers to entry, as it takes time/money to build a reputation with consumers and distributors that your product is safe and works as advertised.

Management expects margins to return to normal in the 2nd half of this year. That would be nice, but I don't think it's necessary for this investment to pay off. The company is safely capitalized with net debt (including pension) of less than $400 million, whereas 2017 operating income was $271 million.

In the meantime, these temporary issues have had a large effect on the company's share price. The shares are down almost 50% from their 2017 highs, which puts the company at an EV/EBIT (ttm) of under 7. Considering the oligopolistic nature of the industry, I consider this an attractive level.

While capex spending is a little higher than I'd like, overall capital allocation is not bad. The company has reduced its share count by over 20% over the last four years. On the last conference call, there was a short discussion about whether current conditions warranted accelerated share repurchases thanks to the low share price. It's rare that a company actually buys more shares when the chips are down, but the returns could be tremendous if Cooper does so and comes out alright. On the other hand, management's ownership level is a bit of a joke so I'm not expecting miracles. Nevertheless, I think the downside is relatively well protected thanks to the low price, and the potential for consolidation in this industry.

Disclosure: Author has a long position in shares of CTB

5 comments:

Brian Harper said...

Thanks for note, will take a look. It's a tough biz, I owned GT for years, and every year there were huge "rationalization" charges, they were constantly battling an underfunded pension. Massive capex, etc...thx again

shlomi ardan said...

Do you have any guess as to why they spend more than 200m this year (!!) on capex? It's not like they're growing.

Saj Karsan said...

As is the case with the vast majority of managements, they do want to grow, hence the spending. While I think capex is high, I do give them credit for shrinking the business over the last few years as they let some low-margin business go. They are focused on margins, which is what I like to see.

Taha Suria said...

Saj, nice write up.

Is there any reason why you selected CTB in particular? I see that Goodyear is also at a relatively lower PE of 11.33 for example.

Saj Karsan said...

It just seemed the best value to me. I could be wrong, though, and/or there could be others in this industry that do better.

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