White Brook Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. The fund posted a return of 2.23% for the quarter (net of fees), underperforming their benchmark, the S&P 400 Index which returned 4.77% in the same quarter. You should check out White Brook Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, White Brook Capital highlighted a few stocks and Goodyear Tire & Rubber Co (NASDAQ:GT) is one of them. Goodyear Tire & Rubber Co (NASDAQ:GT) is a tire manufacturing company. Year-to-date, Goodyear Tire & Rubber Co (NASDAQ:GT) stock lost 33.5% and on October 26th it had a closing price of $10.35. Here is what White Brook Capital said:
“During the third quarter of 2019 White Brook entered Goodyear Tire, the year to date worst performer in the Fund. Covid, set the company back a year, but the thesis remains in tact.
Goodyear is one of the 3 largest tire companies in the world and operates a distributed manufacturing capability globally. 50% of their revenue comes from the America’s region, with the US and Brazil as the notable markets within that group, EMEA is 30% of the business and the rest is Asia Pacific which contains the notable markets of China and India. About 80% of their revenue are replacement tires with the balance sold to new car manufacturers (OEM).
Within the OEM market, there’s a distinct sales cycle, where tire manufacturers pitch and are awarded business for specific models from the OEMs. It can sometimes require custom tires to be launched to support the model. While less profitable, OEM business is important as it’s guaranteed revenue and because consumers “know” the product when it comes time to replace. In the past year, that business has taken two hits. First, Covid-19 seriously impaired volumes in the 4th quarter of 2019 through the second quarter of 2020. Additionally, as manufacturers struggled, Goodyear had to cut the prices charged to OEMs – of between $2-$4.
Goodyear uses a size nomenclature to denote premium and non-premium tires, where less than 17 inches, is a commodity tire and above, is premium. Most of their business is non-premium, commodity tires, where they earn on average $8 per tire in the replacement market, and $5 at the OEM. However, a rapidly increasing percentage of tires are now above 17 inches due in large part to the popularity of SUV and light truck sales and now make up almost 50% of the replacement market. Goodyear earns $15 on average in the OEM channel and $28 when replacing a 17-inch tire.
In 2019, Goodyear took some short-term pain, dropping some low profitability 16-inch OEM business, in order to be able to guarantee production for more profitable 17-inch business that will come online in 2020 and 2021 and buttress revenue growth. Those cuts led to a consolidation of the manufacturing footprint that should help margins as volumes return in 2020 and 2021. Additionally, during the 4th quarter of 2019 and into 2020, the Company began to rationalize it’s European distribution channel filtering out those retailers who didn’t prioritize Goodyear tires. This process should end during the 4th quarter of 2020, setting up very easy comparables and much better cash flow prospects for 2021.
Electrification of autos is a tailwind for Goodyear. Tires for electric cars are different from those for combustion engines and the cost to compete in new electric tires is significantly higher than in combustion cars that have only changed incrementally for a century. Additionally, given the importance of the after-market and being able to widely manufacture and distribute, the industry is likely to change in a way that favors today’s market share leaders. The competitors earning small profits on thin margins are likely to have difficulty manufacturing an electric car tire, and the industry structure is therefore likely to change to favor those with the capability to invest. As a proof point, Goodyear currently wins over 50% of the electric car fitments that it competes for. I expect that momentum to continue and result in better gross profit margin moving forward. Goodyear’s sizable replacement business partially insulates the Company from the impact of new car sales. Recessions, however, still impact the business as tire replacement is a function of consumer confidence and miles travelled. In China, miles travelled is back near pre-covid levels, and Goodyear has taken market share during the downturn. Europe and the US continue to struggle, but auto sales have been stronger than expected during the summer, particularly for class 8 trucks, which had declined precipitously during covid, and was projected to recover at a slow rate. Additionally, trade hostilities were a headwind in 2018 and 2019. Hopefully they will not recur in 2021 as severely or 2022.
In 2017, Goodyear traded for $35 a share, a year ago it traded at ~$15, and it trades for $10 today. As business improves in 2021, the company should become more profitable and cash flows should improve significantly more than revenue. The Company should be able to service its debt and I believe will be identified as a company whose prospects are rapidly improving and garner a price that reflects that. At 5.5x 2021 EBITDA, and a mid double digit 2021 FCF yield, I believe Goodyear is inexpensive. They’ve made necessary short-term sacrifices to ensure the long term which they should have benefited from in 2020, but Covid pushed to 2021. Their business is macroeconomically resilient, and with a $100mm+ EBITDA tailwind based on the cessation of a raw material headwind alone, I am confident in their ability to generate substantial cash flow over the medium term. I believe owning the stock at these prices represents a solid investment opportunity.
I continue to be constructive as it pertains to midcap value stocks especially relative to large cap stocks and on an absolute basis for the medium to long term investment horizon.”
Copyright: baranq / 123RF Stock Photo
In Q2 2020, the number of bullish hedge fund positions on Goodyear Tire & Rubber Co (NASDAQ:GT) stock decreased by about 19% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t believe in GT’s growth potential. Our calculations showed that Goodyear Tire & Rubber Co (NASDAQ:GT) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.
