The global marketplace is showing concerns over the Chinese economy’s possible slowdown. A manufacturing report known as the Flash PMI showed a drop in orders to 48.1 – below the 48.7 expected by analysts. Even if China’s economy cools down, however, Chinese demand for natural resource based goods can still benefit investors.
The market for natural and synthetic rubber is over $32 billion and expected to grow 3.8% annually according to the International Rubber Study Group. China makes up 35% of the world’s total demand for rubber, mainly for tyres. In fact, 70% of rubber in China is used just for tyres.
Tyres are the leading cause of the rising demand for rubber with global demand increasing 4.7% through 2015. China makes up 20% of the world’s automotive production and some estimates show that production could double by 2017 to 27 million vehicles made.
China isn’t the only economy with growing tyre demand. The European market has finally stabilized thanks largely to increased demand in the commercial sector. Sales are expected to increase by around 4% for 2014 – an improvement from the 3% increase seen last year.
Goodyear is leading the way for the tyre industry
The largest market share in the tyre industry belongs to Goodyear Tire & Rubber (GT) at 15.5%. The U.S. based company is the #1 tyre manufacturer in North America and Latin America with 52 plants in 22 countries. The company closed out 2013 with record-setting figures and high expectations for 2014. Goodyear reported the highest operating income in the company’s 115-year history at $1.6 billion – a 27% increase over last year. The company’s biggest potential liability, the pension plan, was fully funded entirely by cash as a result of high liquidity keeping debt obligations to a minimum and eliminating contribution requirements – a move that frees up $175 million to $250 million in cash flow over the next 3 years.
Management predicts a 10% – 15% operating income rise through 2016 led mostly by emerging markets in Asia and an improved European front. The Asian segment grew 18% for 2013 leading all other segments for the company. It generated over $1 billion in free cash flow for 2013, a 40% increase over the $701 million in 2012. Gross margins improved by 430 basis points to 23% on improved efficiencies and cost-cutting initiatives.
Valuations are cheap
Goodyear trades cheaply at just 8 times future earnings with future EPS growth around 15%, giving the stock a PEG ratio of 0.53. EPS growth this year was an astounding 193% with ROE over 132%. The stock provides some downside protection as well with its 0.70% dividend yield and $100 million stock buyback program.
The price target for Goodyear was recently raised to $31, up from $24, on the company’s 4th quarter results. This represents a 17% discount from current prices. While other tyre manufacturers like Cooper Tire & Rubber (CTB) should benefit from improved macroeconomics in the industry, Goodyear offers the best value form a P/E and EPS growth standpoint.
Source: Seeking Alpha
Published: 25 Mar 2014