In today's fast-moving markets, investors are always on the
prowl forstocks that can deliver rapidgains . It wasn't always
Back in the days of Benjamin Graham and David Dodd -- known as
the grandfathers of valueinvesting -- an emphasis was placed on
long-term opportunities. These men focused on stocks as assets,
seeking out what a company was worth in relation to its assets,
the defensibility of itsbusiness model , and the level ofcash
flow that could be sustainably produced throughout the years.
Every once in a while, I come across what Icall a "Graham &
Dodd special." These opportunities typically involve large,
well-established businesses that operate in an industry with high
barriers to entry. They often involve large amounts ofcapital
spending, creating an impediment to new firms looking to crack
themarket . And they can count on a steady recurring base of
customers that need to keep coming back to them.
My Graham & Doddstock for 2013:
Goodyear Tire & Rubber (Nasdaq: GT)
, which is just working its way back into favor. It remains
remarkably cheap by almost any measure, and it appears poised for
solidupside in comingquarters and years.
Shares of Goodyear remain far from their pre-recession highs,
even as the North American market auto market strengthens.
Nowadays, it's Europe that weighs heavily. Yet as soon as the
continent 'seconomy hits bottom, we may see a snapback in
European vehiclesales . That market has been depressed for
five years, and the average vehicle age is creeping higher.
Meanwhile,note how cheap this stock has become. Goodyear carries
amarket value of $3.2 billion and anenterprise value of $7.3
billion. Cash flow generation can be erratic, because it's
largely tied to raw materials (read: rubber) prices and unit
In 2009,EBITDA (earnings before interest,taxes ,depreciation
andamortization ) fell to a decade low of $872 million, but it
rebounded to a decade-high of $1.67 billion in 2012. During the
past six years, EBITDA has averaged $1.4 billion. This means the
stock trades for around five times normalized EBITDA.
For a company with such a solid base ofrecurring revenue -- sales
bottomed out at a decade low $16.3 billion in 2009 and are
already back above $20 billion -- and a strong global brand,
that's a very low EBITDAmultiple .
Better still, EBITDA is about to surge higher as Goodyear starts
to benefit from a sharp drop in prices for natural and synthetic
rubber. Goldman Sachs expects EBITDA to hit $2.3 billion in 2014
and $2.5 billion in 2015. That means shares trade for less than
three times projected 2015 EBITDA, which is among the
lowestmultiples in the S&P 500.
The remarkable thing about these forecasts is that the
all-important European auto market is still in deep trouble. If
and when Europe rebounds -- as the U.S. market has already begun
to do -- Goodyear's numberswill only get better.
Free cash flow is the other intriguing angle to thisinvestment .
In recent years, Goodyear has heavily invested in major upgrades
to its manufacturing plants, which should lead to lower operating
costs. But that high level of capital spending has led to
negativefree cash flow for five straight years.
That process is expected to wind down over the next four to six
quarters, setting the stage for free cash flow above $400 million
by 2015, according to Goldman Sachsanalysts , who have a $17price
This stock also scores quite well on a straight-ahead
price-to-earnings (P/E )ratio analysis . Analysts at Citigroup
seeearnings per share (
) rising from $1.91 in 2012 to $3 by 2015. Shares trade for less
than five times that 2015 forecast. That outlook underpins
Citigroup's $20 price target.
The Return OfPricing Power ?
One of the key concerns around tire makers is too much industry
capacity for current demand. Rivals have been adopting aggressive
pricing promotions, which Goodyear has largely sought to
As a result, the company has lost a bit ofmarket share in
recent quarters (though actual market share figures are hard to
verify). Yet still-rising U.S. auto sales, coupled with early
signs of a thaw in Europe, are expected to push tire demandback
up to industry supply levels, which should give Goodyear and
others alot more pricing power.
Risks to Consider:
Rubber prices are always a wild card, so any sort of troubles
on that front will weigh on Goodyear's margins.
Action to Take -->
Tire makers are still wrestling with weak demand and pricing. Yet
Goodyear is still generating very impressive financial metrics.
By the time industry conditions appear more robust, Goodyear
could be posting great cash flow numbers. If you wait until then,
you will likely have missed out on a compelling deep-value
(Editor's note: This is an update of an article published
in May 2012.)
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