This Classic Value Stock Has Up To 57% Upside

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In today's fast-moving markets, investors are always on the prowl forstocks that can deliver rapidgains . It wasn't always thus.

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 volumes.

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 target .

This stock also scores quite well on a straight-ahead price-to-earnings (P/E )ratio analysis . Analysts at Citigroup seeearnings per share ( EPS ) 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 avoid.

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 opportunity.

(Editor's note: This is an update of an article published in May 2012.)



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

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