Personal Finance

Here's How Cooper Tire & Rubber's Management Plans to Respond to a Tough Quarter

car tire on road

Even after warning investors that first-quarter results were going to be weaker than expected, Cooper Tire & Rubber (NYSE: CTB) took it on the chin after releasing earnings and shares haven't improved much since. The broader tire industry is in a tough operating environment lately, but Cooper's management wanted to reassure investors during its conference call that this isn't a prelude to a long-term decline.

Here are some quotes from Cooper's management that suggest the company isn't in as bad of a shape as first-quarter results suggest and what investors should be on the lookout for over the long term.

car tire on road

Image source: Getty Images.

Yeah, we had some temporary troubles

Cooper's first-quarter results weren't the kind that proud parent would post on the refrigerator. Higher material costs, elevated levels of price competition, and some wonky effects from its last-in, first-out (LIFO) accounting methods all led to poor results in its U.S. operations and a steep drop in overall earnings. According to Cooper CEO Bradley Hughes, may of these effects will be alleviated in the coming quarters thanks to some other aspects of the business.

[T]he first quarter was one-off transition as we absorbed higher raw material costs and implemented product price increases. Our strategy to diversify and grow our non-U.S. businesses is paying off as we saw very strong unit volume growth in our faster-growing markets of Asia and Latin America and a continued turnaround with double-digit unit volume growth in Europe.

Cooper's growth rates in international markets are no joke. Cooper posted 13%, 20%, and 80% year-over-year volume growth rates for Latin America, Europe, and Asia, respectively. These kinds of results are off the charts for a mature industry like tires. Granted, profit margins aren't as great in these markets as they are in the U.S. As these markets mature, though, Cooper will be able to gain some pricing power that should translate these high-growth regions into significant profit centers.

We'll get it back in the rest of the year

For investors who may be worried that these first-quarter trends are a sign of something longer term, Hughes tried to squash those concerns as quickly as possible. He reaffirmed previous guidance of 8% to 10% operating margins for fiscal 2017 and explained how Cooper expects to get back into that range for the rest of the year.

Looking ahead, while raw material costs seem to be stabilizing, we expect that additional price and promotional activity will affect U.S. volumes in the second quarter. For the full year 2017, we expect continued strong unit volume growth in our International segment and in Latin America. We continue to closely monitor the raw material and related pricing environment and currently project the pricing dynamics will normalize in the coming quarters. Our unit volume in the U.S. is expected to improve relative to the industry for the second quarter and be in line with the industry in the second half of the year.

We've seen this before

Another way Hughes tried to ease investor concern was to explain that this isn't the first time the company has been faced with the double whammy of higher material costs and severe price competition.

[T]here is one example to this in my tenure here that goes back to 2011 that was somewhat similar. And I only raise that because at that time, again we saw, it was significant movements in raw materials, tire companies making their pricing changes to respond to that, and the timing and the implementation of it was a bit choppy there as well, and it hit us for a couple of months. We responded and moved back in line with the market in a relatively short order. I can't say that this will be exactly the same situation, but we do have confidence that we know how to respond to what we're seeing.

The trends to watch

Most of the call didn't provide much insight for longer-term investors. There were a lot of questions related to shorter-term guidance that have little value to someone looking to own Cooper's stock for several years or more. One item that did get brought up, though, was when one analyst asked what Cooper's management views as the trends worth watching to determine Cooper's future success.

Overall, when you look at some of the important variables that in the past have been good indicators about what's going to happen with replacement tire volumes, like miles driven, like where gas prices are, those things all seem to suggest that there should be some recovery as we look forward over the balance of the year. And we hope to see that. But you're right. In the first quarter, we believe that the industry did see a weaker sell-out environment [in the first quarter].

These indicators are important things to consider when looking at the tire business over the long term. It's becoming more and more apparent that automated driving and ridesharing are going to play a significant role in the automotive industry over the coming years. This trend is likely going to lead to much fewer vehicles. The knee-jerk reaction to this is to assume that the tire industry is going to suffer. For aftermarket tires, this may not be as severe of an impact because the most important underlying factor in tire demand is miles driven. Perhaps there are many fewer vehicles on the road, but those vehicles will drive much more, and their tire replacement schedules will be much shorter.

While Hughes may have been looking at slightly shorter-term impacts of these factors in the call, they are the most important things to consider when investing in Cooper over the long term.

A market shift coming

As one analyst highlighted on the conference call, lower oil prices has led to a significant change in consumer behavior. Smaller vehicles like sedans are out, and SUV and pickup trucks are in. Since Cooper's U.S. sales are exclusively aftermarket, that means any of those newer vehicles haven't been potential customers because they were under warranty and using original equipment manufacturer (OEM) parts. Many of these newer vehicles, however, are starting to roll off warranty, and that means Cooper's products are now an option for these consumers. According to Hughes, management has the right product mix out there to take advantage of this secular shift.

In terms of the to's and fro's of the auto industry, certainly the last several years you've seen a recovery in the light truck and the SUV market. We believe and I think that we've recognized, we have a very strong product lineup to support that part of the market.

This is a good sign for the industry. Replacement SUV and light-truck tires sell at a much higher price point than sedan tires and command higher margins. This is certainly a trend worth watching over the next several years to see how well Cooper captures it.

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Tyler Crowe has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .

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

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

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