The automotive industry in the US has seen its ups and downs, and while it is resurging now, few years ago it was on life support. Many of the factors that were pulling the sector down, such as weak consumer demand, also affected the replacement tires market. Consumer’s were more likely to wait longer to replace their old tires, where possible. Cooper Tires is one of these tire companies that have seen worse days and is now rebounding with general improvement in the economy, and the economics of their business.
Cooper Tire & Rubber Co (CTB) is the 4th largest tire manufacturer in the US, after Goodyear, Bridgestone and Michelin US. However, Cooper Tire manufactures tires for the replacement market only, unlike the other 3 that also make tires for the new vehicles. Cooper produces tires for passenger cars and lite trucks and sells them through own stores as well as mass retail. Its international segment manufactures and sells replacement tires worldwide.
Article Continues After the Advertisement
Why You Should Like the Stock?
Currently the stock can be purchased cheap. The company has now posted 11 consecutive quarters of profits, and the sales have continued to grow on the back of growth in the international segment, especially in Asia. Consider some of the valuation ratios:
- Price to Book multiple = 1.61
- Price to Earnings = 12.23
- Dividend Yield = 2.8%
While the revenues and net income have been variable, they have been profitable in the last 3 years and are able to fully support their dividend and continue to reinvest in the business for growth. In 2011, they used their tax valuation allowance for a one time gain of $2.82/share, which helped them report a EPS of $4.02/share (which also shows up as a PE ratio of 3.81 on Yahoo and other sites, which is misleading). Discounting the one time gain, the company had an earnings decline last year of 44% despite posting a revenue gain of 17% over 2010. The reasons include higher raw material costs, changing product mix, and higher Union related expenses.
Cyclicality in the Automotive Sector
These businesses are cyclical businesses. Currently, the business environment is improving. With increasing demand, revenues go up and at the same time the companies find it worth their time and capital to pursue capacity building projects. Cooper is investing in new plants and increasing their ownership stake in several of the joint ventures they are currently part of. All well and good, but the problem arises when the cycle turns as the new capacity starts coming online. That immediately puts these companies in a cost-reduction mode. If the company has enough cash to fall back on during the lean years, it can come out stronger for the next up-cycle with all the capital investments done earlier.
For Cooper, 2008 was their low point when they lost almost $2/share. Even then, they had $248 m in cash. The cash now stands at $268 m, which is a marginal improvement. Understandable as they have made several capital investments since then. Their Book Value or the Equity has grown significantly during this time (almost doubled). The company should now look to grow their cash balance steadily for the rest of this cycle.
There are 2 questions you should ask when you are considering investing in a company like Cooper.
- Are you paying a good price today?
- Are you willing to wait long enough to see your returns?
The returns to the investment may not show up in the current cycle and you may have to wait for 10 years or so to see a good return. A lot of this can be mitigated by paying as little as possible for the stock today. The stock has ranged between 3 and 24 P/E in the last 10 years, so at the current valuation it sits in the middle, which is a fair price to pay for the stock today. If you are a patient investor, you may want to buy the stock and hold it for a decade or two and you will be happy (watch it constantly though, things might go wrong). 2.8% yield is a good compensation while you wait.