|Shares Out. (in M):||64||P/E||13.8x||49.6x|
|Market Cap (in $M):||1,591||P/FCF||N/A||N/A|
|Net Debt (in $M):||83||EBIT||227||165|
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I recommend a short position in Cooper Tire & Rubber (CTB) due to it over-earning from 2009-2012 as a function of a China-specific tire tariff. In June 2013, nine months following the tariff expiration and prior to CTB missing Q2 estimates (EPS $0.55 actual vs. $0.93 est.), CTB received a bid from Apollo Tyre (APTY:IN) for $35ps, a 43% premium to the pre-bid price of $24.50. Fast forward to 12/30/13 when the merger was cancelled as a function of APTY:IN stock dropping by 28%, labor discord both at a CTB U.S. factory and a China JV, and delayed Q3 2013 financial statements, all serving as a fulcrum for APTY:IN to claim its financing had been withdrawn. Now largely orphaned, CTB trades at a slight premium ($24.90) to its pre-bid price while its fundamentals have continued to deteriorate due to increasing competition post-tariff. As of this week, CTB reports that it is now recovering its financial statements from the China JV (which had locked out CTB since last July) suggesting that CTB’s delayed Q3 10-Q is forthcoming. In court documents filed by Apollo during the merger dispute, CTB reduced its 2013 proxy revenue estimates from $4.4b down to $3.4b - a 23% drop in revenue. CTB's tier 2 replacement products face increasing price erosion and CTB’s private label tires are in much less demand given the glut of higher quality China products now available in the market. CTB is now challenged to stabilize its market share losses and rebalance inventories following the 15 month contentious merger effort. CTB currently trades around 14X my 2013 EPS estimate of $1.80 – a premium to Goodyear (GT) at 11X. For 2014, I expect EBIT margins to normalize with more challenging raw materials comps and market share losses to persist with weak demand in CTB’s tier 2/3 replacement segment and its private label business. With my 2014 EBITDA estimated in a range from $200-250m and an EV/EBITDA target of 4.3X conservatively in-line with GT, this implies that CTB is worth between $12.75-$16.25ps, the midpoint of which is a 42% return from current levels.
Company Background / Tariff History
Cooper Tire & Rubber was founded in 1930 and is based in Findlay OH. It operates 9 manufacturing facilities (U.S. (4), China (2), Mexico (1), U.K. (1) and Serbia (1)) with China and Mexico leading the shift to low-cost country production in 2006-2008 and the closure of the Albany GA plant in 2009. They were the 4th largest N.A. tire manufacturer and 9th largest in the world with $3.9b revenue (70% N.A. / 30% Int’l) and 47m tires in 2011. In 2013, they are now the 11th largest globally, losing 2 positions. Cooper manufactures passenger and light/medium truck replacement tires with only 5% original equipment (OE) tires. U.S. market share was 13%. Principal raw materials (50-55% of COGS) are natural rubber, synthetic rubber, carbon black, chemicals (butadiene), and reinforcement components (steel cord). Labor is 20-30% of COGS. U.S. light vehicle replacement shipments are stable and resilient, ranging from 208-238m from 1997-2012. Their international segment is growing off a low base with performance currently hampered by pricing pressures from intense competition.
The short opportunity is furnished by the first ever use of Section 421 of the Trade Act of 1974. The tariff enacted a China-specific light vehicle tire import duty of 35%, 30%, and 25%, respectively, for 3 consecutive years beginning 09/26/09. It was a blatant effort by the United Steel Workers to “indict globalization”. Of note, no tire producer was on record advocating the tariff and Cooper management downplayed expectations by lamenting the payment on 2-3m of their own tires from China but “in the short term we could see some positives from the enactment of this legislation”. Post-tariff, CTB is now revisiting the same competitive threats that instigated its 2008 Strategic Plan and $145m restructuring charges and the benefits of the tariff that accured to CTB have reversed.
Proposed Apollo/Cooper merger - likely ambitions of the 3rd generation heir apparent to Apollo
|2006||2007||2008||2009 Q1-Q3||2009 Q4||2010||2011||2012||Q1 2013||Q2 2013||Q3 2013|
|Q4 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||Q1 2013||Q2 2013||Q3 2013|
|Tire Size / SKUs tracked||Tire Description||Q2 to Q3 Sequential Price Change||Weight||Weighted Price Drop|
|205_70_15 / 10 SKUs||15" - typically on older cards||-1.9%||25.0%||-0.5%|
|225_60_16 / 15 SKUs||Most common tire size in market (3-4% all sales)||-5.3%||50.0%||-2.7%|
|245_70_17 / 11 SKUs||Common truck tire||-8.4%||25.0%||-2.1%|
|Q1 2013||Q2 2013||Q3 2013 E||Q4 2013 E||
FY 2013 E
|FY 2014 E|
|Other income (expense)||-$0.6||$0.8||$0.8||$0.8||$1.9||$3.2|
|Income Tax Expense||$27.6||$19.6||$12.7||$1.5||$61.5||$16.9|
Thereafter, on September 9, 2013, we received a revised version of a business plan,showing further substantial reductions – $3.6 billion in revenues and $315 million in operating profit for 2013. In discussions with you, we received assurances similar to those we had received in August. In meetings on September 17, 2013, you provided yet another account of the situation at the Company, forecasting a nearly 33% decline in operating profit for September –your projected “catch-up” month – from the forecast delivered only days earlier. Now, we have just received yet another story of the Company’s third quarter forecast and this one reveals the most troubling shortfall yet – $3.4 billion in revenues and $257 million in operating profit for 2013 – in other words, 2013 revenues and operating profit as projected in July were 25% and 48% higher than your current estimates. Your most recent forecast also reflects an additional 25% decline in projected operating profit for September alone, revealing the promised recovery to be illusory and the Company’s current profitability, based on this most recent forecast, to behalf of what was projected little more than three weeks ago. The third quarter has come and gone, and we are saddled with a series of forecasts that leave us confused and deeply concerned over the reliability of the Company’s management and its internal reporting and financial forecasts."
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