Cooper Tire & Rubber Company (NYSE: CTB) is a global manufacturer of tires for the passenger vehicle, light truck/SUV, and commercial market with a focus on replacement demand. CTB is the #5 U.S. tire manufacturer and #12 manufacturer worldwide, with annual sales in 2017 expected to be $3 billion. Sales in its Americas segment account for 82% of revenue and 18% is from its International business. The company’s tires are primarily sold through independent dealers. CTB is positioned as a value alternative to the larger competitors (see Comps table below). The company’s value brands (Mastercraft, Dean, Mentor and Starfire) are priced significantly lower with prices sometimes below $50 for several models. If you check online sites like Tiretab, SimpleTire and TireRack for some popular models , Cooper typically comes in at the low-middle end of the range with Goodyear and Pirelli at the high end.

• Increase in passenger miles driven

 

 

• Shift to higher speeds

 

 

• Supply and Demand balanced through 2020 in HVA (high value-added tires, 17 inches or

greater in diameter)

            o 115 capacity and 110 mm of demand

 

in North America and Western Europe. Passenger tires generally are replaced every 4 to 5 years

irrespective of the cycle. The average age for light vehicles in the U.S. is now over 11 years,

signaling a tailwind for replacement demand.

 

 

 

 

 

1) Move to larger size tires (HVA): Gross margin for replacement tires in the 17-inch and larger

units by 2020.

 

 

2) CTB hints at further automation and cost improvement opportunities from “leveraging the

global manufacturing footprint”

 

3) Overseas growth in OE toward an 8-10% margin in China. After selling out of its original CCT

JV, CTB bought into a new arrangement that gives it access to 2.5mm of capacity. This

business is growing and slightly profitable on an operating basis but showing improvement

each quarter y/y

 

-Expectations have come down meaningfully given the volume declines earlier in the year

 

-CTB gave lower than expected margin guidance as volumes declined…8-10% margin now assumed for

the year

 

-Peak auto thesis has tarred the whole space

 

-Persistent promotional environment 

-Tire PPI is up 2%; CTB increases are above that

 

-Raw materials have pulled back materially after flooding in Thailand sent up rubber prices early in 2017

(see graph below) and squeezed margins; the price/raw material differential has turned positive

especially for a LIFO-based company like CTB which increased price in March while others followed later

into May so the volume effect was felt already and consumers should have adjusted by now to a net 3-

4% price increase. At the same time, rubber has turned almost all the way back as depicted below.

 

 

-CTB posted a 13.5% margin in 2016 with 22mm in tariff expense on TBR (truck and bus radial) so adjusted margin was more

like 14%; conservative 10% margin assumption in 2018 gets you to $4.55 and that could be conservative

if all the margin gains reverse

 

 

 

 

-Forward P/E of 8x 2018e EPS of $4.55 which is at lower end of historical range with margin

improvement on the horizon and a discount to the peer group (show in Table 1 below)

 

 

 

-Implied 2018 EBITDA of $477mm, comparable multiple of 6.0x yields $55/share

 

-As CTB is at the low end of the mkt cap and liquidity spectrum, let’s assume an average group

P/E multiple of 10.5x implies $48/share

 

-Downside protection from already low multiple. If for some reason the cycle turns ugly, EPS

could get as low as $2.50 (.50 higher than last down-cycle in 2013 to reflect operational cost

savings) at a multiple of 12x as multiple usually expands at bottom of cycle, so downside of $30

 

 

significant downturn in the tire industry. CTB could retire another 15% of the share base (I

modeled a net 2-3% decrease).