Goodyear Stock: Not A Good Year (NASDAQ:GT)

When Goodyear (NASDAQ:GT) acquired Cooper Tire & Rubber at the start of 2021, I had a look at the prospects for the combination in this article called: consolidation at work.

Goodyear announced the purchase of Cooper at the time in a quest to add scale and grow margins (through synergies), yet I feared the debt overhang as a result of the announced acquisition. This fear is exactly what played out in the end, as inflationary pressure and softer growth is hurting the business in a big way today.

A Recap

Goodyear announced the purchase of Cooper Tire in a $2.8 billion deal, that is for the equity of the company. With the purchase of the 5th largest North American tire producer, Goodyear would grow pro forma sales to around $17.5 billion (based on 2019 pro forma numbers). I specifically mention the 2019 numbers as the 2020 numbers were not yet known at the time of the deal announcement early in 2021, and they have shown quite some declines amidst the pandemic, of course.

Shares of Goodyear rose from $14 to $17 upon the deal announcement, adding $700 million onto its market value, on the back of the consolidation move, the better yielding business of Cooper Tire and prospects for $165 million in synergies in year two post closing.

Given the 20% move higher, I feared that investors were pricing in the benefits too much, as I called Goodyear a challenged business to start with while some leverage was apparent on the balance sheet, leaving me to hold a cautious stance.

Optimism Fades

After shares rose to the $17 mark early in 2021, shares have been down quite alright, having risen to the $20 mark by year-end. Shares fell back to the mid-teens in February of this year amidst concerns about the geopolitical situation and raging inflation, yet ever since shares have gradually fallen to a level just below the $10 mark.

The deal closed in the summer of 2021, and early in 2022, Goodyear posted its 2021 results. Reported sales rose 38% to $17.5 billion, to an important extent driven by the deal for Cooper, with organic sales up 12% amidst a reopening of the economies. The earnings numbers were quite complicated, with GAAP earnings of $764 million being reported, equal to $2.89 per share.

This earnings number included a $267 million tax benefit, as well as some (structural) restructuring charges as the company has seen some heavy dilution following the Cooper deal as well, as the share count rose 22% on the year, as debt rose quite a bit as well. Fourth quarter revenues trended at $20 billion a year already, with operating earnings coming in around $300 million. After taxes and statutory tax rates, that would actually result in net earnings of around $150 million, equal to nearly half a dollar per share with 283 million shares outstanding.

With earnings power trending at $2 per share on an annual basis, we have to look at the earnings power of the business. EBITDA is trending around $2 billion a year as net debt was substantial at $6.3 billion, as that number even included some operating lease liabilities while inflationary pressures were showing up.

2022 – Toughening

First quarter sales came in at $4.9 billion with pre-tax earnings coming in around a quarter of a billion leaving minimal earnings, as cash flow generation was poor. Adjusted earnings rose from $102 million to $105 million (year-over-year), yet with dilution factored in, adjusted earnings fell six cents to $0.37 per share.

Second quarter results looked quite reasonable with revenues reported at $5.2 billion as adjusted earnings rose from $79 million to $131 million as adjusted earnings per share rose fourteen cents to $0.46 per share as net debt rose to more than $7 billion amidst poor cash flow generation.

Third quarter revenues came in at $5.3 billion, which looks better than it is with inflationary pressures seen in the sales results already to an important extent. After all, revenues rose 8%, yet volumes were down 3%, indicating the pricing has been responsible for all (and some more) of the reported growth.

Amidst a normalization of tax rates and some higher interest expenses showing up already, net earnings came in at just $44 million, equal to $0.16 per share. Adjusted earnings fell thirty-two cents to $0.40 per share. Amidst the poor cash flow generation, net debt has risen to $7.4 billion as EBITDA continues to come in around $2 billion, making that leverage is on the increase as minimal earnings being offset by poor cash flow generation. Moreover, the EBITDA component is to an important extent driven by the “DA” component, with capital spending requirements on the rise as well amidst inflationary pressures.

The 286 million shares now represent just a $2.8 billion equity valuation, which looks low given the EBITDA number, the result of the large leverage position. The issue is that the benefits of the deal, reflected in the synergies, are completely offset by tough operating conditions as well as higher interest rates and inflationary pressures, with the business being energy-intensive of course.

Concluding Remarks

Given the debt overhang in this tough environment, I see no imminent appeal even as shares have come down. Leverage is a concern in this tougher environment, yet the business has been struggling for years, or decades, as it simply cannot escape the issues relating to volatile cycles and the temptation to allocate capital at good points in the cycle.

After all, this was a $70 stock late in the 1990s, which is hard to comprehend, while this was a $4 stock in the early 2000s, with huge swings seen between low-single-digit share prices and highs in the $30s and 40s.

Right now, we are back to low share price territory again, yet the woes are significant. The situation is far from hopeless, as the company is still profitable, yet the debt overhang is clear, certainly if higher interest rates kick in and demand comes under (further) pressure.