The turnaround at the world's largest tire maker had been gaining traction. Goodyear (NYSE: GT) had gone from being nearly bankrupt three years ago to showing record sales and its highest quarterly profits in more than seven years. Holding it back from doing even more were devastating hurricanes and rising costs of raw materials.
That progress got flattened yesterday, following news that the company anticipated raw material costs to outstrip previous expectations, creating a drag on sales and profits. The stock tumbled 16% to close down more than $3 at $15.64 a share.
Raw materials comprise 35% of Goodyear's cost of goods sold, with nearly half of that amount coming from synthetic and natural rubber. A simple penny-per-pound increase in raw material costs translates into a $17 million hit to segment operating income. More important is the increase in oil prices. Since oil is used to not only make the tires, but to fire the plants and transport the finished product around the globe, a $1 change in the price of oil costs Goodyear $20 million. With 60% of the raw materials needed to produce a tire dependent upon the price of oil, record oil prices have had a deleterious effect on the company.
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Q3 2005 Raw Material Costs Breakdown
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Synthetic Rubber*
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26%
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Natural Rubber
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20%
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Fabrics*
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13%
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Steel Cord
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11%
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Carbon Black*
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11%
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Other*
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19%
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*Denotes items dependent on oil
Last year, as the company regained its financial footing, it was able to raise prices to offset those raw material costs. Goodyear initiated a series of price increases on its tires -- ranging anywhere from 5% to 8%, depending on the model -- that helped ameliorate the effects of surging costs, joining competitors Cooper Tire & Rubber (NYSE: CTB), Michelin, and Continental, in the effort.
That was apparently not enough for the fourth quarter, when Goodyear says raw materials rose 13%, more than the 8% to 10% it had forecast. Sales for the quarter are expected to come in at $4.9 billion and a record $20 billion for the full fiscal year. Even so, segment operating income is expected to be flat, around $238 million, though it should climb 20% to 25% on the year.
Goodyear has some expensive legacy costs -- more than $3 billion in unfunded pension obligations -- to contend with, as well as nearly $5 billion in long-term debt to pay down.
The tire maker's five-year restructuring plan still has a few years left on it. While this quarter apparently represents a pothole in its progress, I predict that the analysts who turned tail and downgraded Goodyear to "sell" will once again find they've chosen the wrong rating at the wrong time. With a price to free cash flow ratio of just 15, I believe the company remains a bargain that will gain speed and traction after this bumpy strip of road.
Get a grip on Goodyear with these related Foolish articles:
Fool contributor Rich Duprey owns shares in Goodyear but does not have a financial interest in any other stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
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