Why Are Tire Stocks Running Up?

Tire manufacturing is a tough business. Tire companies must be careful to keep production costs down in order to turn a profit. Expenses for labor, raw materials, and upkeep of legacy plants are huge. Net margins are thin.

India-based tire manufacturer Apollo Tyres will receive access to the U.S. tire market through the acquisition of Cooper Tire & Rubber (NYSE: CTB  ) , a merger expected to close by year end. 

Sales at Cooper Tire and Goodyear Tire & Rubber (NASDAQ: GT  ) were down at both companies in the second quarter, yet their stocks were up 28% and 35%, respectively, year-to-date through Aug. 21. Cooper's sales were down a whopping 16.4% in the second quarter, compared with Goodyear's 5.7% drop in second-quarter sales. Goodyear is still the largest U.S. tire maker, but hasn't paid a dividend in 10 years and is a shadow of its past. 

The merger

Cooper Tire says the merger with Apollo Tyres brings together two "highly complementary brands, geographic presence, and technological expertise." 

I suspect Apollo Tyre will ship its tires through Cooper Tire's distribution network. I also suspect tires will be made more cheaply in India, which is why the company will seek to close legacy-rich Cooper Tire plants in the United States.

Competition from Asia

Goodyear receives about half of its revenue from the North American market, but that market is overcrowded; multiple tire makers from around the world sell products in the U.S. Modern Tire Dealer reports there is increased competition in truck tires from Yokohama Rubber of Japan, Double Coin of China and Bridgestone (ADR)  (NASDAQOTH: BRDCY  ) of Japan.  

Bridgestone acquired Firestone in 1988 and overhauled the company. Bridgestone has diversified into other product lines, such as roofing materials, golf balls and bicycles. Bridgestone's dividend yield is about 1.2%, according to Reuters

For the six months ended June 30, 2013, Bridgestone's revenues increased 15%. Net income applicable to common stockholders increased 56%. Bridgestone stock was up 28% year-to-date through Aug. 21.

Meanwhile, Goodyear's sales in North America were down 10% in the second quarter of 2013 to $2.2 billion compared with $2.4 billion in the second quarter of 2012. The number of tire units sold in North America was down 3.8%. Goodyear stock was up 35% year-to-date through Aug. 21.

Cooper Tire's North American sales were down 19% in the second quarter.

Goodyear was removed from the Dow 30 in 1999, and fell to $4.00 per share by February 2003 after losing money in 2001 and 2002. On Feb. 24, 2003, Goodyear's stock closed at $4.06 per share on the New York Stock Exchange, down from $75 in 1998. Goodyear's stock eventually moved to the Nasdaq.  

Goodyear overhaul

Beginning in the early 2000's, Goodyear made several major changes, including moving a retiree health-benefit obligation to a trust fund called the Goodyear Retiree Healthcare Trust. Hundreds of jobs were cut in North America. Goodyear eliminated its quarterly dividend in 2003. The company had been paying a quarterly dividend of $0.12 per share since October 2001, when it reduced the payout from $0.30 per share. 

The end of the steady dividend in 2003 marked the end of an era for Goodyear stockholders, who had been receiving dividends since 1937.

Cooper still pays a dividend yielding 1.3%. Cooper's stock languished around $20 per share for many years until Apollo Tyre agreed in June to buy the company for $35 per share. Cooper stock has traded as much as 7% below the sale price of $35 per share,; perhaps the market feels Apollo overpaid for Cooper after it reported disappointing results in the second quarter. Cooper stock was up 28% year-to-date through Aug. 21.

Financial Ratios

Financial data shows that Cooper and Bridgestone have less debt and stronger financial ratios than Goodyear. Goodyear reported $6.3 billion in long-term debt with a debt-to-equity ratio of 8.85 and a debt-to-capital of 0.82.

Meanwhile, Cooper's long-term debt was $326.88 million, with debt-to-equity ratio 0.38 and a debt-to-capital ratio of 0.28. And Bridgestone reported $4 billion in long-term debt with a debt-to-equity ratio of 0.25 and a debt-to-capital ratio of 0.26.

The Foolish bottom Line

Expect increased competition from Apollo's entry into the U.S. tire market through its acquisition of Cooper Tire. Goodyear still has too much debt and can't afford to pay a dividend. Bridgestone is stronger financially and is increasing its revenue, and looks like the clear winner in this space. Both Cooper and Goodyear have been losing sales in North America, though shares of Cooper, Goodyear and Bridgestone have risen substantially year-to-date through Aug. 21. Cooper and Goodyear seem overpriced.

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