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Cooper Tire & Rubber's Q3 Earnings Aren't as Good as They Appear

By Tyler Crowe – Oct 31, 2017 at 1:15PM

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Some one-time gains from product liabilities helped boost an otherwise lackluster quarter.

Something always seems a bit strange when a company delivers a solid earnings beat, but shares decline anyways. This past quarter, Cooper Tire & Rubber's (CTB) stock declined close to 10% even though the company posted much better than expected earnings results. Looking at the results, though, it looked like this quarter's performance was from one-time items.

Let's go through Cooper's most recent results to see what's going on with this tire manufacturer. 

Road angle view of a car tire

Image source: Getty Images.

By the numbers

Metric Q3 2017 Q2 2017 Q3 2016
Revenue $733.8 million $720.7 million $750.9 million
Operating income $101.4 million $74.8 million $78.2 million
Net income $61.7 million $45.3 million $50.5 million
Diluted EPS $1.18 $0.85 $0.90

Data source: Cooper Tire & Rubber earnings release. EPS= earnings per share.

Let's get right into the reason earnings outperformed when just about every other metric suggests otherwise. Unit volumes and sales were down 2.3%, and raw material costs were up 6.8% compared to this time last year, but the company's operating profit increased substantially because of lower product liability costs. According to management, its most recent assessment of pending and anticipated product liability claims came to the conclusion that it could lower its liability expenses. 

The one data point you could consider really good news is that the company's sales in Asia are growing leaps and bounds. Total volume sales were up 31.3%, and net sales increased 44.8% from higher volumes and a more favorable mix of products. Operating margins and profits from this segment continue to elude the company, though, as higher product costs led to an operating margin of just 0.4%. 

The rest of the numbers just looked bad across the board. Heavy discounts from Cooper's peers and high inventory levels continued to put pressure on prices and margins. It also suffered from higher material costs. 

Despite the challenges in the third quarter, management was still able to maintain a return on invested capital of 15.2%, and the board of directors approved a $300 million share repurchase program through 2019. One of the ways Cooper has been able to maintain high rates of return is its ability to reduce its total shares outstanding. 

CTB Chart

CTB data by YCharts.

What management had to say

Perhaps another reason the company's stock declined so much was that CEO Brad Hughes' press release statement wasn't exactly the most optimistic outlook for the industry:

Our third quarter performance, particularly the decline in North America unit volume, reflects continued challenges within the tire industry, including raw material cost variability, weak trends in retail sell-out of tires to consumers, elevated inventory in the channels and a fluid promotional landscape. These conditions were exacerbated by the hurricanes in Texas and Florida.

In North America, we continue to respond to current market conditions by being competitive on pricing and promotions. We are addressing the unit volume decline, which was partially the result of the ongoing reduction in our private brand business, by expanding into additional channels with new positions in the car dealer and e-commerce channels, as well as new OE fitments that we will announce in the future. In addition, we have an aggressive schedule of new product introductions underway that continues throughout 2018 and 2019.

What a Fool believes

Management has warned that next quarter will be a tough one. Those high inventory levels have yet to come down, and discounting is still prevalent. It expects that these will result in lower operating margins, but it still expects full-year 2017 results to stay on the high end of its 8% to 10% guidance for the year

All of that sales growth in the Asia-Pacific region is a sign of hope for the company longer term, but it will need to translate those results into some form of operational profit. Investors can probably give the company a few quarters to get its new factory there at full capacity and spread its fixed costs around. 

Buying back shares in a business like this is a good idea. There simply aren't enough places to deploy capital without running into diminishing return rates. Today, shares of Cooper trade for just 8.9 times earnings, and that seems like a good price at which to buy back stock. 

Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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