Cooper Tire & Rubber (NYSE:CTB) is on notice. Despite having never shorted shares in a company in my investing career, I've had "Short CTB" on my whiteboard of promising investing ideas for the past few months.
Dividend cuts and declines
Over the past year, I've spent a great deal of time looking for companies that were likely to cut their dividends -- and I've written about several of them. These companies suffered from a lack of free cash flow (FCF) and rapidly deteriorating balance sheets. And a number of them have cut their dividends, including ConAgra Foods (NYSE:CAG), Glenborough Realty Trust (NYSE:GLB), Ford (NYSE:F), and Dana (NYSE:DCN).
Of course, many of the companies I wrote about did not cut their dividends. Some recovered, and others have slowed the flow of red ink or are continuing to limp along. But having kept track of the experience on paper and singled out the most troubled companies, I've seen that shorting troubled dividend payers can pay off handsomely (although there are some risks associated, so keep reading).
Why go short?
Cooper Tire & Rubber's financial position is weakening as the company burns though its cash at a rapid rate. The company also isn't earning enough money to cover the interest expense on its current debt. Here's a subset of the company's financial data.
|
TTM* |
2005 |
2004 |
2003 | |
|---|---|---|---|---|
|
Sales |
$2,237.7 |
$2,155.2 |
$2,081.6 |
$1,850.9 |
|
Operating Income |
$15.9 |
$26.2 |
$61.3 |
$63.3 |
|
Operating Margin |
0.0% |
1.2% |
2.9% |
3.4% |
|
Interest Expense |
$35.2 |
$36.0 |
$25.5 |
$28.0 |
|
FCF |
-$129.8 |
-$118.6 |
-$57.3 |
$138.5 |
|
Owner Earnings |
-$69.7 |
-$65.9 |
$156.7 |
$93.4 |
|
Dividends Paid |
$25.7 |
$26.6 |
$31.1 |
$31.0 |
|
Cash |
$193.8 |
$280.7 |
$881.7 |
$28.6 |
|
Long-Term Debt |
$502.6 |
$491.6 |
$773.7 |
$863.9 |
|
Gross Margin |
8.1% |
8.7% |
11.2% |
11.3% |
|
Capex/Sales |
7.6% |
8.0% |
7.7% |
5.2% |
Data provided by Capital IQ, a Division of S&P, $ In Millions
The bulk of Cooper's financial woes can be traced back to increasing prices in the petroleum- and steel-based products that are necessary to make and retread tires. What's worse, is the company has proved unable to raise prices to offset rising costs. Competitors such as Goodyear Tire & Rubber (NYSE:GT) and Bandag (NYSE:BDG) have also seen their financials worsen, but not nearly to the extent that Cooper's have. And with oil prices continuing to rise, I'm not optimistic that the situation will improve.
Management
What makes a struggling business even worse is a management team that is not up front with shareholders. Unfortunately, this is the case at Cooper Tire & Rubber. In his 2004 letter to shareholders, after reporting negative FCF, CEO Thomas Dattilo made no mention of the company's challenges. Instead, he chose to focus on the company's recapitalization, its goal of becoming the No. 1 tire company in China, and its unprecedented opportunities. Beneath the shareholder letter was a brief table summarizing some of the company's financial metrics.
After reporting a net loss on the income statement and another year of negative FCF in 2005, shareholders were treated to another letter full of all the great things the business had accomplished, including the quote, "This is a very exciting time for our company!" Absent from the 2005 shareholder letter was a table with a summary of the company's financial metrics and any mention of the company's financial woes.
Now, there's nothing wrong with focusing on the bright side, but shareholders might also be interested in how the company is coping with its financial struggles. I, for one, am curious to see whether next year's shareholder letter continues to ignore the enormous elephant in the room.
Foolish final thoughts
Taking a short position in a stock is not something to do lightly. There is always the risk that the company's condition will improve, and it is important to remember that an investor with a short position is responsible for paying the company's dividend to the shareholder who provided the shares. Because of the possibility of a recovery and the risk that entails, I haven't decided whether I will open a short position. I will most likely wait for next quarter's results and reassess.
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Nathan Parmeleehas no financial stake in any of the companies mentioned in this article. The Motley Fool has adisclosure policy.
