From the beginning of December to Feb. 8, Goodyear Tire and Rubber's (NASDAQ:GT) stock was severely punished: down 24.3% compared to 10.9% for the S&P 500 index. Skepticism about the continued growth prospects of automobile sales is to blame: Over the same period, Ford was down 16.4%, GM 19.9%, and Fiat Chrysler 35%. But what a difference a day makes, when the day includes announcement of record earnings: Goodyear rose as much as 8.7% intraday on the announcement.
Is a decline in new-car sales a threat?
The concern about the auto industry is that, as the recession-induced shortfall in sales is overcome, used-car prices will fall, increasing competition to new vehicles. There's also concern about automakers' ability to maintain sales momentum as rising interest rates affect their ability to offer cheap financing. Yet all this amounts to fear that the market will return to normal: Used-car prices have been unsustainably high, and interest rates unrealistically low, but carmakers expect continued strong sales at least through 2017.
In any case, new-car sales aren't the most important source of tire demand: Replacement accounts for 70% of sales. Automakers demand volume discounts, so original-equipment tires are less profitable than replacements. Consumers often trade up to higher-margin tires than those originally fitted on their vehicles. Growing demand for high-performance tires -- 34.3% of the 2014 replacement market -- is good for tire manufacturers because they're higher-margin, shorter-lived products. Tires are taking more of a beating, too: Miles driven set a new record last year, and the roads on which they're driven continue to deteriorate.
What about China?
Concern about China is similarly misplaced. Tariffs imposed on Chinese tires last year seem to have had some effect, and a new trade case against Chinese tire manufacturers was filed on Feb. 1. In any case, the tires Goodyear sells in the developed world are mostly at price points well above Chinese product. Asia-Pacific accounts for 10.1% of its revenue, mostly of tires selling at 71.6% of Goodyear's average price: Weakness there isn't welcome, but it hardly justifies such drastic underperformance. Goodyear has in fact used imports, including tires manufactured in China, to offset some of its currency exposure, so although sales outside of the U.S. account for the majority of its revenue, currency effects reduced nine month 2015 revenue by only 7.6%.
Goodyear encounters pretty much the same competitors everywhere, but most of them are well entrenched locally, making its non-U.S. business that much more difficult. However, these figures suggest that it's holding its own: It's the No. 2 seller of new tires in the U.S. behind Bridgestone (but ahead of Bridgestone in the replacement market), and the No. 3 worldwide behind Bridgestone and Michelin. Goodyear has preferred to sacrifice share to preserve margin, and has consequently lost some of its previous dominance of sales to carmakers.
With a solid base of U.S. original-equipment sales, strong reasons to expect replacement demand to continue both to increase and to be more profitable, and limited concern about threats from either low-cost imports or its major competitors, Goodyear should be outperforming auto manufacturers. Trading at 7.5 times Yahoo! Finance's consensus estimate for 2016, the stock is certainly cheap. Goodyear is a cyclical stock that has to be bought carefully, and rushing to join the earnings announcement euphoria is probably a bad idea, but its current valuation makes a compelling case for it, and minor pullbacks, if any, should probably be exploited.