Investing in publicly traded tire companies will suit value investors who are comfortable with a mature and low-growth industry. However, that shouldn't be interpreted as a slight on the sector. It's a fascinating industry full of the subtle nuances that make up value investing decisions.
If you're looking for a high-growth industry where revenue growth is king, then look away now. However, if you love cheap stocks in an unloved transportation sector, then tire and rubber industry stocks could be for you.
The market
The market
Before going into the details of the market's dynamics and how to make money from it, here's a list of some leading tire manufacturers. The top players are a pretty diversified group. It's hard to get an exact fix on profit margins in the industry -- measured here in terms of earnings before interest, taxation, depreciation, and amortization (EBITDA) -- since some of these companies also have substantive other businesses.
However, one thing is clear: Size matters. For example, Bridgestone and Michelin are the two most significant producers and have notably higher margins than smaller players Goodyear and Sumitomo. Only Pirelli (a premium tire manufacturer) is bucking the trend with its 20%-plus EBITDA margins.
This stands to reason since building scale usually matters in manufacturing, particularly in a capital-intensive business such as tire manufacturing. Moreover, larger companies can reduce costs by using their greater purchasing power to negotiate better deals.
Generating cost synergies by building scale was part of the reason behind Goodyear's 2021 purchase of Cooper Tires.
The stocks
| Listed Company | Country | Sales in 2023 | EBITDA Margin 2023 | Notes |
|---|---|---|---|---|
| Bridgestone Corp. (OTC:BRDCY) | Japan | $29.6 billion | 11.2% | A global player with around 48% of sales coming from the Americas. |
| Group Michelin (OTC:MGDDY) | France | $3.5 billion | 12.6% | Diversified tire manufacturer making tires for light vehicles, vans, trucks, agriculture, transportation, aerospace, and motorcycles. |
| Goodyear (NASDAQ:GT) | U.S. | $20.1 billion | 8.5% | No. 1 in the U.S. after its acquisition of Cooper Tires. |
| Continental (OTC:CTTA.Y) | Germany | $46 billion | 9.9% | Tires only comprise around a third of total company sales, and management plans to separate the tire business from the automotive business by the end of 2025. |
| Sumitomo Rubber (OTC:SSUM.F) | Japan | $8.1 billion | 12.2% | About 84% of sales are from tires. |
| Pirelli (OTC:PLLI.F) | Italy | $7.3 billion | 21.8% | Generates around 70% of its revenue from high-value tires, so the margin is higher. |
The industry
A mature industry
In a sense, the tire industry is representative of a mature, low-growth industry. Such industries are typically characterized by relatively low growth, emphasizing growth through consolidation and wringing every bit of operational efficiency from tire and rubber manufacturing. In addition, companies can expand growth in new territories or end markets.
For example, the Goodyear/Cooper deal is highly complementary. Cooper was particularly strong in the original equipment market (OEM) in China and the replacement market in the U.S. At the same time, Goodyear was very strong in the U.S. OEM and replacement market.
Consolidation has long been a feature of the industry. Major landmark deals include Bridgestone's purchase of U.S. tire manufacturer Firestone in 1988, Michelin's acquisition of Uniroyal Goodrich in 1989, and the Goodyear/Cooper deal. In addition, a minor player such as Yokohama Rubber (OTC:YORUF) demonstrated the willingness of tire makers to expand into other categories with its acquisition of Alliance Tire Group (off-highway tires) in 2016.
In addition, Continental plans to separate its tire and rubber business from its automotive products business by the end of 2025. This could lead to further industry consolidation.
Low growth is still growth
One interesting facet of the tire business is that sales are a combination of original equipment manufacturing (OEM)- and replacement-led. The last point leads nicely into a key industry point that value investors will appreciate: The industry is not quite as cyclical as you might think.
It's no secret that the key metrics to follow in the industry are global car production and the number of miles driven. OEM tire sales depend on light vehicle production by automotive makers, so when car sales sneeze, tire manufacturers will catch a cold. For the replacement tire market, the key is more cars being driven since more miles driven means more wear and tear on tires.
However, the number of miles driven tends to be relatively more resilient, outside of the highly unusual impact of the COVID-19 pandemic in 2020.
The balance of OEM and replacement demand provides some long-term stability to the marketplace. For example, about 75% of Goodyear's sales go to the replacement market.
All told, it's reasonable to expect a combination of underlying replacement demand and long-term growth in OEM tire demand to lead to at least low-single-digit revenue growth in the industry.
Cost pressures
Cost pressures
Another way tire manufacturers can improve earnings is through lowering costs. The most variable cost, raw materials, moves with the price of oil. Raw materials made up 45% of Goodyear tires' cost of goods sold in 2023 and approximately 70% of that raw material price is influenced by oil prices.
It's a similar story at Michelin, where only steel cord and natural rubber materials aren't exposed to the price of oil.
As such, tire company margins came under pressure when raw material prices surged after the lockdown measures eased.
Consequently, it's worth keeping an eye on raw material prices and thinking of tire manufacturers as a group of stocks worth considering when the global economy is growing and there's moderate raw material price inflation.
A sector to invest in
A sector to invest in
These low-growth characteristics mean tire and rubber stocks will never be valued on the kind of earnings multiples that a high-growth software company will command. However, there are no prizes for only buying highly rated stocks, and investors can still generate high returns from stocks moving from undervalued to fair value.
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That's a consideration that springs to mind when looking at the forward mid-single-digit enterprise value (market cap plus net debt)-to-EBITDA multiples most of the sector -- including Goodyear, Michelin, and Pirelli -- trade on.
A combination of steady, if unexciting, long-term revenue growth prospects, plus some margin expansion through ongoing consolidation and cost-cutting, could generate excellent returns for investors over the long term. That argument should resonate with Goodyear investors as the company builds scale and plays catch-up with Bridgestone and Michelin on margin.
