Image Source: Unsplash
 

Introduction

In the last five years, shareholders of Akron, Ohio-based Goodyear Tire and Rubber Company (Nasdaq: GT) have lost 41% on their investment with dividends reinvested (although they were cut during the pandemic and have not returned). The numbers aren’t much prettier 10 or 20 years out, with annualized returns of 0.13% and 4.57%, respectively. In contrast to the stock’s paltry returns, Goodyear’s family of brands themselves are still well-regarded and widely recognized. Given these two almost conflicting factors, it shouldn’t be a surprise that activist investor Elliott Management announced it bought an approximate 10% stake in the company in early May and plans to appoint five independent directors for Goodyear’s upcoming annual meeting next spring.

Elliott Management has zeroed in on two specific shortcomings: (1) Goodyear’s margin profile is worse than its competitors to an unjustifiable degree and (2) its retail stores have underperformed. Additionally, Goodyear is facing nearly $10 billion of financial obligations due within the next five years, and rolling-over debt will be prohibitively costly as interest rates have vaulted upwards. While it’s evident that Elliott Management is out to make money, and their time horizon is not necessarily long-term, I believe there is plenty of low-hanging fruit in Goodyear’s business. If Elliott Management can effect change, either by successfully appointing its nominees to Goodyear’s board of directors, or by settling with management without a proxy battle, I believe there is risk-adjusted upside in Goodyear’s stock, especially considering the stock’s current undemanding valuation.

The Business

While tire manufacturing is not a business model that carries a strong competitive advantage (or a “moat” as some call it), the barriers to entry are relatively high. As the result of industry consolidation, Globally, Goodyear has seized the number #3 title, behind Bridgestone (Japanese, BRDCF is the ADR) and Michelin (French, MGDDF is the ADR), neither of which counts the US as their primary market. 

The Americas is Goodyear's primary segment, and Goodyear’s brands collectively have the largest share of the US replacement tires with 21% of the market, in front of Michelin (15%), Bridgestone (14%), and Continental (8%). Fun fact: Goodyear is the only publicly traded tire manufacturer based in the US. It follows that Goodyear’s brand presence within the US is strong. The company is known for its famous “Goodyear blimp” appearances, its sponsorship of NASCAR, and other brands it operates like Cooper, Dunlop, Kelly, Mastercraft, Roadmaster, Debica, Sava, and Fulda.

Because the majority of Goodyear’s sales are replacement tires (as opposed to “OE” or original equipment sales), sales are remarkably resilient through the business cycle, given this is a capital-intensive firm (for context, net PP&E sits on the B/S at $7.3 billion, relative to a market cap of $3.8 billion). While the pandemic caused an abnormally large economic shock, sales only declined by 16% from FY 2019 ($14.7 billion) to FY 2020 ($12.3 billion). Pro forma FY 2022 results include approximately two-quarters of the Cooper acquisition and show a 9.0% increase in tire unit shipments (compared to 2021), a strong rebound in OE fitments, and slight gains in domestic market share.

However, ballooning costs caused the bottom line tells a different story. Management Discussion and Analysis (MD&A) in the 2022 annual report cites higher raw material, energy, transportation, and labor costs causing $890 million of incremental costs relative to 2021. Despite revenue increasing by $3 billion from $17.47 billion (FY 2021) to $20.8 billion (FY 2022), these inflationary cost pressures and rising interest expense caused earnings to decline nearly 75%, from $764 million (FY 2021) to $202 million (FY 2022). It is disappointing not to see fixed-cost leveraging (i.e., incremental revenue fall to the bottom line) for a company of this size and scale.

It’s also worth pointing out the significant amount of liabilities coming due over the next five years. In recent years, the company has been able to roll over its annual debt obligations (see the Cash Flows from the Financing section of the S/CF). The cost of debt for a steady, GDP-tracking business like this one is quite low, especially when interest rates are near zero. But, as interest rates have sharply risen in the past year, borrowing costs on new debt will become burdensome.

Elliott Management’s Plan to Course Correct

Elliott Management is the infamous activist investing firm led by Paul Singer. As proclaimed on the activist campaign website, Elliott Management has made investments of $4 billion in the automotive space in “original equipment manufacturers (OEMs), suppliers, dealers, and finance companies” since 2003. I found very little about the return profiles of these deals, which frankly means they were nothing to brag about. Goodyear, for its part, hasn’t had an activist trying to gain control since 1986, when Sir James Goldsmith and investment company Hanson acquired 11% of the stock.

In April 2023, Elliott launched an activist campaign to address many of the aforementioned shortfalls at Goodyear. Elliott Management suggests they will make many changes, but based on my analysis, I distilled Based on my analysis, I distill it into three points: (1) boost gross margins by changing the company’s go-to-market strategy, (2) boost operating margins by cutting costs, and (3) find liquidity to pay off the debt by selling off Goodyear’s physical stores. 

Let’s start with boosting gross margins. At the moment, the namesake Goodyear brand and Cooper (Goodyear’s two biggest brands in terms of sales) are primarily sold through independent dealers. The company’s other brands are primarily sold through company-owned stores, regional/national retailers, and TireHub. TireHub is a wholesale tire distributor, created as a joint venture between Goodyear and Bridgestone in 2018 to compete with American Tire Distributors (“ATD”), which was bought/rebranded by PE firm TPG Capital in 2010 and became the largest national tire distributor in the US after an aggressive roll-up strategy. After TireHub’s establishment, Goodyear terminated its distribution agreement with ATD.

Goodyear's gross profit margin of ~20% is worse than Michelin's (26%) and Bridgestone's (39%). Part of the disparity can be attributed to the fact that Tirehub has cannibalized sales from company-owned retail stores since its inception. To maintain market share, management has prioritized market share over total revenue, leading to ~$400 million in unrealized profits according to Elliott (it’s unclear whether Elliott accounted for if higher prices would have driven less volume in their calculation).

Elliott aims to change Tirehub’s pricing strategy and revamp its distribution strategy by potentially seeking out alternative partnerships. While it’s hard to discern exactly what volume vs. price mix is optimal, it is clear that the distribution at Tirehub leaves much to be desired. While I believe management would eventually shift in this direction anyway, Elliott's pressure drives an increased sense of urgency.

I also favor Elliott’s plan to deleverage Goodyear’s balance sheet by selling off company-owned stores and using the proceeds to pay down debt obligations. At a 13x EBITDA multiple (public peer average), the retail stores would be worth nearly $2.4 billion. This would go far in covering the solvency needs to be pointed out earlier. I believe that Goodyear management has given special attention to its retail footprint; the real estate and local presence of the stores make it a target for a financial buyer like PE or a strategic buyer.

Elliott Management also hopes to increase operating margins by cutting out non-core segments, such as Goodyear Ventures and the online merchandising website. While the company’s current cost-cutting plan is already in place (e.g., in January 2023, the company cut corporate headcount by 5% and closed a tire manufacturing facility in Melksham, United Kingdom, that came from the Cooper Tire acquisition), Elliott Management singles out Goodyear Ventures and the online merchandising website as additional places to dispose of.

Overall, Elliott Management believes its plan can boost operating margins by 385 basis points. While a nearly 4% OPM improvement is bold in my opinion, it would still leave Goodyear well behind (not even in line) with Bridgestone and Michelin. (Yes, Goodyear has a small chemicals business, but the business segment mix between these three tire manufacturers is close.)

Timeline and Logistics of a Possible Showdown

In the past three years, the company’s annual meeting has been held in early April, so Elliott may have to wait another year until it can nominate its own candidates for election to the board. Goodyear and Elliott Management will have ample time to resolve their differences and come to a settlement. However, if a proxy fight does ensue, I believe that Elliott Management would have a good chance at making inroads, given the glaring issues the company has failed to address. 

Goodyear’s Board of Directors is composed of 13 members, all with one-year terms (i.e., not a staggered board) and Elliott Management plans to nominate five independent directors, which won’t be quite enough to seize complete control, although it would be enough to exert significant influence (particularly if Elliott were to decisively win a potential proxy contest). 

Considering that Elliott Management owns 10% of the company’s stock, and insiders own just 1.6% as of February 2023, it will largely be up to institutional shareholders (as well as their proxy advisors like ISS and Glass Lewis) to decide the outcome. Considering Goodyear’s blatant underperformance relative to peers, Elliott Management would be in a strong position to convince Blackrock, Vanguard, and other institutional shareholders to vote in its favor. 

Conclusion

Don't get me wrong, Goodyear is a century-old business that’ll largely track GDP growth over time. The domestic market is completely saturated, AND competition abroad is fierce. But a steady business that's also remarkably recession-resistant can still lead to phenomenal shareholder returns, especially if management is astute about the capital allocation (e.g., $WM and $AZO come to mind). Unfortunately, the capital allocation has not been a strong suit for management in living memory; this is apparent from the prices of previous share buybacks and the inconsistency of dividend payments.

The market has clearly digested management's poor track record by slapping on a low valuation multiple. In the following chart, I used the EV to Sales metric, though other ratios tell a similar story. (The P/E ratio would not be a good metric, however, given the cyclicality of the bottom line.) 

Elliott Management has a lot to say, and while activist investors aren’t typically aligned with the company long-term, (mis)management at Goodyear could likely use a shakeup. The current CEO, Richard J. Kramer, joined the company in 2000 and held various senior roles before assuming the CEO title in 2010. In spite of weak shareholder returns, management has nonetheless rewarded themselves with incentive payouts set at 115% in the last three years, even when the company turned a loss in 2020 and made the Cooper acquisition. If even part of Elliott Management’s plan is realized, I believe there is significant potential to realize shareholder value and asymmetric upside for those who buy into Elliott Management's narrative.

More By This Author:

NRG: Go Back To The Basics To Deliver Returns
6 Director Elections In 2023 That Were Surprisingly Close
International Models Of Corporate Governance