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Valuation Project BAFI 403 12/08/2007 Johannes Albrecht Ryan Arlia Jim Reese Siddharth Sharma Peter Zale PowerPoint Presentation
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Valuation Project BAFI 403 12/08/2007 Johannes Albrecht Ryan Arlia Jim Reese Siddharth Sharma Peter Zale. Executive Summary.

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Presentation Transcript
slide1
Valuation Project

BAFI 403

12/08/2007

Johannes Albrecht

Ryan Arlia

Jim Reese

Siddharth Sharma

Peter Zale

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

executive summary
Executive Summary

Goodyear Tire and Rubber Company has gone through great change in the last ten years, barely skirting bankruptcy as it dealt with recession, labor difficulties and changing demand in the tire market. Avoiding default by mere days, it has rebounded to become a “buy” in most analyst’s portfolios.

Goodyear began its transformation by realizing the growth market for tires was moving away from the commodity-based low margin tires it had featured to higher margin differentiated tires for targeted markets. The strategy requires Goodyear be less leveraged and more equity financed as the risk of selling differentiated tires is greater than that of cheaper commodity tires. Goodyear’s excessive level of debt could not allow for any more risk.

Goodyear is changing from being a highly leveraged high dividend producing company to being a no to low dividend growth company, featuring differentiated tires given value by Goodyear’s superior R&D capability and its worldwide brand equity.

Based on our assessment of Goodyear’s current financial and market structure, have set a price target of $40 for Goodyear’s common stock.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

summary slide
Summary Slide
  • Company Background
  • Executive Summary
  • Industry Information
  • Goodyear Positioning
  • Goodyear Strategy
  • Competitive Analysis
  • Financial Analysis
  • Cash Flow Analysis
  • Valuation Analysis
  • 3 Economic Scenarios and Assumptions
  • Best Estimates
  • Appendix

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

company background
Company Background

The Goodyear Tire and Rubber Company was founded in 1898 by F. A. Seiberling in Akron, OH. Goodyear specializes in the design, manufacture and distribution of tires for automotive and industrial applications. They operate 60 plants in 26 countries for distribution to 185 countries around the globe. Revenues are generated through five operating units based on geographic regions – North America, Latin America, European Union, Asia Pacific, and Eastern Europe (which includes the Middle East and Africa).

Goodyear had 2006 revenues of $20.3 billion on the sale of 215 million tire units.

In 2007, Goodyear sold off its Engineered Products division, which accounted for approximately $1.5 billion in sales for 2006

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

industry information
Industry Information

The tire industry sells through two basic channels:

  • Original Equipment auto manufacturers (OE)
  • Replacement

The original equipment market has traditionally been an outlet where manufacturers could sell many units of guaranteed business while minimizing SKU’s. In addition, the fitments on popular vehicles would result in replacement sets of the same brand when the originals wore out.

Today, with the popularity of leases and higher vehicle turnover, this logic no longer holds true. The OE business is still a good source of high volume but most fitments are either provided at a financial loss or a very small margin.

The replacement market has become a much more profitable segment for tire makers. The popularity of large diameter aftermarket wheels has created a sweet spot in the industry for manufacturers who can produce large bead diameter tires – margins on these units can be well over $100 per tire.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

goodyear positioning
Goodyear Positioning

In 2003 Goodyear was on the brink of bankruptcy. They were overloaded with debt and suffering from years of mis-management. In 1998 Goodyear had net income of nearly $700 million, by 2002, they were loosing nearly $1 billion per year.

Goodyear had sought a growth strategy that involved acquiring businesses to grow market share. Many smaller tire companies were purchased around the globe. This strategy culminated in the purchase of 75% of Dunlop Tires from SRI in 1999 for $125 billion. All of this consolidation activity put Goodyear deep in debt. The weak economy that followed combined with Goodyear’s failure to capitalize on the newly acquired brands lead to a string of financial losses for the years 2001-2003.

Goodyear is now in the 4th year of their turnaround plan. Much attention has been put on improvement in leadership, products, quality, cost and finances. Steady improvement has been achieved and the Goodyear management team believes that they have turned the corner and are gaining momentum towards profitability.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

goodyear strategy
Goodyear Strategy

Goodyear has stated the following strategies to achieve their long and short term goals:

  • Improved Product Mix
  • De-leveraging of the firm
  • Cost Saving

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

goodyear strategy8
Goodyear Strategy

Improved Product Mix

  • Revitalize brand image and position brands for greater market differentiation
    • Goodyear, Dunlop, and Kelly brands
  • Focus development on premium branded products
    • Recent activity includes launches of highly successful “ICON” products including Assurance, Wrangler, Fortera, and Eagle products
  • Reduce unit volume on value-line tires that have low profitability
    • Exited 8 million units of private brand tires in 2006
  • Invest in capacity for larger rim diameter tires

Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

goodyear strategy9
Goodyear Strategy

Cost Saving

  • Continuous improvement/USWA union contract
  • Footprint reduction
  • Asia sourcing
  • SAG reduction
  • VEBA Insurance Deal

Gross Anticipated Savings: $1.8 - $2.0 Billion Over 4 Years

Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

goodyear strategy10
Goodyear Strategy

De-leveraging/Improved Balance Sheet

  • Reduce long term debt*
    • 2006 sold Farm Business Unit
    • 2007 sold Engineered Products Unit ($1.4 billion)
    • 2007 equity offering ($833 million)

*Reduced LT debt from $7.2B in Dec ‘06 to $5.0B in Sept. ‘07

Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitive and financial analyses

Competitive and Financial Analyses

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitive analysis
Competitive Analysis
  • Business Analysis

In the first part of this section, current industry conditions as well as historical developments in the industry are described in order to establish a qualitative framework for the subsequent financial analysis.

  • Industry Analysis

The following Porter analysis provides insights into each major tire industry player’s profit potential within the industry, given each firm’s intentions to compete and their specific aims to exploit synergies across the range of businesses in which they operate.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitive analysis13
Competitive Analysis
  • 5 forces Analysis
    • The above table shows that each of the major tire companies faces pretty much the same competitive landscape and industry pressures.
    • Also the table shows that, from a Porter perspective, the tire industry is relatively unattractive with three areas scoring “High”.
      • Raw material suppliers can exercise high pressure on the prices for their input materials in tire manufacturing due to strong competition in a rather commoditized market.
      • Buyers can exercise high power which keeps prices low.
      • Threat of substitutes is low which is favorable for the existing players.
      • Threat of new entry is low since new entrants are rather not attracted due to the commodity nature of the environment. Also initial costs of entry (creating a manufacturing capability) are high.
      • However, new competition is seen in growing markets such as China, which already has impacted the threat of the new entrants-pressure structure.
      • That said, each of the major players differentiates itself from its competitors in unique ways relating to diversification (Continental), footprint (Bridgestone), premium brand (Michelin) and overall reputation and reputation for new product development (Goodyear).

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitive analysis14
Competitive Analysis
  • SWOT Analysis

Competitor Analysis: Goodyear (USA), Michelin (FR), Bridgestone (JP), Continental Tire (GE).

In the SWOT analysis we begin to see some of the differentiation occurring between the major players in the tire industry. We also see the similar threats faced more or less by all of them.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitive analysis15
Competitive Analysis
  • Market, Segment and Products
    • Over the last ten years, Goodyear, Bridgestone, Michelin and Continental have all faced challenges presented by rising raw material costs and a global excess in manufacturing capacity.
      • Petroleum, steel, and natural rubber are the primary materials used in tires and prices rose greatly over the last few years.
    • Stagnating markets in North America and the European Union, along with the expansion of manufacturing capacities in Asia means that more tires can be made than can be sold.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitive analysis16
Competitive Analysis
  • Market, Segment and Products (Cont.)
    • To counteract these conditions, each company has adopted a different strategy and focused on different segments.
      • Until 2003 Goodyear focused its strategy on high volume, low value tires while it grew its top line.
        • Michelin focused on high end-premium tires and followed a strict branding hierarchy.
        • Continental is a much more diversified company (a good % of its business being in automobile electronics) and deals in both high and low end tires.
        • Bridgestone focused on a rounded product portfolio and leveraged its vertical integration; mainly its large stake in rubber raw material production.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitive analysis17
Competitive Analysis
  • Market, Segment and Products (Cont.)
    • Currently, Goodyear is well positioned for future success.
      • The brand is strong and well positioned in the market.
      • It’s perceived as a quality brand with a good pipeline of new products.
      • It is widely recognizable around the world and is consistently voted as one of the top and most admired companies.
        • Recent product introductions followed by industry accolades are helping Goodyear move towards a higher margin product mix and are driving top line growth.
        • This growth, coupled with aggressive cost cutting measures and landmark labor agreements have set the stage for financial success moving forward.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

competitor analysis michelin
Competitor Analysis: Michelin

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

BAFI 403 – Goodyear Tire &Rubber Company Valuation

18

competitor analysis bridgestone
Competitor Analysis: Bridgestone

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

BAFI 403 – Goodyear Tire &Rubber Company Valuation

19

financial analysis
Financial Analysis
  • This section assesses Goodyear’s current and past performance as well as its expected future financial prospects.
  • First, the product market performance is considered using ratio-analysis.
  • Second, cash-flow analysis is used to determine the firm’s liquidity and financial flexibility and discusses business risk.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis21
Financial Analysis
  • Goodyear 10 year historical strategy & performance
    • The years from 1997 to 2007 can be divided off into two sections to tell an effective story about Goodyear.
      • 2001-2002 should be considered the turning point for the company.
        • At this point, the previous strategic direction the firm had adopted nearly put them into bankruptcy.
        • This was avoided by days and now the firm is on what should be considered a sounder footing and direction.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis22
Financial Analysis
  • Goodyear 10 year historical strategy & performance
    • The new President and CEO Robert J. Keegan took over the office at Goodyear in 2002 and announced “the future begins now” with a solid turnaround strategy of restoring profitability and growth for the troubled company.
      • The period from 1997-2002 was dominated by a more commodity based sales strategy, as Goodyear strove to grow its market share selling OE and private branded “value” tires to please its shareholders with average dividend payouts of 30% of cash flow provided by operating activities.
      • The company’s stock grew impressively during this time reaching a height of $75 per share.
      • Likewise during this time Goodyear leveraged itself quite aggressively. In fact, we noticed that there was very possibly a strategy being employed by the shareholders to, in effect, “milk” the company as its increased leverage led to an escalating stock price and returns for shareholders.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis23
Financial Analysis
  • Goodyear 10 year historical strategy & performance (Cont.)
    • In 2000, when the stock market fell, the company began a slide towards financial distress.
      • In 2002, enforced by a non-cash charge of $1.2 billion in tax provisions, the firm reported a net loss of $1.22 billion.
    • The troubles culminated in the firm facing bankruptcy in early 2003 when it issued $1.3 billion long-term debt securities.
      • The company however was supported by its continued strong R&D capability, focus on innovation, leadership, and brand building which allowed it to launch several successful new products just at the right time to help it skirt the most severe financial troubles and buoy it for restructuring which continues to the present.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis24
Financial Analysis
  • Goodyear 10 year historical strategy & performance (Cont.)
    • The focus in 2004 and 2005 was on higher margin products and increased market and customer focus which successfully drove sales.
    • In 2006, Goodyear announced that it would exit about half of its private branded value-line business, reducing it by approximately 8 MM units. Also, it has begun outsourcing some of the remaining value-line production to Chinese suppliers.
      • This strategy allowed Goodyear to close down high cost plants in North America and lower the costs associated with producing low margin products.
      • The strategy involves some risk however as the manufacturers sourcing the product are outfitted to produce higher value added products (the various sized tires spoken of earlier).
      • These suppliers could be tempted to leave the partnership with Goodyear if another “suitor”, more closely aligned with their best capabilities, approached them for tire supply.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis25
Financial Analysis
  • Goodyear 10 year historical strategy & performance (Cont.)
    • In addition to product mix, Goodyear also is expanding capacity in Asia and Eastern Europe to serve those growing markets.
    • Investment in its own facilities in countries like China presents a risk in that the Chinese government cannot be completely trusted to not “nationalize” foreign industry.
      • Similar threats have been carried out in Venezuela.
    • We don’t consider this a high or even medium threat presently, but the regime in China is such that we cannot completely dismiss this possibility, particularly with the nation’s extraordinarily rapid growth and what could well be concomitant social, economic and environmental turbulence.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis26
Financial Analysis
  • Goodyear 10 year historical strategy & performance (Cont.)
    • In 2007, Goodyear extended an equity offering of 23 million shares of common stock, earning the company about $850 million.
      • This is being put towards refitting its manufacturing capability so that it may address the changing needs of the tire market which now requires a wide variety of different sized tires (13”-22”) for various standard cars and light and heavy trucks. Also Goodyear is interested in the growing airline tire market.
    • Also, Goodyear recently sold its Engineered Products Division for roughly $1.4 billion and used the money to restructure its debt.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis27
Financial Analysis
  • 10-year overview of net sales, gross profit and net income

Figure 1: Profitability

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis28
Financial Analysis
  • The margins
    • It is interesting to observe that between 2003 and 2006, sales increased about 30% from $15 billion to $20 billion dollars per year indicating that the turnaround efforts were gaining momentum from a sales volume perspective.
    • At the same time though gross-profit declined which indicates that Goodyear’s ability to turn sales dollars into profits was impaired.
      • This stems from increasingly more expensive raw materials such as rubber, oil, and steel.
      • The price for natural rubber had doubled during 2006 and remains at high level. According to the 2006 annual report, overall a 17% increase in all raw materials was pressuring on Goodyear’s margins.
    • In addition, Goodyear appears to have had difficulties passing along price increases through sales to customers, which could be related to strong competition in a rather commoditized product market, where low cost is an important driver of overall performance.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis29
Financial Analysis
  • Current Profitability and comparison with Competition
    • Goodyear vs. Michelin
      • Looking at Michelin’s asset management, Michelin consistently reports a lower Inventory Turnover Ratio than Goodyear due to maintaining higher levels of inventory.
      • Goodyear is also performing better in regards to managing its accounts receivable, beating out Michelin by 30 days in 2006 in its Accounts Receivable Days Ratio.
      • This of course reflects Goodyear’s value tire strategy of greater sales of less expensive tires.
        • One might almost consider this a “Wal-mart like” strategy of beating the competition with quicker turnover leading to faster sales, smaller inventory and handling costs and buyer power with suppliers from whom you can possibly command smaller charges because you are paying them faster and thus lessening their own need to finance.
      • Goodyear also maintains higher liquidity ratios than its competitor Michelin.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis30
Financial Analysis
  • Current Profitability and comparison with Competition (Cont.)
    • Goodyear vs. Michelin
      • In the past four years, Goodyear has kept its Quick Ratio above a 1.0, whereas Michelin has failed reach this level of liquidity in the past five.
      • Decision makers should also note that Michelin’s liquidity level has been on the decline year after year, while Goodyear has shown improved liquidity over the same given time frame.
      • Overall Goodyear is showing good working capital management along with a stable cash flow position as illustrated in Figure 5.
      • Turning to profitability performance, Michelin seems to be operating more efficiently in relation to Goodyear, reporting a higher Operating Profit Margin for the past three years.
      • Michelin’s ROA and Gross Profit Margin have also been higher than Goodyear’s in the past five years.
      • Goodyear’s poor profitability performance seems to be attributable to the company’s higher costs directly related to costs of goods sold as seen in Figure 3.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis31
Financial Analysis
  • Current Profitability and comparison with Competition (Cont.)
    • Bridgestone Analysis
      • Bridgestone’s Inventory Ratio falls just short of Goodyear’s figures every year for the past five years.
      • Bridgestone’s Asset Turnover ratio has decreased every year for the past five years.
        • On the other hand, Bridgestone’s asset management earns high marks for gradually reducing its Accounts Receivable Days Ratio 14% over the last five years.
        • However, this ratio still does not compare to the low levels of Goodyear’s receivables.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis32
Financial Analysis
  • Current Profitability and comparison with Competition (Cont.)
      • Taking a look at Bridgestone’s financial management ratios, one can see significant decreases in company liquidity.
        • Bridgestone’s Current Ratio declines every year for the past four years for a combined 28% drop, while Bridgestone’s Quick Ratio declines every year for the past four years as well for a combined 38% drop.
      • Despite these apparent changes in company liquidity, there is little need for concern as the current level of these ratios remains relatively safe.
      • Approaching 2006, Bridgestone, and the entire tire industry, appear to be slowly losing profit margins.
      • However, Bridgestone has still managed to consistently produce higher Gross Profit Margins and Operating Profit Margins than Goodyear over the past five years.
      • The resulting depressed profitability figures for Goodyear resonates in the company’s high cost of goods sold (see Figure 3).

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis33
Financial Analysis
  • Gross-Profit Margin Comparison

Figure 2: Gross-Profit Margin comparison

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis34
Financial Analysis
  • Operating Profit Margin Comparison

Figure 3: Operating Profit Margi

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis35
Financial Analysis
  • Net Profit Margin Comparison

Figure 4: Net Profit Margin

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis36
Financial Analysis
  • Current Profitability and comparison with Competition (Cont.)
    • The overall lower operating profit margin of Goodyear compared to Bridgestone could indicate that the firm pursued a differentiation strategy which requires overall higher SG&A costs, more R&D, more frequent new product introductions, high-end products, branding activities, support and full service activities.
    • However, the overall lower gross-margins contradict the differentiation strategy and suggest rather a low-cost approach.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

financial analysis37
Financial Analysis
  • Current Profitability and comparison with Competition (Cont.)
    • Michelin has been able to improve its operating management between 2003 and 2005 significantly and outperformed both Goodyear as well as Bridgestone in 2005 and 2006.
    • What business activities cause Goodyear to under perform at the operating margin? Goodyear’s strategy through the 1990’s focused on high-volume, value-line tires with small margins. Michelin has focused on the premium, high-margin segment. As raw material prices have increased, the margins on the value-line products have been reduced by a higher percentage. This has resulted in much lower operating margin for Goodyear when compared to Michelin and even Bridgestone.
    • Goodyear’s strategy moving forward is to focus on reducing their share of the value-line business and increasing their share of the premium, high-margin business. They are also aggressively pursuing cost reductions in materials, manufacturing and other operations. These strategies should help Goodyear command more dollars per tire in price and reduce the cost per tire to manufacture. The coupling of these strategies will result in higher operating margins and more flexibility to compete for shelf space with competitors.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis
Cash Flow Analysis
  • Cash Flows
    • Despite a 300 million loss in 2006, Goodyear was able to generate positive cash flow from operating activities during the year.
      • Overall, the firm has had positive cash flow from operating activities throughout all ten years with exception of 2003.
      • Cash flows from operating activities appear to be quite volatile though.
      • Significant investments in property plant and equipment have been made in 1999 and 1998 and at a smaller scale continuously throughout the remaining years.
    • Three major financing events occurred.
      • In 1999, the firm increased borrowings by $1.4 billion.
      • In 2003 it added $1.4 billion in debt.
      • In 2006, the firm issued $1.7 billion debt.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis39
Cash Flow Analysis
  • Cash Flows
    • As discussed earlier the 2003 debt issuance had to do with the turnaround and refinancing activities in the face of distress.
      • The fact, that the company yet again issued significant portion of debt in 2006, indicates that it still faces significant difficulties.
      • The 2006 annual report discloses that Goodyear has sold off several non-core businesses and continuous with this divestment strategy.
    • Change in cash has been positive and increasing; the strongest peak being in 2006, when the firm was able to increase cash by 80% compared to the beginning of the year.
    • Net income and net cash from operations are moving closely together, particularly in the last 3 years. This indicates no unusual events for Goodyear’s accounting policies or practices. The Cash flow from operations to sales ratio declined in 2006 to 30% which indicates that the firm struggles increasingly to translate sales dollars into cash compared to 2005 and 2004, when 40% of sales manifested in cash flow from operations.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis40
Cash Flow Analysis
  • Cash Flows

Figure 5: Cash Flows

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis41
Cash Flow Analysis
  • Income and CFO

Figure 6: Income and CFO

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis42
Cash Flow Analysis
  • Future prospects, growth potential, and business risk for Goodyear
    • Goodyear’s results of operations, financial position and liquidity could be adversely affected in future periods by loss of market share or lower demand in the replacement market or the OE industry, which would result in lower levels of plant utilization and an increase in unit costs.
      • Also, the firm could experience higher raw material and energy costs in future periods.
    • These costs, if incurred, may not be recoverable due to pricing pressures present in today’s highly competitive market and Goodyear may not be able to continue improving its product mix.
    • Future results of operations are also dependent on the firm’s ability to successfully implement cost reduction programs and address increasing competition from low-cost manufacturers.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis43
Cash Flow Analysis
  • Future prospects, growth potential, and business risk for Goodyear (Cont.)
    • With this, the major drivers of ROE are strongly limited as asset turnover is expected to remain stable or otherwise decrease if demand slows down and utilization decreases, profit margins will be crucial.
    • However, the firm has had as discussed earlier much lower margins than its competitors Michelin and Bridgestone and will struggle with these due to environmental cost conditions pertaining to raw materials and consumer unwillingness and inability to pay premium prices.
    • The currently extreme high leverage most likely must be reduced in the future and recent equity offerings confirm this trend, which in return will impact ROE negatively.
    • The overall growth rate is expected to align with averages in the US due to the effect of mean reverting.
    • Industry structure and competitive environment will also constitute limitations to ROE.
      • As a matter of fact, Goodyear has achieved high ROE’s solely due to financial leverage and as this must decline in the future, ROE is expected to be lower.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis44
Cash Flow Analysis
  • Key Data

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis45
Cash Flow Analysis
  • Future prospects, growth potential, and business risk for Goodyear (Cont.)
    • Comparing Goodyear to its competitors in a couple of key margins provides insight into the future business risk which must be considered highest among the three compared companies.
    • The key drivers of ROE indicate various strategies toward return generation.
    • While Goodyear shows low margins compared to the competitors, it has higher asset turnover.
    • In an environment with dominating market share and stable demand for products, this position of Goodyear might be sustainable.
    • However, industry structure and future expected developments as described, indicate that weak margins cannot be compensated which results in an overall low return on assets for Goodyear versus Bridgestone and Michelin.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

cash flow analysis46
Cash Flow Analysis
  • Future prospects, growth potential, and business risk for Goodyear (Cont.)
    • The other key driver for ROE is financial leverage and it is obvious that Goodyear, in contrast to its competitors, is pursuing a different financial policy with a highly levered balance sheet.
    • This can result in excessive shareholder returns during stable business environments, however, in unstable environments it can pose a major business risk.
    • The high beta for Goodyear of 2.6 indicates that investors internalize these circumstances as they reflect a higher volatility of stock prices compared to the market.
    • Bridgestone has the lowest beta of 0.9 followed by Michelin with beta of 1.59, and 1.78 for the industry benchmark.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

valuation analysis

Valuation Analysis

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

purpose
Purpose
  • Based on preceding
    • Business and Industry Analysis of Goodyear
    • Historical and Financial Analysis
    • Competitor Comparison in the industry
    • Future economic prospect for the firm and the industry
  • Conducting Valuation Analysis of Goodyear Rubber & Tire
  • Over a 10 year time frame
  • With the goal to determine ultimately the best estimate of current stock price per share
  • Based on 3 economic scenarios

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

methodology for valuation dcf analysis
Methodology for Valuation (DCF-Analysis)
  • Using the Discounted Cash Flow Valuation Technique
    • Forecast essential financial statements
      • Income Statement
      • Balance Sheet
      • Cash Flows
    • Based on
      • Percentage of Sales method
    • And Assumptions about
      • Operational future performance of the firm
      • Expected capital structure policy changes
      • Expected cost of capital
      • 3 General economic scenarios

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

objectives
Objectives
  • Establish best estimate of Present Value:
    • Of the Firm
      • The Value of the Firm is obtained by discounting expected cash-flows to the firm
      • Cash flow to firm: the residual cash-flows after meeting all operating expenses and taxes, but prior to debt payments and without the benefit of tax-shelter
      • Discount rate: weighted average cost of capital (WACC)
    • Of Common Equity
      • The Value of Equity is obtained by discounting expected cash-flows to equity
      • Cash flow to equity: the residual cash-flows after meeting expensed, meeting all tax obligations and interest and principal payments
      • Discount rate: rate of required return by equity investors (CAPM)
    • Determine stock-price per share

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

variable forecasting control parameters
Variable Forecasting Control Parameters
  • Incremental Sales Growth Rate for each year
  • Gross-Profit Margin
    • Indicating the company’s ability to charge premium prices
    • Lowering their costs of goods sold
  • Operating-Profit Margin
    • Operational efficiencies and ability to manage firm effectively
  • Total Asset-Turnover
    • Proxy for the ability of the firm to utilize assets and their infrastructure. The need for further investment in property, plant and equipment
  • Debt / Equity
    • How much leverage will the firm use in the future? What capital structure policy changes might influence the return of the firm?

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

variable forecasting control parameters cont
Variable Forecasting Control Parameters (cont.)
  • Current Ratio
    • Coverage of short term liabilities with cash and equivalents
  • The Cost of Debt
    • Depending on economic scenario, inflation, company bond rating
  • The After Tax Cost of Debt
  • The Cost of Equity
    • Depending on risk premium, beta for the firm, and country risk premium
  • Beta for the Firm
    • Based on historical movement of Goodyear’s stock vs. market

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

fixed firm specific parameters
Fixed Firm-Specific Parameters
  • The corporate tax rate for Goodyear assumed to be 35%
  • Depreciation on PPE assumed to be 53%
    • Estimated using historic average percentage of PPE
  • Depreciation Expense per fiscal year assumed to be 4%
    • Estimated using historic average percentage of Sales
  • Current Liabilities portion assumed to be 24%
    • Approximated using historic average of Sales

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

fixed external parameters
Fixed External Parameters
  • Based on Financial-Market Research
  • Risk Free Rate assumed to be 4.5%
    • Computed based on 10 year average (1997-2007) of 10 Year Government T-Bonds
  • Expected Market Return assumed to be 8.3%
    • Historical arithmetic average of S&P 500 since 1928 (80 years).
  • Market Risk Premium assumed to be 3.8%
    • 20-year arithmetic Average

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

3 economic scenarios and assumptions

3 Economic Scenarios and Assumptions

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

recession
Recession:
  • Sales are going to decrease
  • Margins are decreasing due to price pressure
  • Leverage going up due to need for borrowing to cover liquidity issues having low cf
  • Beta estimated to be high due to bond grading, due to leverage, due to risk
  • Cost of debt is high at 9%
  • Cost of equity is about 15%

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

recession57
Recession:
  • The market and economy are stagnate or in recession. GT struggles to grow sales revenue but maintains levels based on execution of their product mix and cost cutting strategy. Low margins result in the inability to de-leverage any further but the bad economy keeps interest rates low.
  • The soft economy keeps raw material cost increases lower than in previous years. GT profit margin is flat via management execution of strategic plan.
  • The cyclical nature of markets see improvements by 2011

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

recession cont
Recession (cont.)
  • Cost of Equity = 15.9% (including 2% country related risk)
  • WACC for the 10 years forecasting period (to 2017)
  • Beta 2.47

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

slide59
Flat:
  • Sales increase initially a little due to positive effect of product mix and restructuring
  • But then remain stable without much growth
  • Decline slightly at the bottom of the period and will slight come back
  • Margins decline slightly as the effect of products towards higher margin products do not materialize fully
  • Leverage will remain lower as the strategy and policy changes manifest
  • Yet borrowing will become necessary again mid of period in order to support lacking revenue streams
  • Beta of 1.7 as rating improves due to restructuring then stable due to un-levered balance sheet
  • Then increasing to 1.9 mid term to reflect the new borrowings

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

slide60
Flat
  • The market and economy are estimated to be relatively flat. GT maintains a low growth in sales revenue based on execution of their product mix strategy.
  • The soft economy keeps raw material cost increases lower than in previous years. GT profit margin increases slowly via management execution of strategic plan

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

flat cont
Flat (cont.)
  • Cost of Equity = 13% (including 2% country related risk)
  • WACC for the 10 years forecasting period (to 2017)
  • Beta 1.7

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

slide62
Boom
  • 20 B to 28 B B Net Sales is a reasonable assumption based on
    • History steady increase rate in sales
    • Increased prices due to higher raw materials  higher margins
    • Product mix and strategy objectives fully materializing
    • Larger customer base
    • Emerging markets, more infrastructure
    • More international business
    • Approaching competitor margins due to high margin products
    • Un-levering the firm pays off and debt to equity is improved
    • Mid term new expansion and borrowings in order to benefit tax-shelter again and increase ROE
    • Cost of debt decreases as bond rating will improve
    • Beta at the 10-years historic price fluctuations

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

slide63
Boom
  • The market and economy continue to grow. GT increases sales revenue based on execution of their product mix strategy and strong global presence.
  • The growing economy sees raw material costs continue to increase but they are offset by price increases and product mix. GT profit margin increases rapidly via management execution of strategic plan

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

boom cont
Boom (cont.)
  • Cost of Equity = 12% (including 2% country related risk)
  • WACC for the 10 years forecasting period (to 2017)
  • Beta 1.45

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

3 sales revenue projections
3 Sales Revenue Projections

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

3 different stock prices
3 Different Stock Prices

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

best estimate based on probability
Best Estimate based on Probability

Probabilities

Boom = 20%

Flat = 50%

Recession = 30%

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

best estimates
Best Estimates
  • Conclusion

Goodyear Tire and Rubber Company is well positioned to grow in profitability in the next ten years in either a boom, flat or bust scenario. This is because Goodyear has taken steps to align its corporate strategy with the changing competitive landscape for its products and has adjusted its financial strategy to fit this direction.

Goodyear is changing from being essentially a highly leveraged mass low margin “cheaper” tire seller paying high dividends to shareholders to a more equity financed higher margin targeted seller of quality, differentiated tires. They will grow with this strategy because there is potential in the high margin differentiated market in the otherwise flat North American and European markets which comprise 75% of Goodyear’s sales. Goodyear can capture the growth in this market by leveraging both its brand and its superior R&D capability.

Goodyear is supplementing this with a lower risk maintenance of low margin tire selling to emerging markets in Eastern Europe, Asia and Latin America. Odds are these markets will grow to become enamored of Goodyear’s higher margin tires over time.

While there are risks due to increasing costs of raw materials and ever increasing competition from rivals, we feel Goodyear is a good buy for investors looking for a stable growth stock paying less dividends in the next ten years.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

appendix

Appendix

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

country risk
Country Risk
  • To estimate country risk, find country rating (www.moody.com) and estimate default spread for rating over a default free government bond rate.
    • Basis: Traded country bonds.
  • This becomes the added risk for the country and is added to historical risk premium for a mature equity market (U.S.) to get total risk premium.
    • Multiply default spread by relative equity market volatility (STD DEV. in country equity market/STD DEV. in country bond.)
    • Emerging market average = 1.5 (emerging equity markets approx. 1.5 X more volatile than bond markets.)
      • Estimate of country Risk Premium.
      • Add this to U.S. Historical Risk Premium of 3.8 to get the total risk premium.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

country risk71
Country Risk
  • Making Lambdas
  • Company has exposure to country risk different from exposure to all other market risk.
  • Call this Lambda and, like Beta, scale around 1 (>1 = greater country risk; <1 = less country risk)
  • The cost of equity for a firm in this market is written as:Expected Return = Rf + Beta (Mature Market Risk) + λ (County Risk)

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

country risk72
Country Risk
  • Lambdas
  • Company’s risk exposure to country risk reflects revenues it derives from the country.
  • Goodyear can have exposure to country risk because it has revenues from and production facilities within these markets.
  • Estimate Lambdas by revenues.
    • A company getting a smaller % of its revenues from a market should be less exposed to country risk than one with a larger %.
    • To get Lambda, scale % of revenue company gets from a country, dividing it by % of revenues all companies in the market get from the country, i.e. its local GDP.
      • For example: Goodyear did approximately 0.018 (1.8%) of its business in Brazil compared to .92 (92%) for the average company (8% of Brazil’s GDP was in exports and 92% local), so we measure Lambda as 0.018 / 0.92 = 0.02 and we multiply this by the country risk premium (0.0486) 4.86% which is the difference between the mature equity risk premium of 0.038 (3.8%) and country premium of 0.0866 (8.66%).
        • 0.0486 x .02 = 0.00097 and this is then added to the cost of capital. The process is repeated for each country Goodyear does business in that has risk beyond the mature market equity premium.

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

country risk for goodyear
Country Risk for Goodyear
  • Estimate % business done in each country out of approx. $18.5 billion in net revenues.
  • N.America: $10 billion: US: 6 billion = 30% Canada: 2 billion = 10% Mexico: 2 billion = 10%
  • European Union: $5 billion in sales Average across 7 countries $.71 billion EA = 24.5% (3.5% EA)
  • Eastern Europe, Mideast, Africa: $1.6 billion Average across all 3 countries $.53 billion EA = 7.2% (2.6% EA)
  • Latin America: $1.8 billion Averageacross all 5 countries $.36 billion EA = 9% (1.8% EA)
  • Asia Pacific: $1.6 billion Average across all 11 countries $.145 billion EA = 8% (.72% EA.)

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation

country risk74
Country Risk

(2.1%)

WSOM BAFI 403 – Goodyear Tire & Rubber Company Valuation