Friday, November 13, 2009

Goodyear Tire (NYSE:GT): Upgraded to Buy at Goldman Sachs

Goldman Sachs is making an interesting call on Goodyear Tire (NYSE:GT) upgrading it to a Buy from Neutral with a 6-month target of $19 (prev. $17).

Goodyear shares have declined 20% (vs. an average increase of 12% for Goldman covered suppliers) since they reported 3Q09 results on Oct 28th based on weak 4Q09 guidance. While they were also surprised by the 4Q outlook, the shortfall was largely driven by the transitory accounting impact of production cuts (specifically the resulting unabsorbed fixed costs flowing through the P&L on a lagged basis), which does not impact firm's longer term outlook. Goldman sees the selloff, which put shares back to their July 21st levels, as an opportunity to build positions in the shares.

Increasing their GT estimates on better pricing outlook
Goldman is raising their 2010/2011/2012 ests to $1.05, $1.88 and $2.49, for GT from $0.95, $1.77 and $2.38, respectively, on better pricing. They expect a much more favorable supply/demand balance in 2010 to be supported by the safeguard tariffs which increase the costs of tires at lower end of the market. Firm sees Goodyear’s announced price increase of up to 6% in the US and recent price increases by Pirelli and Toyo as evidence of this.

Pricing looking like more of an opportunity than a risk
Pricing has remained a positive surprise for the industry during the past year. Following the broad based increases of 2007 and 2008, pricing remained stable in the face of falling raw material costs and extremely low levels of capacity utilization, two conditions which they thought were likely to lead to more competitive actions than actually took place. Now having exited what they would consider to be the highest risk environment Goldman thinks the pricing landscape looks good for several reasons. Most basic is that following an estimated 60mn units in Goodyear production cuts we think supply is much tighter than it has been over the last 2 years, and they believe it will be even more so as we head into 2010 where they forecast a 4% increase in tire demand versus the -27% peak to trough decline experienced over the last 4 years (using their 2009 volume estimate). Goldman also sees pricing benefiting from the safeguard tariffs levied on imports of Chinese tires. While Goodyear has largely exited the private label products that compete with these imports, by raising prices at the lower end it does establish a higher floor which is healthy for the more expensive branded products. As such they are encouraged by the price increases recently announced by or planned by Toyo, Sumitomo, Bridgestone, Pirelli and now Goodyear to offset the cost of safeguards and/or the increased cost of raw materials.

See 38% upside in Goodyear shares
Goldman expects GT to see a sizable earnings improvement post 4Q09 driven by: increased consumer tire demand, benefits from improved fixed cost absorption, and continued cost reduction from better manufacturing flexibility afforded by the new USW contract. This underpins their new 6-month PT of $19 (from $17) with 38% potential upside.

Notablecalls: First of all, this is a dual call as Goldman is concurrently downgrading Federal-Mogul (NASDAQ:FDML) to a Neutral from Buy.

GT got whacked two weeks ago following a messy quarterly report and hasn't really recovered since. It's down 3 pts and I think the Goldman blessing will help it to retrace at least 1-1.5 pts of it, putting $15 level in play today.

The car-parts sector continues to be red-hot.

Let's see how it works out.

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