The Goodyear Tire & Rubber Company (GT) Earnings Call Transcript & Summary

Hello, everybody. I'm Adam Jonas from the Morgan Stanley Global autos and shared mobility team. I'm delighted to have with me representing Goodyear, Darren Wells, Executive Vice President and Chief Financial Officer of Goodyear. He is joined off camera by the Investor Relations and finance and treasury team, Christina Zamarro and Nicholas Mitchell. Thank you very much for joining us. I want to -- before we get into the fireside, I just want to read the disclaimer, and then we'll get on with more exciting stuff. Note that this webcast is for Morgan Stanley clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out. Separately, for important disclosures, see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, don't hesitate to reach out to your Morgan Stanley sales representative. Okay. So with that out of the way, Darren, I just wanted to give you a chance at the top to kind of convey any key messages to investors or any update of messages and guidance before we get started.

Yes. No, listen, Adam. Thank you for that, and thank you for having us today. The -- I guess, maybe if I were to hit on a few points here, just to bring people who are listening up to speed with what we've been seeing since we released our second quarter earnings, I might take that opportunity. And it probably makes sense to start with volume because the recovery of volume is probably the single most pertinent topic and has been for a number of months now, trying to figure out initially how bad volume was going to get and now trying to figure out how quickly volume is going to recover and maybe how sustainable that recovery is going to be. When we announced our second quarter earnings back in July, we were digesting June results and looking at early results for industry volumes in July and planning for a third quarter that would continue to show some of the upside that we saw in June but expecting that there might be some further disruption to sales as a result of resurgence of COVID-19 in different parts of the country, different parts of the world. And therefore, we took a view that industry volumes, if we looked at it globally, it might be down something like 20% in the third quarter, which is similar to the levels that we saw in June. I think what's clear to us now in mid-September is that July, August and early September have played out more positively than that. And if I took that same view today, we'd probably be looking at global volume for Q3 down something more like 10%. But I think with some pluses and minuses that, as we've analyzed it, and so certainly acknowledge that auto production and even replacement tire sales at retail have continued to show some very good recovery. That's true in the U.S., true in Europe, although it took a little bit longer in Europe and certainly true in China, where in China, we've gotten to the point where automotive production is above where it was a year ago. So we've got some good pluses there. We've also had a couple of factors probably helping boost replacement tire, at least reported industry volume and replacement tires. So I think we're seeing some increase in imports. And I think we're still studying it, but we're reading it as potentially being an early indication of distributors stocking up on lower-end Asian imported tires ahead of potential tariffs early next year. So there's some things there that are moving demand in the right direction and are causing industry volumes to look stronger than we might have expected. I guess if I balance it out, I would say we saw July and August in replacement in the U.S., if I take the 2 months together, it was effectively flat to a year ago, including the effect of those imports. But if I look at vehicle miles traveled for gasoline usage, all indications are that driving is probably still 10% below where it was a year ago. And so I think we look at that, and we're asking ourselves the question how much demand here is just restocking a bit of trade inventory and how much of it is selling out to end users. And that's, I guess, the balance that we're trying to strike here. At the same time, I would also say that, for us, and I think for other manufacturers, we're a little bit tight on our own supply because we did cut back on production. We cut back on our own inventory. And then starting in June, we've seen market volume recovery -- recovering more quickly than we expected, and so we've been working to try to keep up with that. So I think that probably balances out some of the strength as that there's probably a bit more demand from distributors than there is supply at times right now, particularly for high-end tires. So -- and we still obviously got some markets that are going through significant disruptions. And so I think there's still some things that would create some uncertain industry volume, but overall, a picture that looks better than we might have expected. If I look -- there are some unique factors for Goodyear as we look at volume, and maybe the most significant one is the fact that Walmart closed their auto service centers during the pandemic and has gradually been reopening them. We're category captain at Walmart for tires. So that is a very large sales channel for us. And at the end of July, Walmart had reopened about 1/3 of their 2,500 auto service centers. If we look today, we're up to about 2/3. And so obviously, making some progress here. So we're 45 days later, and we've gone from about 1/3 to 2/3, but there's still 1/3 of those stores that we're waiting to reopen. And so that will continue to be a volume headwind for us until we work through that process. But we are still, I think, trending in the right direction. It's something that we'll -- hopefully, we'll get that -- we'll see that resolve itself by the time we get to the fourth quarter. The -- so that covers some of the volume points I want to make. Another area, obviously, that we're very focused on is the raw price versus raw materials equation given that before we went into the disrupted 2020, we had already seen 3 years of compressed margins as a result of rising raw material costs and pricing not keeping up. I think sitting here in the middle of 2020, we had a period of time where pricing has remained pretty stable, still showing some increases year-over-year. And we're going through a period where raw materials have gone down fairly significantly with the drop in entire production. And while we're seeing those raw material prices, in some cases, start to rise again as production grows, it still looks like there's going to be an opportunity for us to recover some of the raw material costs or price versus raws that we lost. Now for us, I think that's effectively not going to start until the fourth quarter. And part of that is the fact that we're first in, first out in our inventory accounting. So there's a lag from the time that we buy the lower cost raw materials to the time it comes out in our P&L. Also, though, the fact that we've got some locations where currency has affected the cost of raw materials when they're calculated locally. And Brazil and Turkey are 2 very large production locations for us. And there are 2 currencies that have dropped in value a lot over the last year. So if I look at the third quarter by itself, raw materials are going to be a slight negative for the company, similar to what we saw in the second quarter, and it's really being driven by the adverse currency effect. So we got that transactional and currency effect that's going to make raw materials a slight negative for the quarter. And then we'll get into the fourth quarter, and we'll start to see more of the benefit of the lower cost raws that we're buying now. I think from a cost perspective, I feel good about the progress we're making on cost. Really cut a lot of cost to make it through the disruption of the second quarter. We then took the opportunity to get a factory closed in the U.S., that was an older factory, one that wasn't able to make products that are relevant in the market today. That does bring our cost structure down. And so as we ramp our volumes back up, it gives us an opportunity to have an average per unit cost that looks a lot better. And so that's, I think, is a positive for us in the second half, and we're seeing those benefits. And finally, maybe just to touch on cash flow because that was a big focus for us in the second quarter, making sure our cash, our liquidity and our balance sheet were protected as we went through this disruption. As we moved into the third quarter, I think we were expecting that we might use some cash because we had a need to rebuild some inventory as we went through the third quarter partly because of the higher volumes we've seen. That's been harder to do. And as a result, I think we're looking at cash flow in Q3 to be closer to breakeven. All right. So -- and that job of trying to rebuild some of our own inventory is probably going to get pushed out to the fourth quarter and beyond at this point because the demand from our customers is there. So -- but I think it continues to show the disciplined approach that we've taken to try and protect the balance sheet and keep our cash and liquidity in a good place. As we prepare for the recovery and understand we still are in a position where the recovery is going to be, an extended recovery, and there could be some bumps in all of that.

That's great. Very, very detailed update along key causal factor. Appreciate that, Darren. Maybe a couple of questions I've just kind of written down here as you've gone through that. And one of the messages I'm getting is demand is looking better than you had stated at your last reporting, but you're kind of taking the approach that -- and naturally, that some of it is replenishing and maybe not to be fully extrapolated, and you want to kind of keep -- want to be wary of extrapolating too much, right, given the restocking, both at the industry level, distributor level and your own level. But you are describing a situation where it's tight, right? And where the delta in demand is progressing at least as fast as the delta in supply, if not faster, right? And so what does that then mean -- and maybe you alluded to it, and I missed it in your wording of recoveries, but what does that mean for the pricing environment in real-time? And again, wary of not extrapolating good pricing because that could be temporary as well, but could you comment a little bit more specifically on pricing?

Yes. Yes. So I think if we look at our pricing, I think we're -- we come into 2020 understanding that we've had margin compression for us and for -- and that is just true for other players in the industry over the last 3 years. So I think there is -- it remains a key focus area for us. And I think we've continued to raise our prices to the extent that we feel like our products and our brands are able to demand value from consumers in the marketplace. And most recently, in the second quarter, we took a price increase in North America. So we've continued to see -- to take those actions ourselves. If we look at replacement pricing in North America and Europe. I think that we continue to see pricing flat to up in both markets, notwithstanding raw materials being down, and that's true in replacement. Now OE pricing, as we've talked about earlier in the year, has been more of a negative. There has been a lot of competition for OE fitments, and I think the automakers themselves are working very hard to address cost structure, particularly on some legacy vehicles as they grapple with the investments that need to be made for the transition to electric drivetrains. So we have definitely seen some of that. But in the replacement market, I think we feel like pricing has been a good news item for us. And I think particularly so, given how much raw materials have come down. So I think we feel like that's giving us an opportunity, as we've seen in past cycles. We go through these periods of time where there's an opportunity to recapture some of the lost margin. I think we're looking at the coming quarters as an opportunity to do that.

Okay. Thanks, Darren. And maybe a little bit more commentary on mix, if you don't mind. I mean, you mentioned tightness, particularly on the high end. I assume you mean like high performance, ultra high-performance or larger diameter size. But if you could elaborate there and then maybe by segment, if you could. And then just broadly, passenger vehicle versus commercial vehicle or some other specialty segments, if you wanted to call anything out there.

Yes, sure. So I think you're reading my comments correctly. And so there continues to be very strong demand for large-rim diameter tires, high-performance tires, SUV and light truck tires. Those tend to be some of our most profitable products. And they are products -- they're probably in highest demand. And I -- this is -- it's an interesting effect that we've seen. Because we've been through this period of time where Walmart auto center shut down, and that is a location where a lot of smaller-rim diameter tires are purchased. As a result, some other sales channels have seen an increase in their smaller-rim diameter sales. And I think it's just -- it's a bit of noise in the analytics, but it raised questions as to whether or not that means there's a mix down in the industry of some sorts. I mean we see that the demand continues to grow in large-rim diameter and some of the more complex fitments. The lower end of the market continues to be around 25% of the industry overall and continuing to see -- even within the category of large-rim diameters, continuing to see rim sizes move up. And those are hard tires to make. There's fewer people who offer them, and that tends to mean that there is more tightness in supply there. I think the fact that the auto production has begun to recover in the way that it has probably makes that an even bigger challenge because those are the type of tires and the type of equipment we use to make the OE tires is the equipment that makes our larger, higher-performing tires.

Yes. Can I ask -- and maybe this is from another era, and it's not like this anymore. I'm a former tire analyst. You got to go back to the '90s for when I was really in the weeds here. I'm probably dating myself a little. But if the OEs are starting -- if your OE customers are at a point where they have critically low levels of inventory, right, and you're not going to deliver a car without 4 tires on the car, am I right that, that you're going to prioritize that ramp and that, that could be having, all else equal, a bit of a negative channel mix impact? And I'm wondering if that's something that as we kind of exit and normalize at the dealer level, complete new vehicles, that, that's another factor. I don't want to get too lost because I know there's so many puts and takes, but just -- I don't know if that was a significant one.

No. I mean, Adam, I think there are some -- yes, there are some cycles in our industry that don't change. When we go through periods of big ramp-up in OE production. I think for all of us who have OE customers, they do get priority of supply. And therefore, if we're supplying more to OEs, and we've got constraints, and we saw this late in 2018 as well, if we go through this period of times, it does sometimes mean that our replacement channels get supply that's not as strong. And that's something that we're really working hard to avoid because we take our customer service commitments very seriously. But we managed our business through the middle of this year really focused on making sure we had good control of working capital. And then we had inventory in line with where demand is. So -- and I -- there's evidence out there that, that's not just us and that as we're seeing this ramp-up in demand at OE and the ramp-up in demand in replacement, it has created a tight supply environment for the main one.

Okay. I want to clean up 1 or 2 things, just fact check some things that you were saying that was new to me. And Walmart, roughly how much of your U.S. replacement business are those channels? I didn't know if that's something you disclosed or provided an order of magnitude around.

No. I mean, it's -- we don't disclose specific numbers on the Walmart business. They are our largest single replacement customer.

Okay. And then your comment about the impact of the inventory restocking relative to demand and that you had expected that to be cash flow -- cash out in 3Q and pushing that into 4Q, is that -- are you able to say -- or is it premature to have to say what the impact could be on total cash flow? Meaning, remind us, is 4Q normally a cash flow positive business that might be negative because of this delay? Or what else can you say at the corporate level?