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

Yes. I'm Victoria Greer from the European autos research team. I'm covering all the European tire stocks and more recently Goodyear also. Before we get started, I just need to give us a quick disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com and for special research disclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. So I'm very pleased to be here today with Goodyear and Darren Wells, EVP and CFO. Welcome. Thank you very much for joining us. I think, yes, Dan, let's get started and just have you cover some of the key themes and very recent events before we get into some Q&A.

Okay. Thanks, Victoria, and good morning and good afternoon. So we did our second quarter earnings call at the beginning of August, and we had a number of key themes there, including the recovery and replacement volume, including some of the disruption that we have had in our OE volume based on OE production schedules. The progress that we had made on price/mix and improvements in price mix, more than covering the cost of raw materials and talked a little bit about the events that are taking place in supply chains generally and the impact that, that's having on cost inflation. So I thought it might be good to just give the observations from the last couple of months as we've moved forward in time because I think there are some relative pluses and minuses over that period of time. So I think on the challenge side, OE production, obviously not really recovering in a significant way, at least as we go through the third quarter. So we were down in the second quarter in the U.S., a little over 20%. That has continued in July and August. So we continue to see profit in OE volume. We've also continued to see challenges in the supply chain. And while the challenges -- we've been able to overcome the challenges and keep material supply flowing to our factories, it has resulted in some challenges trying to get finished goods to market. And that's certainly been true in some of our emerging market businesses [indiscernible]. So we've had some challenges there. We also continue to have some challenges in terms of labor availability and general cost inflation. And we highlighted those during the second quarter call, but certainly, we're seeing that. And as a result of those challenges and cost pressures in transportation and in late, we had went into the quarter expecting about a $40 million incremental cost increase in Q3 relative to Q2. So quite a bit of inflation there. I think that clearly, we are seeing that plan. And the cost of transportation, particularly ocean transportation, has remained very high. So a few of the challenges that we were seeing then have continued to be challenges. On the other hand, I think there are some real positives in the last couple of months. And the consumer replacement business, volumes have continued to be strong. We were up in the second quarter, 13% versus 2019, though 13% over pre-COVID levels. And in July and August, we've continued to be above pre-COVID levels. Although the increases in July, the U.S. consumer replacement industry was up about 9% in August of about 6%. So no longer double-digit increases over 2019, but now coming and getting more consistent with the sell-out. So these metrics are all sales from manufacturers into distribution channels. And those details from distributors out to retailers in the market have been in that mid-single-digit range. And so now we can see that the sales for manufacturers into the channels are coming back more in line with sell-out, which is what we expected to happen. But we're still seeing very strong sell-out and very, very strong market growth in the U.S. And we're continuing to see recovery in other markets as well. And European volumes, while they aren't back to 2019 levels, continue to strengthen and particularly, I think, in certain segments of the market. So while winter tire sales haven't been very strong to date, we're seeing very good sales in all-season tires as the market has continued to sort of shift from winter to all season in some ways. So -- but the overall market conditions there continue to improve. So I think that that's good. I think commercial truck replacement has also been very strong. And that's true for us in North America, true for us in Europe, true for us in other markets around the world as well. So the commercial truck business has continued to be a highlight. So those trends have continued. I think there were questions as to whether or not we can continue that momentum, the markets have. I think we feel very good about our position within those markets. And that brings us back to the, I guess, the price mix versus raw material trend. And we have been recovering some of the margin compression that we experienced in 2017 and 2018 as raw materials rose and we were not able to recover them. We've been recovering some of that by having price mix ahead of raw materials. And I think as we left the second quarter, there were some questions as to whether or not we would continue to see the consistent pricing across the market. And now as we are most of the way through the third quarter, I think we have continued to see it. In the third quarter, in the U.S., we've seen 8 of the 9 competitors that we track raise prices. And obviously, all of those competitors have raised prices earlier in the year as well, so third quarter continuing the trend. Goodyear has an additional price increase for consumer September 1 of up to 8%. Cooper brand, we've raised prices both on July 1 and on September 1, again, up to 8% in those -- in both brands. So we've continued our journey to make sure that we're addressing raw material costs and getting the full value for our brands. So I think we're feeling good about that continued ability to recover not only the raw material cost inflation but to help address some of the other cost inflation that we're seeing. Raw materials have continued to see some pressure as we move through 2021, compared to where we were at the beginning of August when we did our second quarter call, things have flattened out a bit. And in fact, natural rubber is below $0.03 or $0.04 a pound below where it was at the beginning of August. So that's softened a little bit. Carbon black, another one of our key fillers is essentially flat to where it was in early August. So we've seen those prices steady. The petrochemicals, including butadiene is a component of synthetic rubber, that's where we've seen the most significant step-up in raw material costs. And over the last 60 days, we saw butadiene go from just over $0.70 a pound, actually went up over $1 briefly, but now it's been trending back down and is around $0.85. So while we saw a brief spike there, and I think there are always concerns as we see storms approaching the Gulf Coast of the U.S., where a lot of that production takes place for North America, as we have not seen any significant disruption since the [ winter storm ] that happened back in February, we've actually seen those prices coming back down. And we'll see. I think there could still be some volatility there. But I think overall, we're feeling like the fact that raw material costs have steadied is probably a good thing. And the fact that pricing has continue to be available, I think, is a good thing as well. So I do think we're continuing to see some real good trends there.

Yes. It's just been an extraordinary operating environment really for the whole industry. I wanted to touch on a couple of things that you hit there. We talked about that gap that there has been between the sell-in and the sell-out numbers. And as you said, starting to see that close now. But you and most of the other tire companies really just haven't had any opportunity yet to restock their own inventories. You exited 2020 with a supply under 80%, very low level versus history. That moved obviously pretty sharply in the Q2, but some of that was around the Cooper Tire impact. I think that the Q2, at the start of August, you were commenting that you were able to start to make some kind of progress on restocking. Is anything changing there? Or is it still just make every tire you can and there's demand for it?

Yes. I could say -- I think I would say in the Americas, we've got to make every tire we can. And so to put the inventory situation in perspective, and I'll share a couple of statistics here. They are not statistics that we normally publish. But the -- so at the end of June, we were -- our inventories were about 13 days below where they were at the end of June 2019. And so if you want to take that in percentage terms, that sales adjusted, that's about 13% below where we were in 2019, so if you wanted to think of that as more of a normal level. However, if I take the Americas, in the Americas, we were down about 24 days. And so that's approaching 25% below where we would like to be. And for both those statistics, we have a lot more of that finished goods inventory sitting on the water in containers. So even -- so the actual situation is even a bit worse than those statistics would indicate because the inventory that we have is not all as accessible. And that's consistent with every industry, I think, because there are ships waiting for containers to be unloaded. And our products, particularly when we're shipping to emerging markets, markets where we don't have factories they are reliant on those tires being shipped from our -- some of -- from other countries. And those tires are spending more time on the water than they normally would. So yes, I mean, we're at a point where, clearly, in the Americas business, we have not made progress in recovering inventory. We now see that taking us well into next year. I think in the European business, our inventory levels, we have been able to replenish our inventories to some degree there because the industry recovery has not been as robust there. Outside of Europe and North America, there are different situations. But I think generally, we're working to keep production as high as we can.

Yes. And then I wanted to come a bit on talking about pricing. As you said, it seems like there's just been much more discipline -- even more disciplined than usual across all of the competitors that, that whole move to take pricing in response to the raw materials has just been, yes, very smooth and has worked very well, of course, for Goodyear this year, too. Do you think if we look a little bit longer term, firstly, do you think that we could be more structurally in an inflationary environment for some of your raw materials? And then connected to that somewhat, do you think there is an incremental opportunity into 2022 to really reposition our pricing into next year, independent of whatever might happen with raw materials?

Yes. So I think the industry right now does have tight supply dynamics and relatively strong demand coming out of COVID. So I think that there are some things that I would considered to be a bit unique right now. But I also think about that in the backdrop of the industry having experienced margin compression for several years coming out of the industry peak in 2015, 2016. So the industry saw that margin compression. The trends in the industry are actually toward higher levels of technology and complexity. And I think electric vehicles is the latest in the trends that are making tire construction more complex and more reliant on technology. It's also -- those are also trends that effectively reduce the productive capacity of the manufacturing footprint that we have. So it means the same factories can produce fewer tires. So I think all trends that make it understandable that there would be an opportunity and a need, in fact, to recover margins because of the investment that has to take place to continue to serve the market and produce these more demanding products. So I could argue that there could be an ongoing trend there. I also think that there -- well, raw materials right now are suffering from the -- a little bit of imbalance. So the industry is working very hard to catch up with demand. And that's true for finished goods. Raw materials similar as there is a real strong demand, and there are problems with shipment and a lot of just supply chain difficulties. Eventually -- and the industry itself is building ahead of end-user demand because we -- first, we're trying to replenish dealer inventories. And now we're going to be trying to replenish our own inventories. That will eventually normalize. And that should also normalize the demand for raw materials. So I think there are some materials where there'll be more of a normalized demand and perhaps less pressure on the price of raw materials. But I don't see anything that leads me to believe raw material prices are going to go down. So I think, if anything, there is some pressure upward. Even before we got to the pandemic, we were seeing a lot of upward pressure in petrochemicals. And part of that is just the actions that we are all taking to try to reduce environmental footprint. And those actions extend into places like China where a lot of that petrochemical input production was taking place. And either there was production being shut down or the production, there was investment in order to reduce the environmental impact. And those are all things that place upward pressure in more of a long-term sense. I don't think that, that necessarily explains the quick ramp-up that we've seen over the last 12 months. But I do think that it means that we would not really expect raw materials to come back down significantly even as we move past the ramp-up and the restocking process that we're going through right now.

Then I wanted to switch over and talk a bit about your like, yes, really, material acquisition that you've done this year and in the form of Cooper Tire and really to come to a couple of questions around cost synergies there. You've talked about being able to recover, in terms of cost synergies, about $165 million, rationalizing duplicated structures, R&D spendings and procurements and distribution. And then aside from that, obviously, the $250 million were impactful opportunity and then $450 million plus in tax savings. We are also in a wider integration process to think about other opportunities. Are you able to share any more with us yet around, yes, whether there's -- you think that there is some upside to that $165 million, it was distribution and maybe coming into manufacturing footprint also. Yes, are you any closer to being able to share anything there?

Yes. So I think every day, every week, we get closer to the point where we're going to be able to share more. Our team has been going through about a 3-month process to develop sort of a full robust list of the opportunities that we plan to go after and to develop work plans around each of those opportunities. And that will start to inform not only what the full range of synergies might be, including the elements that you're pointing to, but also will start to give us a better feel for the timing. As I know there's a high level of interest in what level of synergies that we might achieve in 2022 and in 2023. And what I'll say before I come back to your specific question is that we continue to feel better and better about the opportunity. And so I know that, that's sort of a real-time assessment is every week and every month that passes. I think that we're continuing to find more opportunities. So I think we feel good about getting at least the level of cost synergies that you're suggesting. And we continue to identify opportunities that are outside of the areas that we articulated back in February. So feeling very good about that and also feeling very good about our ability to work with the Cooper team. I mean they -- and the fact that they really do have some knowledge and approaches that are really incremental for us, for the Goodyear team. So both teams are adding a lot to this conversation. So I do think that while we recognize that in the original synergy assessment that there would be some benefit for distribution and that we thought that there was some work in North America that TireHub could do to help with distribution of Cooper product. And we thought that there was some overlap in our warehouse and transportation network that we would be able to take advantage of. I think we're continuing to look at further opportunities. And we did not include in that initial assessment any opportunities overseas, and we are clearly seeing some. And I think that in China, in particular, we're going to find opportunities for the Cooper brand in the replacement market. And we've got over 2,500 points of sale there that we can leverage to help with that. Continuing to look in Europe and particularly in the U.K. where the Cooper brand and the Avon brands are more well established, so looking for opportunities there. And then in -- the North American market where both companies are large, I think there's continued review of how the product lineups and the complementary brands should fit together and how we can best leverage both brands. And a lot of cases, we're already selling through the same channels. So it's a matter of trying to make sure that each brand is leveraged to its best outcomes. And both companies have a lot of momentum right now. So we're building from a strong position. But I think the teams are already finding small ways that I think will ultimately become larger ways that we can benefit from the complementary brands. So I think we continue to be excited about those distribution opportunities. The -- we're also -- we are looking at manufacturing. And I think the point of view that we're taking on manufacturing, at least in the Americas, is that we've got both the Cooper brand and the Goodyear brand, the historic supply chains are both full. So we are -- in both cases, we're building all of the tires that we can. So we're running at the highest level of capacity that we can run at given that we do have some issues on availability of labor as most businesses do right now. But aside from that, we really are building all the tires that we can. I think the question we're asking ourselves is that given we've been in a situation where the demand for tires is rising and we have a need to produce more and that these are tires that are more complex and tend to push us towards lower factory output and we continue to have the challenge of having a greater array or a greater -- a larger lineup of tires, I think there's a number of different manufacturing challenges there that having a bigger factory footprint might help us address. And that could be -- not that we would produce different products, but we have opportunity to think about specializing factories or specializing lines of equipment in a way that's greater than we would be able to do as separate companies. And that -- there are some things there that I think we'll learn from Cooper and that there -- they have a lot of experience with high-volume replacement tire lines and keeping the manufacturing process simple and streamlined. And I think that those are lessons that may be able to apply to some of Goodyear's tire lines. So I think that by itself is exciting. But being able to look at how we might specialize and define plant rules, I think, is going to be an interesting opportunity as well. And -- now those things are -- we talked about the initial 2-year period of the core synergies. I think, realistically, those type of changes in manufacturing tend to take longer. So I think that we'll get through and deliver the $165 million or more, of course, synergies, along with the working capital and tax benefits. But what is exciting about this is it means there's going to continue to be opportunities to drive synergies well beyond that initial 2-year mark. I think the final point I think on manufacturing is that there is the additional opportunity to expand some of the low-cost locations. And now we have a larger number of locations that are -- the CRE opportunities for brownfield expansion for future growth. And I think, in the end, that will be good for our capital expenditure efficiency and will also allow us to ramp up additional production capacity more quickly than if we had to resort to greenfield construction. And there may be some of both of those things in the future. But I think those brownfield opportunities are going to be exciting for us as well.

Great. So we've gone just over the half hour mark. Darren, thanks so much for joining us, and we'll leave it there. Thank you.

Thanks, Victoria.