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

Great. Good morning, everybody, and thank you so much for joining us for this session with Goodyear as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the lead U.S. autos and auto technology analyst at Deutsche Bank. Goodyear is obviously one of the largest tire makers in the world. It is currently in the process of integrating its fairly recent still acquisition of Cooper Tire, while focusing on regaining share across some of the major end markets and improving profitability and margins. And I'm extremely pleased to be joined this morning by Darren Wells, who is the CFO of Goodyear, for a fireside chat. So Darren, thank you so much for being with us.

Good morning, Emmanuel. I'm very glad to be here.

Thank you. So the format for this session will be a fireside chat around some of my prepared questions, but also topics from all of you on the call. To submit a question or topic, please type it in the box in the upper right-hand corner, and I will try to integrate it into a conversation. I will try to incorporate into this discussion. So with that, thanks again for being with us. And maybe before we dive into my specific question, Darren, would you like to share some update about the current industry conditions and operating environment as well as what you expect for the rest of 2022?

Yes. So Emmanuel, the environment that we're operating in, I think, has remained relatively consistent with the environment that we discussed when we announced our first quarter earnings, which is a little bit more than a month ago. We continue to be in a pretty stable demand environment with having recovered to pre-pandemic levels in -- particularly in our replacement markets. A number of parts of the world, still obviously experiencing some lower volume in the original equipment space. But demand has remained consistent from the conversations we had back in early May. We continue to see the cost pressure from both raw materials and raw material inflation. So that has remained with us. And we've had a lot of conversations about that. We've obviously been able to continue to offset raw material costs and in fact, offset most of the other inflation that we've experienced as well. And we expect it to continue to be able to do that as we from Q1 into Q2. We continue to see a number of pricing announcements and even a number of announcements since our May 6 call, and that includes a recent announcement by Goodyear, that we would be increasing prices in our consumer business by up to 10% effective July 1 and up to 6% in our commercial truck business. So that is additional price increase that's consistent with the view that we expressed that we had additional pricing we needed to do in order to address the raw material costs that we see coming in the second half of the year. So not a whole lot of new news over the course of the last month or 1.5 months, but a continuation of a lot of the trends we discussed then.

Great. That's a very helpful overview. And definitely, thanks for flagging the upcoming price increase, and we'll absolutely come back to this a little bit later in the conversation.

But maybe starting just from the bottom line, is it fair to say that even with the incremental inflationary headwinds you described during the last earnings you're still expecting decent SOI growth in 2022? Obviously, when you last reported, you didn't really change your expectations or scenario for breakeven free cash flow. And obviously, our math around that and the various cash items you suggested would suggest an SOI in 2022 of anywhere from $1.4 billion to $1.7 billion or so, which would be still up decently from $1.3 billion last year. So I guess long question, but I guess with all these factors going on, but also their offsets. Is it still fair to say that you see the opportunity to improve earnings this year?

Okay. So Emmanuel, I'm going to take this in a couple of different directions because you're aware, we don't give earnings guidance. And we never intended for the cash flow analysis that we've provided to represent earnings guidance. Having said that, we feel very -- I mean we've got very strong profitable and strong margins in our commercial truck business. and we're feeling very good about that. We've continued to have really strong profitability and continued progress and market share gains in our consumer replacement business. So that's been good for us globally. We've gotten good continued earnings improvement in our off-highway businesses which were hit very hard during the COVID lockdowns. And the one business we have that is more challenging from an earnings and margin perspective right now is the consumer OE business. And obviously, it's continued to have lower volumes. And the pricing dynamics in the OE business are not the same as they are in the consumer replacement business. But having said that, we've had a lot of very favorable trends. And in fact -- and I should probably mentioned this as well, some very good earnings trend in our emerging markets businesses. And that's true both in the emerging market areas of Europe, Middle East, Africa and in Latin America. And in fact, a lot of the Asian markets outside China -- I think we all realize China is a little bit of a special case. But we've got a lot of the Asian markets that are recovering very well as well. So I think we're feeling overall, very good about the earnings trends that we have. And there are a couple of things there that we still have to tackle and consumer OE and how the COVID situation in China or probably the principal ones among it. But overall, I think feeling very good about that. And I think we'll come back to the cash flow question. So I won't try to answer that right now. But hopefully, that gives you some color in and around earnings.

Yes, absolutely. So let's go -- let's please go over some of the puts and takes of this year's environment. First, so the volume outlook, which you just mentioned, how is tire demand been tracking on the replacement side in particular? Any signs of slowing down doesn't seem like it. And then on the OE side, where -- I guess how exposed are you to these COVID shutdowns in China and the volume disruptions in Europe?

Yes. So I think that the overall picture on volume, as you suggest, has continued to be pretty stable, pretty good. So relatively good volume dynamics. There are some places where we had real strength and dealer restocking a year ago. So I'm not always just referencing '22 versus '21, I'm generally taking a view versus pre-pandemic and just say, if we had a big tick up in the market, and it's returned to a little bit more normal levels. I think that's okay. But generally, I think the volume trends have been pretty good. As you suggest, the OE disruption has continued. And I think that our European business has done a pretty good job. And in fact, the -- while OEs have been disrupted there, our -- the win rate that we've had and the share gains that we've had in the OE business have actually meant that we haven't taken as big a hit as the industry has. So in the first quarter, I think the production levels were down about 18% year-over-year. ROE volume in Europe was only down about 9%. So only down about half as much as the industry. So I think that it was actually a good time to be picking up some of those new fitments and that meant the impact for us wasn't as significant from a volume point of view. I'm going to move on to China then say that the China disruptions that we saw and that we discussed during our first quarter earnings call, we had said there that we had taken several weeks of shutdown in one of our Chinese factories and a little over a week in another one. And the combined impact of that we saw is around $10 million for the second quarter. We have not seen any further shutdowns at this point, understanding that there are still shutdowns taking place in China. They just haven't affected us at this stage. I think it's a continued watch out. But it's a fairly significant effect for us. So it's going to be important given that about half of our business in China is OE. It's much more heavily indexed to OE than our business anywhere else in the world. So when we see those shutdowns in OE, it has a much bigger impact in our Chinese our Asia Pacific business than it would for us in other parts of the world.

Understood. And I guess coming back on the market share dynamics in the first quarter and what you're seeing in the quarters ahead. I guess, what led to further concessions in the U.S. in the first quarter and alternatively drove your strength in Europe?

Yes. I think the first quarter in the U.S. a year ago, and in fact, the first half last year, there was a lot of push from the distribution channels to restock. And our ability to supply, given our nearshore production, was higher than a number of our competitors. So the Goodyear's share position was really strong a year ago. So I do think we're up against some strong comps there. And our volume continues to be pretty good. But I mentioned on the prior call that we had -- the timing of pricing there might be playing a role as well. So -- but nothing there that we see that represents any long-term concern for us. Just a little bit of variation as we go through this process of restocking dealer inventories and recovering from the pandemic shutdown. In Europe, I think the story is a little bit more interesting because there -- the market hasn't recovered as quickly, and we have recovered -- but we have recovered more quickly than the market, which I think is partly a reflection of the strength of our product lineup, but partly a reflection of the continued traction that we're getting in the -- based on the restructuring of our distribution channels. So the aligned distribution project that we began in the beginning of 2020. And therefore, during 2020, we took an even -- we took a very significant volume hit, 2.5 million units or so that we that we feel like we gave up because of the changes we were making in distribution. We started to get that volume back in 2021. And now we feel like we're in a much better position, much better alignment with the distributors that we're working with. And as a result, much better demand. The third element that I think is also a positive right now is the fact that we don't have any manufacturing exposure to Russia and Ukraine. And as a result, our ability to supply products including winter tire products has not been affected by that conflict. And I think it actually positions us pretty well as we go into the part of the year where we're starting to ship winter product into distribution channels.

Understood. So, I guess maybe shifting to the cost side of the equation. You had identified $700 million to $800 million of raw material headwind in the first half, indicated potentially similar headwinds could be expected in the second half. Any signs of improvement, I guess, in terms of some of the pullback in some commodities recently, admittedly on the spot price side? But can that still influence your year? Or I guess at this point, any movements happening in late June which probably be for next year?

Yes. I think that largely the reflection is what is the last point that you made, which -- as we look at changes in raw material costs, increasingly, it will be more of an influence over 2023 than it will on 2022. And prices initially following our earnings call, prices moved down a little bit. Now they've moved back up a little bit. So there is some movement in and around them. I think spot prices today are probably marginally higher than they were on May 6, but we went through a period where they were lower. So I don't know that it's really changed the outlook very much. And so it's -- I mean, we're largely facing, in the second half, the environment that we were expecting to face. Still understanding that we're -- it's not completely clear where we're going to see raw material costs go. And oil prices have been very volatile, and our oil-based commodities in this case, have been reacting to that. So there's still some uncertainty out there. But in the end, we've been able to manage the raw material situation. And we remain confident that we'll be able to keep doing that.

Right. And then you also had mentioned large expected negative impact from non-materials, inflation, including labor cost in North America, energy in Europe, transportation. How do you expect this to play out in the second half? And then what's the opportunity to recover some of this?

Yes. Well, I think that we're certainly expecting to continue to see that inflationary pressure outside of the raw material category. And the recent inflation statistics continue to emphasize that. And there are a number of our labor contracts that have cost of living adjustments that are benchmarked off consumer price index or similar economic metrics. So we'll continue to see some of that pressure. It's what we've experienced and what we've been expecting. We said at the -- in the first quarter call that we expect the peak in terms of year-over-year increases to occur in the second quarter and third quarter. And then we're getting to an easier comp by the time we get to the fourth quarter. We've been able to offset much of the additional inflation, but haven't been able to offset all of it with price mix. And that puts us in a position where we're going to have to -- we'll still be working to pass through as much of that cost as we can, but also continue to work on our own efficiency and cost-saving programs to try to deal with the rest of it. And the one area that is probably the most challenging, it is our agreements with OE. The OE manufacturers -- our raw material index agreements don't cover these other inflationary factors. And that's something that I think we're going to have to deal with. I think it's an industry question. It's not just a question for us. But I think we've been in a very low inflation environment for a long time. As a result, OE contracts haven't generally addressed the questions around these other categories. And that's something that we're going to have to focus on as we have conversations with our OE customers going forward.

And are these conversations that are going on as we speak -- obviously, traditional auto suppliers for other components are very aggressively considering those right now.

Yes. I think -- I mean, obviously, the factors that are affecting us are the same ones that are affecting suppliers across categories. And so I think the answer is yes. I mean, this is something that is -- it's a significant factor for us. And we've got a very high level of technical and resource commitment to our OE customers. And we appreciate those relationships. But the economics of those relationships, our current fitments have obviously been affected in a very significant way. And that's something that we're going to have to find a way to address.

And then following up on the rest of pricing, which is obviously a large expected offset to the cost pressure, how would you describe the outlook for -- or the pricing environment, I guess, in the replacement market? Many of your competitors have announced additional price hikes lately. You obviously had one early in 2022, as you mentioned in your introduction, another one in July -- as of early July coming up. How would you describe the current environment, the reception to those? And I guess, demand elasticity through some of these price increases?

I think that as a general matter, our customers understand the cost increases that are impacting us and how those cost increases are impacting how we need to address the value proposition on our product. So -- and we've -- as you say, we've continued to see a number of different pricing actions in the market across competitors and across product, product types and categories. So I think generally, the pricing that we've seen has continued to be fairly significant. And I think that's the kind of environment we're in. We've gone through an environment like this back in 2011 and 2012, where there are very significant cost increases and a reaction by the industry. And it's -- I think we're in a similar situation now, and we're seeing similar kind of activity as there is a continued need to address the cost increases that we're seeing.

And just in terms of pricing math, you mentioned about a 10% announcement for June 1, obviously, on top of the price increase....

July 1.

Sorry?

July 1.

July 1, yes. July 1 on top of the one announced earlier in the year. Would that be enough to offset the magnitude of raw materials increases that you have been guiding for the second half or would you have to take additional actions in order to fully offset the raw materials?

Yes. So I really don't want to start to speculate about any actions beyond the one that we've announced already. However, I think that we're relatively well positioned now having taken this additional price increase. And I think we're feeling -- and the price increase that we've announced obviously is North America. We have also taken price increases in other markets, including Europe in recent months. And if we take all of the actions that we are taking in aggregate, I think we continue to feel pretty good now as we go into the third quarter. And the fourth quarter, there's still some uncertainty around what the raw material environment will be. So we'll address that when we get to it. But I think we're -- we felt like we were well positioned to address the second quarter and now feeling good about being well positioned for the third quarter.

Great. Very helpful. And I guess beyond pricing, what are internal initiatives? Are you undertaking to offset the rising level of inflation?

Yes. Well, I think one of them probably wouldn't surprise you, and that is we're already very focused on driving cost synergies in the integration of Goodyear and Cooper. And as we look at the inflationary environment, the cost synergies and efficiency that we're getting are, if anything, more valuable than they would have originally been. So eliminating any duplicative activities and looking for opportunities to streamline our operations. So we're continuing to stay very focused there and very focused on the areas, including the IT system integration that will set us up for additional synergies as we get into 2023. We're also even beyond the integration of Goodyear and Cooper. We're continuing to focus on what we can do to leverage Goodyear's shared service centers and centralize and automate administrative tasks. So this kind of environment makes those actions also more valuable even than they would have been historically. And we're continuing to spend a lot of time and energy focused on our plant optimization programs, which are the -- effectively are our process for running our factories and for ensuring that we're getting the best outcomes and most consistent outcomes of each piece of equipment. So continuing to put a lot of emphasis there. And I think we're learning things from the combination with Cooper that are going to allow us to be creating even more impact in our manufacturing environment. So I think that's something that's exciting now and exciting going forward.

Right. And I guess following up on the Cooper contribution, you will obviously get a full year of earnings contribution and of cost synergies this year. Now Cooper contributed nearly $150 million of SOI in the fourth quarter of '21, only $69 million in the first quarter of '22. What is a reasonable run rate? And how much of the $250 million in targeted cost synergies you identified could be achievable in '22?

So let me take the last question first, and then we'll come back to the run rate question. So if I take our $250 million of targeted synergies, which is the run rate that we expect to achieve in mid-2023, part of that is about the $165 million that we announced originally is cost savings. And the remaining part of the $250 million is effectively volume and mix related. So there are some benefits we can get from -- in other areas that I think are -- may not be cost related. What I'm going to address, though, is all the synergies. So just think about what run rate we might be getting relative to the $250 million. And if I go back to the second half of last year, we were getting -- in the fourth quarter, we got in the range of $15 million to $20 million. of synergies already. So that became part of the 2021 base. As we went into the first quarter of the year, the run rate has improved a bit. So probably got a bit more than that, call it, $20 million to $25 million in synergies in the first quarter. And every quarter as we move forward, we're getting a little bit more momentum. And in the second quarter, we've actually started to sell some Cooper product through Goodyear distribution, which is another opportunity in that category. So that's another synergy opportunity. And it's something that we will ramp up over time, but excited to get started on that. So I think you may see a bit better in the second quarter and then obviously, every quarter after that, we're hoping to improve even further. I will say this, though, because there is a little bit of a step-up that will occur after we get the ERP systems in place. And we've targeted to get that work done by the end of this year. That means there will be a natural step-up in the first half of 2023.

Okay. And again, on the run rate, I guess, in the part of the question is it $150 million in the fourth quarter of $69 million of SOI in the first?

Yes. Yes. So Cooper's earnings, if we look at the pro forma earnings that we've published there, it does show some seasonality with fourth quarter being the strongest quarter of earnings. And I think that we're -- in the first quarter, Cooper earnings were not -- if we exclude the impact of the factors that impacted -- that were an impact from the combination itself. If we separate those out, then the earnings would have been at $77 million, which isn't -- it was a little bit over $80 million in 2021. So not too much different. So I think that we're -- in both quarters, we're significantly better than the pre-pandemic earnings that Cooper is delivering. So I think we're continuing to feel like Cooper is performing well. They're continuing to perform at or above levels that are premerger, pre-pandemic levels. I don't know that I have a number that I could reference for a quarterly run rate because I think every quarter, it's going to be a little bit different. I will say that we continue to see and expect continued benefit from Cooper's historical earnings and Goodyear's historical earnings and then obviously, the synergies that we get between the 2.

Yes. Okay. No, that's very helpful. Let me shift gears to the free cash flow then, which I'm now hesitant to call guidance since it's not guidance. But I guess the scenario for breakeven in '22, did you really feel the balance sheet is in such a good shape that investors are willing to forgo free cash flow generation in favor of investments? Or are these investments that are urgently needed?

Yes. So I think that -- let's say, we've had -- since we did our year-end earnings call, we have had a lot of opportunity to have discussions with investors, both in group settings like this as well as in one-on-one sessions. I think generally, the type of investments that we're communicating are part of the investment program that we're initiating this year. I think generally speaking there's a high level of comfort with the economics of those investments and the need to make those investments, both to continue to modernize factories in order to allow us to keep pace with increasing levels of technology, including the technology that we're going to need to build tires for electric vehicles. And also investments that we need to continue to make to ensure that we're making progress on our manufacturing cost per tire, which there's a good understanding that's a competitive matter for us. Having said that, I do think that the level of comfort is even better given the slide that we provided with our first quarter earnings deck, which was Slide 13 in that deck, and then there was another annotated version of it with some extra information, it was Slide 21 of that deck. But that was the 12-year cash flow view, which we added to the first quarter earnings deck in order to provide some perspective on our ability to generate cash even with CapEx that is a bit above depreciation. And I think you're familiar with this slide, but I thought the -- when I've gone through that slide with investors and been able to lay out a couple of different points, one of which is that if we look at what we were calling that slide, our structural cash flow, which is effectively our operating cash flow before pension contributions less CapEx. That has averaged over the last 12 years about $500 million a year. And it averaged $500 million a year, even with CapEx averaging a couple of hundred million above the depreciation rate. So the -- it also made it very clear that when we're looking at the cash flow that we're experiencing in 2022, that's a unique moment in time we're rebuilding working capital. and that happened once before into 2011. And those are isolated points. So when we go through a downturn, just after the downturn, we tend to go through a rebuild of working capital. And that's happened after the Great Recession, and it's happening post COVID. But it also made it clear that wasn't -- in 2011, that was not an indicator of any sort of run rate on cash flow, just like this year it's not an indicator of any sort of run rate. I think that the fact -- that reminder of our ability to generate cash flow consistently over longer periods of time, even as we invest CapEx a bit above depreciation rate added to the comfort level that investors had with us making these investments now is like they're realizing that this -- the increase of the recovery in working capital really just a 2022 action. And our 2021 balance sheet was in better shape than investors were expecting because we didn't rebuild as much inventory last year as we were expecting to. And so the fact that we're able -- that we're doing this program, not adding any net debt because we'll expect to be able to cover all of those -- all the CapEx and all the working capital rebuild and then get -- put ourselves back in a position where we're generating cash thereafter, I think generally, they understand that is still -- we are still taking the right actions to take care of the balance sheet.

Understood. And so then maybe just to put a final point on this before we run out of time. When would you expect to generate more positive free cash flow? And what do you see as a normalized free cash flow with Cooper?

Yes. So I think that last 12 years, that structural cash flow that we generated over the last 12 years, I mean that was $500 million a year on average. And that was with segment operating income of about $1.3 billion on average. And I understand that was Goodyear stand-alone. But I don't -- I think that, that gives a pretty good indication of where Goodyear's cash flow generating capability has been. Obviously, Cooper was cash flow generative as well. And we were expecting to maintain and improve on Cooper given that we'll have both the run rate of Cooper and the synergies that we can create, both the earnings synergies and the cash flow synergies and particularly the tax savings, which over the next several years is going to be significant just in terms of eliminating the cash taxes in the U.S. So I think we'll -- we're looking to take the Goodyear and Cooper historical run rates and add something to that with synergies. And I think we're comfortable we're going to be able to do that.

Right. So we're out of time. So Darren, I really appreciate you joining us and providing all these color and updates. We very much look forward to continue monitoring Goodyear's progress. I want to thank all the investors on the line as well for tuning in and participating. Thank you very much and very much look forward to seeing most of you over the next 3 days at the Global Autos Conference, starting in person tomorrow. So Darren, thanks again. And take care.

Thanks Emmanuel.

Bye.