September 13, 2011 at 08:46 AM EDT
Goodyear Could Put Your Portfolio on a Roll
Goodyear's extremely low valuation and rapid earnings growth might offset recent bad balance sheet.

GoodyearSecond-quarter 2011 S&P 500 earnings hit an all-time record of $25.44. One of the fastest-growing earners of the lot was Goodyear Tire & Rubber (NYSE:GT), whose EPS popped 442%.

This tire maker’s earnings growth was driven by more than just cost cutting — in the second quarter, it reported a 24% sales increase. Here are two reasons to consider investing:

Two negatives:

  • Flat sales and declining cash — but lower losses and less debt-laden balance sheet. Goodyear sales have remained about the same at $18.8 billion over the past five years, while its net loss has declined from -$373 million (2006) to -$216 million (2010). Its debt has fallen — but its cash has declined faster. Specifically, its long-term debt fell at a 10.2% annual rate, from $6.6 billion (2006) to $4.3 billion (2010), while its cash dropped at a 15.4% annual rate, from $3.9 billion (2006) to $2 billion (2010).
  • Under-earning its cost of capital but getting better. Goodyear is earning less than its cost of capital — but it’s getting better. How so? It’s producing positive EVA momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half of 2011, Goodyear’s EVA momentum was 2%, based on first six months’ annualized 2010 revenue of $17.6 billion, and EVA that improved from first six months’ 2010 annualized -$822 million to first six months’ 2011 annualized -$385 million, using a 9% weighted average cost of capital.

Whether to invest in Goodyear is a difficult call. Based on past performance, it looks like this company is a financial mess. However, if future forecasts are accurate, the stock is trading at a huge discount to its value — giving investors a margin of error. Thanks to its track record of beating quarterly expectations, I’d give the edge to Goodyear’s bullish case.

Peter Cohan has no financial interest in the securities mentioned.


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