An Indirect Way To Play The Automarket

Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The economic recovery is under way across the US and China is also starting to recover.

I believe one of the best ways to play the recovery is through the demand for new cars which is already starting to pick up. However, in my opinion the auto stocks such as Ford and GM are too risky, with much more cyclical exposure than I would like. The alternative to auto manufactures is tire producers.

According to Google trends Internet searches for cars tires have remained relatively stable over the past 10 years – indicating there is a recurring market for the tires.

 

Although not a definitive method of research this does provide some indication of the demand out there. 

It is not only the improving auto market that sparks my interest in tire producers - the price of rubber is currently at lows not since 2009.

Most of the tire producers have to buy in the rubber they make their tires from, as a result lower rubber prices lead to higher margins for the tire manufacturers. 

 

The price of rubber is falling; leading to higher margins for the tire producers.

Despite falling rubber prices and constant demand, I believe the biggest market for tire producers is the auto market. With auto sales currently on the rise I believe the tire manufactures now have the perfect blend of both low input costs and rising demand to outperform the market over the next few years.

But Where To Invest?

Well, the tire maker with the most history and global exposure is:

Compagnie Generale des Etablissements Michelin SCA

Which is a mouthful, however, the company is more commonly known as Michelin. (NASDAQOTH: MGDDF) Although the company is listed in the US it has almost non-existent volume and is only really traded in Euros in Milan

Michelin produces tires for every conceivable reason you would produce tires and even NASA's moon rover is decked out with a pair. The company also produces the well know road maps and travel guides. Despite the fact the company is not really traded in the US, it could be one of the best investments.

Michelin is trading on a forward P/E of 7.8, around the same as the sector average, has a ROE of 20%, and one of the highest net profit margins in the group, 8%. This net profit and the company's reputation have allowed it to produce the 2nd largest EPS growth in the group over the past 5 years of 17%.

The rest of the major tire producers I have ranked in order of age:

Date Founded

  • Michelin -1888
  • Goodyear – 1898
  • Cooper – 1913
  • Bridgestone – 1931

The Goodyear Tire & Rubber Company (NASDAQ: GT)

The second oldest company in the quartet is Goodyear, another well-known brand. However, the company has been the worst performer over the past 5 years. Goodyear's EPS have fallen -14% over the past 5 years. This could in part be down to the tiny profit margin the group generates, which is roughly 2% net profit on revenue - the smallest in the group. The company has produced a 23% return on shareholder equity over the past year; and due to its falling earnings, it has the lowest valuation in the group -trading on only 6 time forward earnings. 

Cooper Tire & Rubber Company (NYSE: CTB)

Cooper Tire & Rubber is by far the fastest growing company in the group. Earnings per share have grown 42% over the past five years - despite high rubber prices and slow global demand. The company produces the highest return on shareholder equity in the group. ROE was 57% in the last year, presumably leading to the high EPS growth through reinvestment. Along with Michelin, the company also produces the highest net profit margin of 8% and is also valued on the same grounds -- trading on a forward earnings multiple of 8.4.

Bridgestone Corp (NASDQOTH: BRDCY)

The final and youngest company is Japanese based Bridgestone. The company is also the most expensive in the group on a forward P/E of 13.4. Despite this high premium, the company only managed a 9% ROE in the past year, which is the groups lowest, and a lowly 4% net profit margin. 5-yr EPS have grown, but only just 4% - less than 1% per year!

 Financial Ratios

Company

Forward P/E

ROE

Net Profit Margin

5-yr EPS growth rate

Goodyear

6

23%

2%

-14%

Cooper Tyre and Rubber

8.4

57%

8%

42%

Bridgestone

13.4

9%

4%

4%

Michelin

7.9

20%

8%

17%

What About Future Growth?

I have already mentioned the falling price of rubber, but how much is this forecast to effect these companies?

Predicted EPS Growth

Company

2013 predicted EPS

growth

Goodyear

€2.3

39%

Cooper Tyre and Rubber

$3.1

1.6%

Bridgestone

¥258

27.8%

Michelin

$9.2

9.5%

Goodyear is forecast to be the most effected as earnings are forecast to grow nearly 40% next year! This shows the earnings multiple paced on the company is seriously undervaluing its potential. Bridgestone is forecast to grow EPS just under 30% justifying its high forward earnings multiple. Michelin has the majority of its operations in Europe so its earnings growth is not expected to be as spectacular as the rest. Lastly there is Cooper, who appears to be taking a break after its explosive growth over the past 5 years with growth this year predicted to be only 1.6%.

Finally

Tire manufacturers have underperformed the market in the past few years due to soaring prices of rubber and low demand. However, with rubber prices falling and demand coming back into the market they could be the perfect stocks to play both the auto and global economic recoveries.

And If You Don't Fancy Tires...

One of the best stocks to own here apart from the auto producers such as GM and Ford is CarMax (NYSE: KMX) - a retailer of used and new cars in the US. The company should benefit significantly from the increasing turnover of autos as the market picks up and financing becomes easier to get hold of. 

CarMax has really been struggling over the past few years but the stock has recently headed skywards as the recovery gets underway. Indeed, the stock is up over 40% since mid-2012. CarMax is currently trading on a TTM P/E of 21 forecast to fall to 18 next year on rising EPS. EPS are forecast to grow at 10% next year beating the average of 3% a year for the past 5 years. In-fact EPS have grown 15% in the last quarter alone!

Brokers have recently turned bullish on CarMax upping the average price target to $40.3 a share from the low $30's. 

A decent play on a sector that is slowing coming back to life.


RupertHargreav has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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