Citigroup is out with a bullish U.S. Autos & Auto Parts (47 pg.) call. In the call they are upgrading Goodyear Tire & Rubber (NYSE:GT) to Buy from Hold with a $17 (up from $14) target noting the name could have 90% upside to low $20’s.
Proprietary Vehicle Density Survey — Citi’s latest density survey (which forecasts future plans amongst 2,100 respondents) showed solid improvement from their August survey, revealing a 1.9% forecasted 2-year density erosion— consistent with a 13-15 million SAAR outlook. More so, firm’s survey yielded strong indications of existing pent-up demand suggesting that a stronger macro outcome could conceivably push SAAR to a 14-16mln range.
– Goodyear Tire & Rubber Co (GT): Upgrade to Buy: Out of Favor, But Momentum Could Build in 2011
Citigroup is upgrading Goodyear Tire shares to Buy from Hold, raising the target to $17 from $14 (5x ‘12E EBITDA) and raising the risk rating to Speculative from High in recognition of the unique volatility in Goodyear’s business model and this stock call. Following significant underperformance in the shares over the past 12-months, they believe the risk/reward may be poised to tilt favorably in 2011, as the stock appears washed out and out of favor.
Framing Risk/Reward – Though the Goodyear story has suffered one set back after another (unabsorbed overhead, rubber, Venezuela), the long-term earnings power of the company hasn’t changed much. In a year that should see a continued recovery in global volume, improving mix (aftermarket and commercial) and further cost savings, Goodyear’s future earnings power may receive a second look from the market. To be sure, Citi still thinks 2011 street estimates need to come down (rubber re-pricing), but the resetting of expectations should be priced-into the stock and may actually prove refreshing to the market. At a normalized $2 billion of EBITDA and 5.0x multiple, upside to a low-$20s (90%) can be justified, a proposition that’s hard to find in autos after a stellar 2010. Downside risks at a $1.5 billion EBITDA level look to be in around $10 (17%). Liquidity remains in good shape with ample runway through 2013, in their view.
Recent Management Meetings More Positive – After recently visiting management, Citi notes they walked away with added comfort on a number of issues :
1) Management continues to believe that the spike in rubber prices is not indicative of a structural supply/demand issue;
2) Management remains confident that pricing should continue to catch up with raw material inflation, and the dealer body experienced a strong 2010;
3) Future tire labeling regulations could become a catalyst towards improving Goodyear’s value proposition;
4) At a normalized $2 billion EBITDA, Goodyear could generate $0.6 billion of free cash flow before growth capital expenditures (the returns of which would be additive to EBITDA) and pension funding in excess of expense ($0.2 billion).
A 10x multiple of $0.4 billion FCF (incl. pension) would support Citi’s $17 target. They believe that confusion over Goodyear’s somewhat complex reporting has contributed to the poor share price, but also believe that corrective action on the part of management could go a long way to helping investors frame the earnings power story.
Notablecalls: For several reasons, GT looks like a winner.
– The upgrade is going to catch a lot of people by surprise as the sentiment in the sector has been on the pessimistic side.
– This thing hasn’t seen a decent upward rating change in a while. Merrill upgraded the name with a puny 12.50 price target back on Dec 9 2010, causing a 11-12% move on the day. For objectivity’s sake, a Japanese competitor did announce raising tire prices that same morning.
– Needless to say, GT has lagged the Auto Parts space and now Citi is flashing a +ve low $20’s scenario (90% upside) in front of investors starving for opportunities like this. That’s how they generate attention.
I’m thinking this one could trade closer to $13 level today. Use the pull-backs for entry.
UPDATE (09:07 AM ET): After another look, I think this one could trade over $13 level, possibly toward $13.50 or thereabouts.
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