Analyzing the global tire industry: Saul Ludwig has a ‘big picture’ mentality, which makes him less likely to overreact when talking about companies like Goodyear

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Analyzing the global tire industry: Saul Ludwig has a ‘big picture’ mentality, which makes him less likely to overreact when talking about companies like Goodyear

Financial analysts are a highly focused breed. Their expertise usually is limited to one or two industries, but that gives them uncanny, targeted insight into specific companies. Saul Ludwig is just such an analyst. He has been covering the domestic tire and chemical industries for decades; to him, monitoring raw material costs or deciphering quarterly reports is a way of life. So is studying the global marketplace, which gives him a better understanding of what’s going on in the United States.

That attitude makes him the top analyst in his chosen fields.

Ludwig is a managing partner with McDonald Investments Inc. in Cleveland, Ohio. He has been writing about the tire marketplace for Modern Tire Dealer since 1975. But he has been an integral part of our January Facts Issue since 1973, when he began his annual review of the tire industry. This year is no different, whether he’s discussing 2004 shipments (they will be “significantly higher” than in 2003) or Goodyear’s financial troubles (“bankruptcy is not a near-term risk”).

MTD: What were the U.S. replacement shipment highlights in 2003 vs. 2002 for passenger, light truck and medium truck tires?

Ludwig: At the consumer replacement level, shipments were up slightly, thanks to a strong year-end push. I estimate 193 million passenger tire units were shipped in 2003, compared to 190.4 million in 2002. That’s a 1.3% increase. At the start of the year, I estimated a slight drop to 190 million units.

Light truck tire units were down about 1.4%, from 33.6 million units in 2002 to 33.1 million units.

Medium truck tire shipments were up almost 3%, from 14.4 million units in 2002 to 14.8 million units.

MTD: How about original equipment shipment comparisons?

Ludwig: At OE, both passenger and light truck tire shipments were down. I estimate 54.2 million passenger and eight million light truck tires were shipped last year. Medium truck tire shipments were up almost 8%, from 3.8 million units in 2002 to 4.1 million last year.

MTD: What are your predictions for the coming year for replacement and OE passenger, light truck and medium truck tires?

Ludwig: At the replacement level, I predict shipments will come in significantly higher in all three categories. Passenger tire shipments will be close to 199 million units in 2004, while light truck units will reach the 34 million mark. I estimate there will be 15.4 million medium truck tires shipped this year.

At OE, both passenger and light truck tire shipments will be up vs. 2003, although I don’t expect them to reach 2002 totals. OE medium truck tire shipments will total 4.3 million units.

MTD: Who gained and lost domestic market share in 2003?

Ludwig: With respect to the replacement market, imports were the big winner -- the imports from China, Korea, Taiwan and Indonesia. I also think Bridgestone/Firestone gained market share. I think the losers in market share were Goodyear and, to a lesser extent, Michelin. I think companies like Cooper and Continental probably held fairly stable.

On the OE front, I think the big winners were Continental, Hankook, Michelin and Pirelli, and the losers at OE were Goodyear and Bridgestone/Firestone. Goodyear is certainly dropping OE market share as part of its profitability strategy, while Bridgestone/Firestone is winding down its business with Ford and is not trying to lose market share. I think Michelin gained at the OE end, picking up business lost by Bridgestone/Firestone at Ford. So did Continental.

In the medium truck tire segment, I think Michelin gained significant share on the replacement side, but at OE truck they lost market share in 2003.

MTD: There were two waves of tire price increases last year. Have they held?

Ludwig: I would say about half of those have held, but typically all announced price increases do not stick. In all cases the companies experienced margin degradation in 2003 vs. 2002 because of the pressure of raw material costs, which were not fully offset by price increases. So the price increases were needed, as are the new round of announced increases.

MTD: You also analyze the chemical industry. How are chemical companies faring in relation to tire companies? Does one industry’s performance directly affect the other’s, and, if so, how?

Ludwig: I think the chemical industry is more totally influenced by the general economy than is the tire industry. Tire demand is less sensitive to economic fluctuations.

The chemical industry started off the first half of the year very, very soft, then picked up steam and ended the year very strong. Overall, most U.S. chemical companies were profitable, whereas most of the North American tire manufacturing operations probably lost money.

Michelin and Cooper made money in North America, but Goodyear, Continental, Bridgestone/Firestone and Pirelli all probably lost money in North America in 2003. On balance, the chemical industry, while not having a stellar year, did better than the tire industry.

The chemical industry sells a lot of chemicals to tire manufacturers. Even the chemical companies were not able to totally offset their costs last year, so there was a price squeeze that took place in the chemical industry and a price squeeze that took place in the tire industry.

MTD: Goodyear’s financial status was a hot topic in 2003. With one year of its three-year turnaround strategy completed, is Goodyear on course? What does present management have to do to get back to profitability?

Ludwig: I recently downgraded my rating on Goodyear to “underweight,” which is an indication that the odds of turning the operations around have been diminished. I think in North America they are clearly behind schedule. In the rest of the world, they’re probably on target and doing as well if not better than expected. (Editor’s note: On January 21, Ludwig upgraded Goodyear’s stock from “underweight” to “hold.” See January 22 item.)

The biggest disappointment at Goodyear has been a continued loss of market share over the last few years, excluding the temporary windfall business they had in 2001 with Ford as part of the Firestone recall. So the challenge for Goodyear’s leaders is to regain market share, which will enable them to run their plants at a higher level of efficiency and, of course, gain profits.

Goodyear also has lost market share at OE, but I believe its strategy there has been to improve profitability -- or shall I say reduce the losses -- of its OE business. And I think the company has made progress in reducing those losses.

However, in the long-term is it wise to give up this OE market share, given that there is some propensity to replace OE tires with the same brand? That is the question.

Goodyear is trying to reposition its OE business to have the right brand on the right car. For some cars, the Goodyear brand is the appropriate brand. On other cars, Dunlop might be appropriate, and for the first time ever, you’re going to see Kelly brand tires on some OE cars. Kelly will be on vehicles that are targeted to the Kelly buyer.

MTD: Is bankruptcy still a possibility for Goodyear?

Ludwig: Goodyear has no risk financially of having to declare bankruptcy for well over a year. Its bank lines are adequate until April 2005, and it has more than $1 billion in cash in the bank today. So bankruptcy is not a near-term risk by virtue of financial insolvency.

The labor contract that Goodyear signed gives the company certain concessions. Management closed the Huntsville plant, and laid off 1,200 additional workers in the fourth quarter. These moves will give Goodyear well over $100 million in savings and should pave the way toward profitable operations in the North American tire business in 2004.

Now, from an operational standpoint, Goodyear has to begin reporting profitable operations, because they can’t continue to borrow forever. If Goodyear doesn’t generate cash and make money, lenders will feel uncomfortable.

It’s critical that Goodyear executes its turnaround plan and show progress because if it doesn’t, a year from now the company may find it difficult or costly to refinance debt. Then the issue of bankruptcy would loom larger on the horizon. But at this point, I don’t believe bankruptcy is in the cards for Goodyear.

MTD: Your thoughts on the status of the following North American tire manufacturers, starting with Bridgestone/Firestone North American Tire LLC.

Ludwig: Bridgestone/Firestone is making good progress, but its U.S. wholesale operations -- the core business of selling consumer tires to its dealers -- are still losing money, in my opinion. The company does very little private brand business, it does very little mass merchandiser business. Its business is primarily to dealers. But that business is still working hard to get into the black. Remember, the company did have a big drop in the Firestone business during the recall, and it is still crawling back from that event.

But Bridgestone/Firestone’s company-owned retail stores, which are run through a different division, business in South America and its non-tire businesses are doing very well.

This company, unlike some others, has not instituted major cost-slashing programs. It is investing in productivity and manufacturing efficiency and in its dealer organization. And it is trying to increase its share of its dealers’ business. Overall, Bridgestone/Firestone is making very good progress, which is remarkable given the situation it was faced with in 2000.

MTD: Pirelli Tire North America.

Ludwig: Pirelli is making very good progress in North America. It’s losing money, but that’s called investment spending. The new MIRS plant in Georgia is making tires, and the new plant in Brazil is exporting tires to the U.S. Pirelli successfully gained good fitments at Ford as it has worked its way into being an OE supplier.

I think Pirelli’s management, led by Guy Mannino with the support of Francesco Gori, is executing its North American strategy. It will still be a couple more years before Pirelli turns into the black.

MTD: Continental Tire North America Inc.

Ludwig: Continental is losing money in North America and aggressively moving to meet its goal of being profitable in North America by the fourth quarter of 2005. To do this, the company has dramatically reduced its production of tires in Mayfield, Ky. -– a high-cost plant -- and moved that production to low-cost operations in Mexico. I personally would not be surprised to see some further trimming in Mayfield and additions to Mexico.

Continental, which re-opened negotiations with the United Steelworkers of America (USWA), has not yet completed negotiations toward an amended union contract. It is having a hard time trying to point out the need for concessions to return the business to profitable operations.

Martin de Louw, the new CEO and president, is focused and driven. He has a clear vision of how he’s going to make the operation profitable. I think the interesting thing about that strategy is the aggressiveness Continental has shown at OE, where it’s going to have a 20% to 30% increase in business in 2004 vs. 2003. The company hopes this increased exposure at OE will allow it to leverage more business with its dealers and distributors in North America.

Conti also has a very weak dealer organization, and it needs to fortify that. I think de Louw has recognized that and is working at rebuilding and strengthening the dealer network.

MTD: Cooper Tire & Rubber Co.

Ludwig: Cooper is really on a roll. It has a lot of new business coming on in 2004, some four to five million additional units that represents growth of about 10% in volume. Its new high performance tires are receiving good reviews, and while not talked about a lot, the acquisition of Mickey Thompson is fortifying Cooper’s presence in the racing and high performance sectors in the market.

The deal with Kenda Rubber, which, first, will supply Cooper with additional tires in 2004 and, second, will lead to construction on a new joint venture tire plant, is a clear part of the company’s strategy to drive costs lower and be competitive in all segments of the tire market.

I’m very optimistic about Cooper’s progress, and it should have a terrific year in 2004.

MTD: Michelin.

Ludwig: As the creme de la creme product in the market, Michelin’s going to be a strong force for the long term. It operates at the high end. I think the softening economy that we had in early 2003 resulted in consumers changing their preference to lower cost tires, and that’s not an area where Michelin is strong. I think that had something to do with its modest loss of market share in North America in 2003, but from an operational standpoint the company is very strong.

Michelin does not have a lot of direct dealers. It has major positions with mass merchandisers and large distributors. But the brand is just so strong, Michelin is going to continue to be a major force to be reckoned with for years to come.

MTD: Care to voice an opinion on any other brands that you think are having an impact on the marketplace?

Ludwig: Of the Japanese companies, more dealers have told me how pleased they are with Toyo. They think Toyo Tire (U.S.A.) Corp. President Carlos Kibata is doing a terrific job of servicing their needs.

Toyo seems to be making very good inroads into the North American market. I’m not sure how profitable this has been for Toyo, particularly as we have a very weak dollar in comparison to the yen, but from a standpoint of servicing the customers and satisfying them, Toyo rates very high.

MTD: Titan International Inc.

Ludwig: I would describe Titan as long on expectations, short on results. But one thing looking better for Titan is that the farm economy in America has really picked up dramatically. Farm prices are up, farmers are making more money than they have in years, and this means they are going to invest more in product and expansion. Titan, being an important player in serving the farm market, should participate in this improvement and economy.

As a company, Titan has lost money for a number of years, and it has leveraged its balance sheet. Its long-term future is uncertain.

MTD: TBC has more than doubled its stock price in the last year. Are the company’s financial results as good as they appear? Can we expect further growth?

Ludwig: We put out an initial recommendation to buy TBC stock about a year ago at $12 a share. It’s now up in the high $20s. That recommendation was based on TBC not only having a successful year in 2003 but also in 2004. TBC has the financial wherewithal to leverage its success into even greater success in the years to come.

TBC’s acquisitions of Mueller Tire in 2002, Merchant’s in 2003 and NTB as 2003 came to a close are all working well. This gives TBC greater buying power and more operating leverage.

Taking all of its market share together, the company now represents more than 10% of the total U.S. tire market, making TBC the largest single buyer of tires in the country. I would expect TBC to rev up its acquisition activity late in 2004 once the NTB acquisition is fully integrated and assimilated into TBC’s internal systems.

MTD: How would you describe the state of the tire retail segment? The wholesale segment?

Ludwig: I think tire dealers had a pretty good year in 2003, particularly in the second half of the year. By then the hard fighting in Iraq had come to an end, the economy began to improve and gasoline prices actually receded. Also, the free tires that were given away in 2000-2001 were beginning to come up for replacement. So all of these factors increased the demand for tires. Well-run tire dealerships should have done very well in 2003.

Wholesaling was a mixed bag. I’ve long felt that tire wholesaling is in a secular decline because as retail consolidation occurs, more and more tires will be purchased directly from manufacturers and less through wholesalers. While there’s no good data on this, my sense in talking with wholesalers, retailers and manufacturers is that my beliefs are materializing. Overall, wholesalers did not grow as fast as the industry in 2003 and I think that will be the case next year as well.

MTD: Are there any other influences -- or potential influences -– that are impacting or will impact the tire industry in the near future?

Ludwig: I think the influx of low-cost imports is something that we can’t ignore. They are not going away. Plant expansions in Asia, Russia and Eastern Europe are going to create more supply from abroad, which is going to exacerbate capacity in the United States. I think all the manufacturers who have plants in the U.S. have to be fully cognizant of this and must adjust capacity accordingly.

I think consolidation at the retail level will continue, and I think there will be some new entrants into tire retailing in the U.S. in 2004. One possibility could be Sumitomo Rubber, which has announced its intention to open 400 retail stores in China. This signals its interest in tire retailing, even though to date it doesn’t have any presence in the United States.

The contract between Goodyear and the USWA will have an impact on the union’s negotiations with other tire manufacturers. Goodyear did get some significant concessions and cost benefits that will help the company over the next couple years. On the other hand, it had to give up certain flexibilities in terms of limitations on the number of tires it can import and the number of staff cuts it can make at union plants. Goodyear also has less freedom to close plants than it had in the past.

I think most of the companies don’t like the Goodyear union agreement, and that’s why you haven’t seen any settlements with Michelin, Bridgestone/Firestone or Continental. Cooper’s Findlay plant also is negotiating with the union.

Strikes are no good for anybody, and I think tire manufacturers ultimately will come to a resolution with the union.

Unfortunately, unless Congress imposes tariffs or other trade barriers, more tires are going to come in from low-cost countries, and it will become increasingly difficult for U.S. plants to compete at the low-end of the market. Eventually, the foreign plants will begin to produce the high-end, more challenging products. So I don’t see this import problem going away anytime soon, especially if we don’t see a re-evaluation of currencies in the Asian countries vs. the U.S. dollar.

MTD: Thanks, Saul.
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