The year in review, plus the foreseeable future: Our favorite tire industry analyst weighs in on everything from Goodyear's turnaround (it's not complete) to domestic tire manufacturing's
The tire industry has changed dramatically since analyst Saul Ludwig first began writing for Modern Tire Dealer in April 1975. "Unit sales for radial passenger tires averaged out at 24% -- nearly one out of every four passenger tires sold!" he wrote in his first column.
More than 30 years later, radialization is no longer an issue in the consumer tire market. According to Ludwig, however, there are three major differences between 1975 and 2005 that will continue to impact the industry in the near future. They are:
1. an "unprecedented" surging of raw material costs.
2. size proliferation.
3. the encroachment on the North American market by low-cost Asian imports.
Those trends were among the events that affected the way tire dealers and their suppliers did business in 2005. Higher gasoline prices also had an effect. And remember the millions of tires that artificially entered the domestic market in 2000-2001 following the recalls by Bridgestone Firestone and Ford Motor Co.? Ludwig does.
Here are how all the events in 2005 tie together, courtesy of our annual interview with Ludwig, a managing director with the KeyBanc Capital Markets division of McDonald Investments Inc.
MTD: What were the U.S. replacement shipment highlights in 2005 vs. 2004 for passenger, light truck and medium truck tires?
Ludwig: Overall, I would say tire sales were somewhat better than expected in 2005. Replacement passenger tire shipments were surprisingly strong. Last January, I predicted passenger tire shipments would reach a record 201.5 million units; the final total was closer to 205 million. I'm surprised higher gas prices didn't have more of an effect. All those free Firestone tires in 2000 and 2001 and the tires needed for Ford's recall may have finally worn out, thus explaining the higher-than-expected demand.
Replacement light truck tire shipments were down. Maybe that's where high gasoline prices took their toll. I predicted a slight increase in shipments from 2004 to 2005. There was actually a slight decrease.
Replacement medium truck tire shipments came in very close to what I predicted, around 16 million units.
MTD: What were the U.S. original equipment shipment highlights in 2005 vs. 2004 for passenger, light truck and medium truck tires?
Ludwig: On the OE passenger tire side, incentives by car companies boosted tire sales higher than they otherwise might have been. I predicted a decrease of three million units, from 53 million to 50 million. In reality, shipments stayed about the same compared to 2004.
OE light truck tire shipments were down even more than predicted, from 7.4 million in 2004 to 6.8 million last year. Despite incentives, SUV sales were softer than forecast.
Again, truck tire shipments came in as predicted, around 6.2 million units, an increase of 10.7% over the previous year.
MTD: What are your predictions for the coming year for replacement and OE tire shipments in the U.S.?
Ludwig: In 2006 I predict only modest growth in replacement passenger tire shipments, to 206 million units. We are coming off a year when demand was unusually strong, and in my contact with dealers, they say their inventories are bloated. OE passenger tire shipments will be flat.
In the light truck segment, I expect replacement shipments to be flat as well, while OE shipments will be down slightly. Both replacement and OE medium truck tire shipments will be down, replacement shipments by 600,000 units.
MTD: Who gained and lost domestic market share in 2005 compared to 2004?
Ludwig: In general, the Asian companies were the winners while the domestic producers lost market share. Chinese imports were very strong. So were imports from Hankook and Kumho. Toyo and Pirelli also gained market share. Cooper Tire & Rubber Co., Michelin North America, Goodyear Tire & Rubber Co. and Continental Tire North America were the losers. Michelin's overall market share is down partially because it has cut back on its private brand business, although the Michelin brand has held steady.
In Goodyear's case, the Goodyear brand actually gained market share. But corporate-wide, the company's sales, particularly the Kelly and Dunlop brands, didn't keep pace with the industry's growth overall. Goodyear's replacement passenger, light truck and truck tire units were up almost 2%, while the industry was up about 3%.
I think Bridgestone Firestone remained very stable.
MTD: Goodyear pushed the Dunlop brand hard in 2005. Why didn't Dunlop grow?
Ludwig: Dunlop's programs were not as effective as expected. Dunlop is trying to sort out what its market focus should be, and I think Goodyear sees it as a sporty, BFGoodrich-type brand in terms of both replacement and OE fitments.
MTD: The catchphrase in the financial community when it comes to profitability appears to be "improved mix."
Ludwig: Everyone seems to be selling high performance and other higher margin tires. Even Cooper, with its Zeon line, is following suit.
In the last few years, new cars have come equipped with 17- and 18-inch tires more often, and those sizes are becoming a bigger part of the market. I think all the tire companies see this opportunity, and all in their own way are trying to target that sector.
MTD: For the second year in a row, there were multiple waves of tire price increases during the year. In 2004, you said you thought about half stuck. "The consumer price index is not up anywhere near as much as are the prices the manufacturers charge retailers. But the upcoming ones in early 2005 should stick fully," you said at the time. Did those early price increases stick fully? What about all the 2005 price increases?
Ludwig: In my opinion, about half of the three price hikes -- which, on "an announced basis," totaled about 10% -- stuck. The hikes of 5% to 8% that went into effect on Jan. 1, 2006, have a good chance of holding -- especially with Michelin weighing in with a large increase.
There was a lot of pricing action because raw material costs have gone up steeply. For example, the price of natural rubber at the beginning of the year was 62 cents. By the end of the year it was 77 cents a pound -- a 24% increase.
MTD: Goodyear's original three-year turnaround strategy has been completed. How would you grade the turnaround? How will Goodyear's debt and legacy costs affect the way it does business in the future?
Ludwig: I give Goodyear pretty high marks for achieving what it set out to do. For example, one of the company's goals was to increase operating margins to 6%, and that's what happened. It also became profitable again.
The aggregate results this year were close to expectations. Goodyear is expected to finish just shy of $20 billion in revenues for 2005, with North America responsible for $9.1 billion of that. However, the North American business unit did not come close to reaching its profit goals. Fortunately, international results sharply exceeded expectations.
The problem has been that Goodyear's margins in North America are under 2%. It's a combination of pricing, cost, mix and legacy costs, which are very, very high for Goodyear. The company has a large number of retirees relative to the number of people working for it.
Its legacy costs -- mainly pension obligations -- will require a very large cash infusion in 2006. But Goodyear is set financially to make it. Its debt, while carrying a high interest rate, has been refinanced successfully to extend maturities to 2010, thus eliminating any near-term liquidity concerns. If it sells its Engineered Products business, it will have additional cash to use to fortify its pension plan and, thus, lower its annual pension bill.
The upcoming labor negotiations (the current contract ends in July 2006) are critical to further lowering legacy costs and also operating costs here in North America. These negotiations could prove challenging.
Bottom line, I think Goodyear has to find ways to lower its costs more. That includes eliminating 8% to 12% of its high-cost manufacturing. It also needs to further streamline its product line and reduce the number of SKUs. Finally, it needs to contribute money to the pension fund to reduce its costs.
I think the management team, with Bob Keegan (chairman, CEO and president), Jon Rich (president of the North American Tire business unit) and Larry Mason (president of consumer tires in North America) realize the job ahead and are making progress. Unfortunately, the wheels of progress often grind slowly.
MTD: What are your thoughts on the status of North America's other tire manufacturers?
Ludwig: I'll take them one at a time. The good news for Bridgestone Firestone is that it settled its legal issues with Ford, maintained its market share, and moved into the black for the first time in years. Overall, the company had very satisfactory progress, but more work remains to move margins higher, probably through a combination of pricing and cost efficiencies.
Continental is doing a fantastic job globally, but is still struggling in North America with large losses. It has a weak dealer network, too much OE in its domestic mix, and plant costs that are too high. Will the Charlotte plant survive? It's questionable. Conti needs a strong leader in North America -- CEO and President Alan Hippe is running the passenger and light truck tire division on an interim basis -- but even with one, its challenges are significant.
Cooper suffered through a disastrous year in 2005. It reported a loss for the first time we can ever remember. Operational problems were compounded by a 30-day strike. Dealer relations frayed in the wake of disappointing fill rates. Cooper probably lost one-and-a-half market share points in 2005.
CEO Tom Dattilo is now challenged to restore credibility with both customers and Wall Street. With five separate deals now in place with Chinese companies, Cooper is making a dash to ensure low-cost supply to augment its high-cost U.S. facilities.
Pirelli is small but highly successful in the U.S. It continues to make great strides with terrific products and share gains, and is profitable. And President Guy Mannino remains very popular.
Michelin is the "gotta have" but "don't like" product, according to the dealers we speak with. It is a great name among consumers, but many dealers try all they can to sell another brand. Nevertheless, I think Michelin is making better margins in North America than either Goodyear or Cooper, and it focuses on long-term strategies in setting its marketing agenda. The company has significantly reduced its exposure to private brands in each of the last two years.
Toyo Tire & Rubber Co.'s domestic subsidiary gained share again in 2005. It's a small player, but I think it will sell between seven and eight million tires this year. Toyo's new factory here in the U.S. demonstrates its commitment to this market. And dealers all like Carlos Kibata, Toyo's gregarious president here in North America.
Titan International Chairman and CEO Morry Taylor had an exciting year in 2005. He oversaw Titan's excellent results, enjoyed a huge gain in its stock price, acquired Goodyear's farm tire business and even talked of another acquisition. But the farm economy may not be so friendly in 2006, so Titan can't get complacent in the wake of a very good 2005.
MTD: Are there any other brands that you think are having an impact on the marketplace?
Ludwig: Hankook and Kumho have made great strides. Each experienced a 10% to 15% growth in volume last year. Hankook made great strides at Ford as well. The Chinese brands are less well-known to the American consumer right now, but for sure, they are making a difference in terms of the market. Passenger, light truck and medium truck tire imports from China into the U.S. probably topped 25 million in 2005, up more than 50% compared to 2004.
MTD: Monro Muffler Brake has become a major retail player in the U.S. What are your thoughts on Monro's announced plans to continue expanding? Can Monro become and remain one of the top players in the country?
Ludwig: This company has certainly put its toe into tire retailing, but it is still a small regional player doing very well at where it has chosen to operate. I do not expect Monro to become a national player in tire retailing the way, say, TBC is. Instead, I think it will continue to make smaller acquisitions. I wouldn't be surprised if the owners eventually sell the company, a la TBC.
MTD: Now that you mention it, how does the purchase of TBC Corp. by Sumitomo Corp. of America (SCOA) affect the landscape of the tire industry in the short-term? Long-term?
Ludwig: For now, TBC and Treadways Corp. (also a subsidiary of SCOA) will be managed separately, and I do not believe that the tire retailing landscape will be changed as a result of this acquisition. SCOA realizes that tire wholesaling is a "no growth" business and that the future will be in the retail segment.
I look for TBC to resume its acquisition activities soon. TBC CEO Larry Day and his key executives have equity positions in the company, and as active managers within TBC they will only maximize their personal wealth by being successful in growing the TBC enterprise.
I think eventually, SCOA will have to tie the entities together in some way.
MTD: Retailing seems to be trending away from the mall format. Can Sears Auto Centers continue to survive without off-the-mall stores?
Ludwig: Yes, going to the mall for tires is a declining trend. Sears will continue to be challenged with the mall format, in my opinion. Wal-Mart and similar retailers have free-standing units, and that is the trend in tire retailing.
MTD: Are there any other influences -- or potential influences -- that are impacting or will impact the tire industry in the near future?
Ludwig: It is noteworthy that there were so many purchases of tire distributors last year -- American Tire Distributors, Hercules, TBC, even a big chunk of The Tire Rack. There is a lot of private equity capital chasing distribution, something that hadn't happened previously. Tire distribution is a fairly stable business. It is attracting buyers, and sellers have been able to get a pretty good price for their companies.
There are not that many companies left to purchase, but I would expect more acquisitions, both at the wholesale and retail levels.
The union negotiations also will impact the tire industry. Unions generally are being threatened with surging imports and movement of U.S. production to low-cost countries. It's unfortunate that this is happening, but it's hard to come up with policies to reduce the inertia that is underway.
So the challenge in America is to reduce labor costs per unit, not necessarily labor costs. The absence of legacy costs in Asia and South America give them an advantage. Manufacturers need to produce more tires with the same amount of people because of rising raw material costs. The union and management need to work together to come up with programs that make U.S. products more competitively priced than they are today.
MTD: Thanks, Saul.