Why this tire manufacturer could be an 'under-the-radar' EV play

Published Sun, Feb 27 20228:21 AM EST

The next big electric vehicle play could be a century-old tiremaker. Electric vehicle tires are a growth engine for Ohio-based Goodyear Tire & Rubber Company, according to management and Wall Street analysts. Goodyear estimates revenue for each EV tire is 30% higher than a traditional tire. "Value plays which directly benefit from vehicle electrification are actually pretty rare to come about," said Deutsche Bank analyst Emmanuel Rosner. With Goodyear shares down more than 37% from their highs after nearly doubling in 2021, investors have a buying opportunity for the stock with what Rosner calls an "under-the-radar electric vehicle advantage." 'Many different tiers of tires' EV tires are more complex than their traditional counterpart, which could translate to higher profitability per unit. "The average consumer and investor do not really realize that there are many different tiers of tires," Rosner said. Electric vehicles are heavier, have more torque and rely more on braking — all of which increase strain on the tire. Plus, EV engines are quieter than internal combustion engines, so the tires have to be quieter, too. "The challenge for us, of course, is to make sure that we bring some of that 30% top line to the bottom line," CFO Darren Wells said on Goodyear's Feb. 11 earnings call. "We feel like we've got the opportunity in front of us and we're going to be working to try to improve the margins there." Wells in a recent investor meeting said "electric vehicle tires are going to be the next seed that helps us continue in that direction" toward double-digit profit margins. Goodyear is currently winning EV tire contracts at a higher rate than traditional tires. Fewer tiremakers have the capabilities to product EV tires, which limits supply. That should allow Goodyear to pick up market share and flex pricing power. "It's a very, very favorable supply-demand type of environment," Rosner said. "It has the potential to be not just a profitable shift, but one that could last many years." An opportunity for differentiation In Goodyear's latest earnings report, the company projected breakeven free cash flow in the current quarter as it looks to increase capital expenditures by $1.3 billion to $1.4 billion. In part, that investment will go toward building out its EV tire production capacities. "We feel like electric vehicle transition gives us another opportunity to differentiate products and to design features that are going to be very important to electric vehicle owners," Wells said on the latest earnings call. "We feel good about the investments that we're talking about making and the higher CapEx program that we're looking at." Despite Goodyear's better-than-expected fourth-quarter earnings, investors reacted adversely to the FCF guidance. The stock fell sharply after the report and is down 25% in February. "Overall, the sell-off strikes us as an overreaction," JPMorgan's Ryan Brinkman said in a Feb. 14 upgrade of Goodyear. JPMorgan sees "several compelling trends in the tire industry from which GT stands to benefit," including "structurally higher demand for higher technology tires" like those for EVs. The "sell-off provides favorable entry point" for Goodyear, Argus' David Coleman said in a Feb. 14 note maintaining a buy rating on the stock. Plus, the pullback gives Goodyear a favorable valuation, according to Hennessy Funds' Neil Hennessy. Hennessy Cornerstone Mid Cap 30, a quantitatively managed fund, owns Goodyear. "If you just look at the pure numbers, you're talking from a price-to-sales standpoint, you're buying a dollar of revenue for 20 cents," Hennessy said. Further, if the electric vehicle transition takes longer or is smaller than expected, Goodyear's fundamentals and solid earnings growth have not changed, Deutsche Bank's Rosner said. "The reason we think Goodyear is somewhat unique is that there's no downside on the other side," Rosner said. —CNBC's Michael Bloom contributed to this report.

Tires are stacked in front of a Goodyear auto service location in South San Francisco, California, U.S., on Wednesday, July 22, 2020.

David Paul Morris | Bloomberg | Getty Images

The next big electric vehicle play could be a century-old tiremaker.

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