Goodyear Valuation Final

Valuation Project BAFI 403 12/08/2007
Johannes Albrecht Ryan Arlia Jim Reese Siddharth Sharma Peter Zale
WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation
Executive Summary
Goodyear Tire and Rubber Company has gone through great change in the last ten years, barely skirting bankruptcy as it dealt with recession, labor difficulties and changing demand in the tire market. Avoiding default by mere days, it has rebounded to become a buy in most analysts portfolios. Goodyear began its transformation by realizing the growth market for tires was moving away from the commodity-based low margin tires it had featured to higher margin differentiated tires for targeted markets. The strategy requires Goodyear be less leveraged and more equity financed as the risk of selling differentiated tires is greater than that of cheaper commodity tires. Goodyears excessive level of debt could not allow for any more risk. Goodyear is changing from being a highly leveraged high dividend producing company to being a no to low dividend growth company, featuring differentiated tires given value by Goodyears superior R&D capability and its worldwide brand equity. Based on our assessment of Goodyears current financial and market structure, have set a price target of $40 for Goodyears common stock.
Summary Slide
Company Background Executive Summary Industry Information Goodyear Positioning Goodyear Strategy Competitive Analysis Financial Analysis Cash Flow Analysis Valuation Analysis 3 Economic Scenarios and Assumptions Best Estimates Appendix
WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation 3
Company Background
The Goodyear Tire and Rubber Company was founded in 1898 by F. A. Seiberling in Akron, OH. Goodyear specializes in the design, manufacture and distribution of tires for automotive and industrial applications. They operate 60 plants in 26 countries for distribution to 185 countries around the globe. Revenues are generated through five operating units based on geographic regions North America, Latin America, European Union, Asia Pacific, and Eastern Europe (which includes the Middle East and Africa). Goodyear had 2006 revenues of $20.3 billion on the sale of 215 million tire units. In 2007, Goodyear sold off its Engineered Products division, which accounted for approximately $1.5 billion in sales for 2006
Industry Information
The tire industry sells through two basic channels: Original Equipment auto manufacturers (OE) Replacement The original equipment market has traditionally been an outlet where manufacturers could sell many units of guaranteed business while minimizing SKUs. In addition, the fitments on popular vehicles would result in replacement sets of the same brand when the originals wore out. Today, with the popularity of leases and higher vehicle turnover, this logic no longer holds true. The OE business is still a good source of high volume but most fitments are either provided at a financial loss or a very small margin. The replacement market has become a much more profitable segment for tire makers. The popularity of large diameter aftermarket wheels has created a sweet spot in the industry for manufacturers who can produce large bead diameter tires margins on these units can be well over $100 per tire.
Goodyear Positioning
In 2003 Goodyear was on the brink of bankruptcy. They were overloaded with debt and suffering from years of mis-management. In 1998 Goodyear had net income of nearly $700 million, by 2002, they were loosing nearly $1 billion per year. Goodyear had sought a growth strategy that involved acquiring businesses to grow market share. Many smaller tire companies were purchased around the globe. This strategy culminated in the purchase of 75% of Dunlop Tires from SRI in 1999 for $125 billion. All of this consolidation activity put Goodyear deep in debt. The weak economy that followed combined with Goodyears failure to capitalize on the newly acquired brands lead to a string of financial losses for the years 2001-2003. Goodyear is now in the 4th year of their turnaround plan. Much attention has been put on improvement in leadership, products, quality, cost and finances. Steady improvement has been achieved and the Goodyear management team believes that they have turned the corner and are gaining momentum towards profitability.
Goodyear Strategy
Goodyear has stated the following strategies to achieve their long and short term goals:
Improved Product Mix De-leveraging of the firm Cost Saving
Goodyear Strategy
Improved Product Mix
Revitalize brand image and position brands for greater market differentiation Goodyear, Dunlop, and Kelly brands Focus development on premium branded products Recent activity includes launches of highly successful ICON products including Assurance, Wrangler, Fortera, and Eagle products Reduce unit volume on value-line tires that have low profitability Exited 8 million units of private brand tires in 2006 Invest in capacity for larger rim diameter tires
Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com

Goodyear Strategy
Cost Saving
Continuous improvement/USWA union contract Footprint reduction Asia sourcing SAG reduction VEBA Insurance Deal
Gross Anticipated Savings: $1.8 - $2.0 Billion Over 4 Years

Goodyear Strategy
De-leveraging/Improved Balance Sheet
Reduce long term debt*
2006 sold Farm Business Unit 2007 sold Engineered Products Unit ($1.4 billion) 2007 equity offering ($833 million)
*Reduced LT debt from $7.2B in Dec 06 to $5.0B in Sept. 07

Competitive and Financial Analyses
Competitive Analysis
Business Analysis
In the first part of this section, current industry conditions as well as historical developments in the industry are described in order to establish a qualitative framework for the subsequent financial analysis.
Industry Analysis
The following Porter analysis provides insights into each major tire industry players profit potential within the industry, given each firms intentions to compete and their specific aims to exploit synergies across the range of businesses in which they operate.
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5 forces Analysis
The above table shows that each of the major tire companies faces pretty much the same competitive landscape and industry pressures. Also the table shows that, from a Porter perspective, the tire industry is relatively unattractive with three areas scoring High. Raw material suppliers can exercise high pressure on the prices for their input materials in tire manufacturing due to strong competition in a rather commoditized market. Buyers can exercise high power which keeps prices low. Threat of substitutes is low which is favorable for the existing players. Threat of new entry is low since new entrants are rather not attracted due to the commodity nature of the environment. Also initial costs of entry (creating a manufacturing capability) are high. However, new competition is seen in growing markets such as China, which already has impacted the threat of the new entrants-pressure structure. That said, each of the major players differentiates itself from its competitors in unique ways relating to diversification (Continental), footprint (Bridgestone), premium brand (Michelin) and overall reputation and reputation for new product development (Goodyear).
SWOT Analysis
Competitor Analysis: Goodyear (USA), Michelin (FR), Bridgestone (JP), Continental Tire (GE). In the SWOT analysis we begin to see some of the differentiation occurring between the major players in the tire industry. We also see the similar threats faced more or less by all of them.
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Market, Segment and Products
Over the last ten years, Goodyear, Bridgestone, Michelin and Continental have all faced challenges presented by rising raw material costs and a global excess in manufacturing capacity. Petroleum, steel, and natural rubber are the primary materials used in tires and prices rose greatly over the last few years. Stagnating markets in North America and the European Union, along with the expansion of manufacturing capacities in Asia means that more tires can be made than can be sold.
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Market, Segment and Products (Cont.)
To counteract these conditions, each company has adopted a different strategy and focused on different segments. Until 2003 Goodyear focused its strategy on high volume, low value tires while it grew its top line. Michelin focused on high end-premium tires and followed a strict branding hierarchy. Continental is a much more diversified company (a good % of its business being in automobile electronics) and deals in both high and low end tires. Bridgestone focused on a rounded product portfolio and leveraged its vertical integration; mainly its large stake in rubber raw material production.
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Market, Segment and Products (Cont.)
Currently, Goodyear is well positioned for future success. The brand is strong and well positioned in the market. Its perceived as a quality brand with a good pipeline of new products. It is widely recognizable around the world and is consistently voted as one of the top and most admired companies. Recent product introductions followed by industry accolades are helping Goodyear move towards a higher margin product mix and are driving top line growth. This growth, coupled with aggressive cost cutting measures and landmark labor agreements have set the stage for financial success moving forward.
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Competitor Analysis: Michelin

PROFITABILITY Return On Assets Return On Invested Capital Cost of Goods Sold To Sales Gross Profit Margin Operating Profit Margin ASSET UTILIZATION RATIOS Assets Turnover Inventory Turnover LEVERAGE Total Debt Pct Common Equity Equity Pct Total Capital Total Debt Pct Total Assets Common Equity Pct Total Assets Total Capital Pct Total Assets Dividend Payout LIQUIDITY Quick Ratio Current Ratio Inventories Days Held 12/31/2006 4.61 7.61 65.81 28.88 8.03 12/31/2006 1.03 3.28 12/31/2006 104.62 62.09 30.83 29.47 47.47 33.74 12/31/2006 0.78 1.35 111.16 12/31/2005 6.91 11.68 64.35 30.5 8.75 12/31/2005 1 3.3 12/31/2005 105.05 58.18 30.27 28.82 49.53 20.39 12/31/2005 0.89 1.49 110.66 12/31/2004 3.94 6.65 66.5 28.19 4.8 12/31/2004 0.97 3.71 12/31/2004 106.02 60.95 30.17 28.46 46.69 25.88 12/31/2004 0.9 1.65 98.44 12/31/2003 2.69 4.57 67.47 25.01 1.49 12/31/2003 0.95 3.68 12/31/2003 120.61 56.55 32.26 26.74 47.3 41.16 12/31/2003 0.96 1.72 99.08 12/31/2002 4.24 7.3 66.75 27.35 4.72 12/31/2002 0.96 3.39 12/31/2002 117.25 57.09 30.9 26.35 46.16 19.53 12/31/2002 0.92 1.78 107.69
WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation BAFI 403 Goodyear Tire &Rubber Company Valuation
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Competitor Analysis: Bridgestone

PROFITABILITY Return On Assets Return On Invested Capital Cost of Goods Sold To Sales Gross Profit M argin Operating Profit M argin AS S ET UTILIZATION Assets Turnover Inventory Turnover LEVERAGE Total Debt Pct Common Equity Equity Pct Total Capital Total Debt Pct Total Assets Common Equity Pct Total Assets Total Capital Pct Total Assets Dividend Payout LIQUIDITY Quick Ratio Current Ratio Inventories Days Held 12/31/2006 3.65 5.43 62.81 32.33 6.38 12/31/2006 1.03 3.7 12/31/2006 59.78 73.72 24.39 40.8 55.35 23.86 12/31/2006 0.76 1.48 98.54 12/31/2005 7.98 12.05 60.96 34.3 7.95 12/31/2005 1.05 3.91 12/31/2005 51.37 74.5 22.54 43.88 58.9 9.28 12/31/2005 0.84 1.54 93.26 12/31/2004 5.56 8.52 59.48 35.91 8.18 12/31/2004 1.07 3.98 12/31/2004 51.29 73.32 21.33 41.58 56.71 11.58 12/31/2004 0.98 1.67 91.79 12/31/2003 4.59 7.04 58.75 36.72 7.96 12/31/2003 1.08 4.02 12/31/2003 54.87 67.07 22.83 41.6 62.03 15.21 12/31/2003 1.22 2.06 90.86 12/31/2002 2.45 3.57 57.93 36.76 8.18 12/31/2002 1.11 3.91 12/31/2002 59.07 70.84 23.19 39.26 55.42 30.33 12/31/2002 0.94 1.68 93.3
WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation BAFI 403 Goodyear Tire &Rubber Company Valuation
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Financial Analysis
This section assesses Goodyears current and past performance as well as its expected future financial prospects. First, the product market performance is considered using ratio-analysis. Second, cash-flow analysis is used to determine the firms liquidity and financial flexibility and discusses business risk.
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Financial Analysis
Goodyear 10 year historical strategy & performance
The years from 1997 to 2007 can be divided off into two sections to tell an effective story about Goodyear. 2001-2002 should be considered the turning point for the company. At this point, the previous strategic direction the firm had adopted nearly put them into bankruptcy. This was avoided by days and now the firm is on what should be considered a sounder footing and direction.
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Financial Analysis
Goodyear 10 year historical strategy & performance
The new President and CEO Robert J. Keegan took over the office at Goodyear in 2002 and announced the future begins now with a solid turnaround strategy of restoring profitability and growth for the troubled company. The period from 1997-2002 was dominated by a more commodity based sales strategy, as Goodyear strove to grow its market share selling OE and private branded value tires to please its shareholders with average dividend payouts of 30% of cash flow provided by operating activities. The companys stock grew impressively during this time reaching a height of $75 per share. Likewise during this time Goodyear leveraged itself quite aggressively. In fact, we noticed that there was very possibly a strategy being employed by the shareholders to, in effect, milk the company as its increased leverage led to an escalating stock price and returns for shareholders.
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Financial Analysis
Goodyear 10 year historical strategy & performance (Cont.)
In 2000, when the stock market fell, the company began a slide towards financial distress. In 2002, enforced by a non-cash charge of $1.2 billion in tax provisions, the firm reported a net loss of $1.22 billion. The troubles culminated in the firm facing bankruptcy in early 2003 when it issued $1.3 billion long-term debt securities. The company however was supported by its continued strong R&D capability, focus on innovation, leadership, and brand building which allowed it to launch several successful new products just at the right time to help it skirt the most severe financial troubles and buoy it for restructuring which continues to the present.
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Financial Analysis
The focus in 2004 and 2005 was on higher margin products and increased market and customer focus which successfully drove sales. In 2006, Goodyear announced that it would exit about half of its private branded value-line business, reducing it by approximately 8 MM units. Also, it has begun outsourcing some of the remaining value-line production to Chinese suppliers. This strategy allowed Goodyear to close down high cost plants in North America and lower the costs associated with producing low margin products. The strategy involves some risk however as the manufacturers sourcing the product are outfitted to produce higher value added products (the various sized tires spoken of earlier). These suppliers could be tempted to leave the partnership with Goodyear if another suitor, more closely aligned with their best capabilities, approached them for tire supply.
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Financial Analysis
In addition to product mix, Goodyear also is expanding capacity in Asia and Eastern Europe to serve those growing markets. Investment in its own facilities in countries like China presents a risk in that the Chinese government cannot be completely trusted to not nationalize foreign industry. Similar threats have been carried out in Venezuela. We dont consider this a high or even medium threat presently, but the regime in China is such that we cannot completely dismiss this possibility, particularly with the nations extraordinarily rapid growth and what could well be concomitant social, economic and environmental turbulence.
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Financial Analysis
In 2007, Goodyear extended an equity offering of 23 million shares of common stock, earning the company about $850 million. This is being put towards refitting its manufacturing capability so that it may address the changing needs of the tire market which now requires a wide variety of different sized tires (13-22) for various standard cars and light and heavy trucks. Also Goodyear is interested in the growing airline tire market. Also, Goodyear recently sold its Engineered Products Division for roughly $1.4 billion and used the money to restructure its debt.
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Financial Analysis
10-year overview of net sales, gross profit and net income
Net Sales 25,000.00
Gross Profit
Net Income
20,000.00
15,000.00
10,000.00
5,000.00
0.00
-5,000.00 Figure 1: Profitability
12/31/06
12/31/05
12/31/04
12/31/03
12/31/02
12/31/01
12/31/00
12/31/99
12/31/98
12/31/97
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Financial Analysis
The margins
It is interesting to observe that between 2003 and 2006, sales increased about 30% from $15 billion to $20 billion dollars per year indicating that the turnaround efforts were gaining momentum from a sales volume perspective. At the same time though gross-profit declined which indicates that Goodyears ability to turn sales dollars into profits was impaired. This stems from increasingly more expensive raw materials such as rubber, oil, and steel. The price for natural rubber had doubled during 2006 and remains at high level. According to the 2006 annual report, overall a 17% increase in all raw materials was pressuring on Goodyears margins. In addition, Goodyear appears to have had difficulties passing along price increases through sales to customers, which could be related to strong competition in a rather commoditized product market, where low cost is an important driver of overall performance.
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Financial Analysis
Current Profitability and comparison with Competition
Goodyear vs. Michelin Looking at Michelins asset management, Michelin consistently reports a lower Inventory Turnover Ratio than Goodyear due to maintaining higher levels of inventory. Goodyear is also performing better in regards to managing its accounts receivable, beating out Michelin by 30 days in 2006 in its Accounts Receivable Days Ratio. This of course reflects Goodyears value tire strategy of greater sales of less expensive tires. One might almost consider this a Wal-mart like strategy of beating the competition with quicker turnover leading to faster sales, smaller inventory and handling costs and buyer power with suppliers from whom you can possibly command smaller charges because you are paying them faster and thus lessening their own need to finance. Goodyear also maintains higher liquidity ratios than its competitor Michelin.
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Financial Analysis
Current Profitability and comparison with Competition (Cont.)
Goodyear vs. Michelin In the past four years, Goodyear has kept its Quick Ratio above a 1.0, whereas Michelin has failed reach this level of liquidity in the past five. Decision makers should also note that Michelins liquidity level has been on the decline year after year, while Goodyear has shown improved liquidity over the same given time frame. Overall Goodyear is showing good working capital management along with a stable cash flow position as illustrated in Figure 5. Turning to profitability performance, Michelin seems to be operating more efficiently in relation to Goodyear, reporting a higher Operating Profit Margin for the past three years. Michelins ROA and Gross Profit Margin have also been higher than Goodyears in the past five years. Goodyears poor profitability performance seems to be attributable to the companys higher costs directly related to costs of goods sold as seen in Figure 3.
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Financial Analysis
Bridgestone Analysis Bridgestones Inventory Ratio falls just short of Goodyears figures every year for the past five years. Bridgestones Asset Turnover ratio has decreased every year for the past five years. On the other hand, Bridgestones asset management earns high marks for gradually reducing its Accounts Receivable Days Ratio 14% over the last five years. However, this ratio still does not compare to the low levels of Goodyears receivables.
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Financial Analysis
Taking a look at Bridgestones financial management ratios, one can see significant decreases in company liquidity. Bridgestones Current Ratio declines every year for the past four years for a combined 28% drop, while Bridgestones Quick Ratio declines every year for the past four years as well for a combined 38% drop. Despite these apparent changes in company liquidity, there is little need for concern as the current level of these ratios remains relatively safe. Approaching 2006, Bridgestone, and the entire tire industry, appear to be slowly losing profit margins. However, Bridgestone has still managed to consistently produce higher Gross Profit Margins and Operating Profit Margins than Goodyear over the past five years. The resulting depressed profitability figures for Goodyear resonates in the companys high cost of goods sold (see Figure 3).
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Financial Analysis
Gross-Profit Margin Comparison
Gross-Profit Margin
40.00
35.00
30.00
25.00
20.00
15.00
10.00
5.00
0.00 12/31/06 12/31/05 12/31/04 Year Goodyear Tire & Rubber Company Bridgestone Corporation Michelin 12/31/03 12/31/02
Figure 2: Gross-Profit Margin comparison
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Financial Analysis
Operating Profit Margin Comparison
Operating Profit Margin
10.00 9.00 8.00 7.00 6.00
5.00 4.00 3.00 2.00 1.00 0.00 12/31/06 12/31/05 12/31/04 12/31/03 Michelin 12/31/02
Goodyear Tire & Rubber Company
Bridgestone Corporation
Figure 3: Operating Profit Margi
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Financial Analysis
Net Profit Margin Comparison
Net Profit Margin
8.00
6.00
4.00
2.00
0.00
12/31/06 -2.00
12/31/05
12/31/04
12/31/03
12/31/02
-4.00
-6.00
-8.00
-10.00 Goodyear Tire & Rubber Company Bridgestone Corporation Michelin
Figure 4: Net Profit Margin
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Financial Analysis
The overall lower operating profit margin of Goodyear compared to Bridgestone could indicate that the firm pursued a differentiation strategy which requires overall higher SG&A costs, more R&D, more frequent new product introductions, high-end products, branding activities, support and full service activities. However, the overall lower gross-margins contradict the differentiation strategy and suggest rather a low-cost approach.
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Financial Analysis
Michelin has been able to improve its operating management between 2003 and 2005 significantly and outperformed both Goodyear as well as Bridgestone in 2005 and 2006. What business activities cause Goodyear to under perform at the operating margin? Goodyears strategy through the 1990s focused on high-volume, value-line tires with small margins. Michelin has focused on the premium, high-margin segment. As raw material prices have increased, the margins on the value-line products have been reduced by a higher percentage. This has resulted in much lower operating margin for Goodyear when compared to Michelin and even Bridgestone. Goodyears strategy moving forward is to focus on reducing their share of the value-line business and increasing their share of the premium, high-margin business. They are also aggressively pursuing cost reductions in materials, manufacturing and other operations. These strategies should help Goodyear command more dollars per tire in price and reduce the cost per tire to manufacture. The coupling of these strategies will result in higher operating margins and more flexibility to compete for shelf space with competitors.
Cash Flow Analysis

Cash Flows
Despite a 300 million loss in 2006, Goodyear was able to generate positive cash flow from operating activities during the year. Overall, the firm has had positive cash flow from operating activities throughout all ten years with exception of 2003. Cash flows from operating activities appear to be quite volatile though. Significant investments in property plant and equipment have been made in 1999 and 1998 and at a smaller scale continuously throughout the remaining years. Three major financing events occurred. In 1999, the firm increased borrowings by $1.4 billion. In 2003 it added $1.4 billion in debt. In 2006, the firm issued $1.7 billion debt.
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Cash Flow Analysis

Cash Flows
As discussed earlier the 2003 debt issuance had to do with the turnaround and refinancing activities in the face of distress. The fact, that the company yet again issued significant portion of debt in 2006, indicates that it still faces significant difficulties. The 2006 annual report discloses that Goodyear has sold off several non-core businesses and continuous with this divestment strategy. Change in cash has been positive and increasing; the strongest peak being in 2006, when the firm was able to increase cash by 80% compared to the beginning of the year. Net income and net cash from operations are moving closely together, particularly in the last 3 years. This indicates no unusual events for Goodyears accounting policies or practices. The Cash flow from operations to sales ratio declined in 2006 to 30% which indicates that the firm struggles increasingly to translate sales dollars into cash compared to 2005 and 2004, when 40% of sales manifested in cash flow from operations.
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Cash Flow Analysis

Cash Flows
Cash Flows
2,000.00
1,500.00
1,000.00
500.00
0.00 12/31/06 -500.00 12/31/05 12/31/04 12/31/03 12/31/02 12/31/01 12/31/00 12/31/99 12/31/98 12/31/97
-1,000.00
-1,500.00
-2,000.00 Cash Flow Provided By Operating Activity Cash Flow Provide By Financing Activity Cash Flow Provided By Investing Activity Net Change in Cash or Equivalents
Figure 5: Cash Flows
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Cash Flow Analysis

Income and CFO
1,500.00
1,000.00
500.00
0.00 12/31/06 -500.00 12/31/05 12/31/04 12/31/03 12/31/02 12/31/01 12/31/00 12/31/99 12/31/98 12/31/97
-1,000.00
-1,500.00 Net Income(Loss) Net Cash Provision (Used) By Operations
Figure 6: Income and CFO
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Cash Flow Analysis

Future prospects, growth potential, and business risk for Goodyear
Goodyears results of operations, financial position and liquidity could be adversely affected in future periods by loss of market share or lower demand in the replacement market or the OE industry, which would result in lower levels of plant utilization and an increase in unit costs. Also, the firm could experience higher raw material and energy costs in future periods. These costs, if incurred, may not be recoverable due to pricing pressures present in todays highly competitive market and Goodyear may not be able to continue improving its product mix. Future results of operations are also dependent on the firms ability to successfully implement cost reduction programs and address increasing competition from low-cost manufacturers.
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Cash Flow Analysis

Future prospects, growth potential, and business risk for Goodyear (Cont.)
With this, the major drivers of ROE are strongly limited as asset turnover is expected to remain stable or otherwise decrease if demand slows down and utilization decreases, profit margins will be crucial. However, the firm has had as discussed earlier much lower margins than its competitors Michelin and Bridgestone and will struggle with these due to environmental cost conditions pertaining to raw materials and consumer unwillingness and inability to pay premium prices. The currently extreme high leverage most likely must be reduced in the future and recent equity offerings confirm this trend, which in return will impact ROE negatively. The overall growth rate is expected to align with averages in the US due to the effect of mean reverting. Industry structure and competitive environment will also constitute limitations to ROE. As a matter of fact, Goodyear has achieved high ROEs solely due to financial leverage and as this must decline in the future, ROE is expected to be lower.
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Cash Flow Analysis

Key Data
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Cash Flow Analysis

Comparing Goodyear to its competitors in a couple of key margins provides insight into the future business risk which must be considered highest among the three compared companies. The key drivers of ROE indicate various strategies toward return generation. While Goodyear shows low margins compared to the competitors, it has higher asset turnover. In an environment with dominating market share and stable demand for products, this position of Goodyear might be sustainable. However, industry structure and future expected developments as described, indicate that weak margins cannot be compensated which results in an overall low return on assets for Goodyear versus Bridgestone and Michelin.
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Cash Flow Analysis

The other key driver for ROE is financial leverage and it is obvious that Goodyear, in contrast to its competitors, is pursuing a different financial policy with a highly levered balance sheet. This can result in excessive shareholder returns during stable business environments, however, in unstable environments it can pose a major business risk. The high beta for Goodyear of 2.6 indicates that investors internalize these circumstances as they reflect a higher volatility of stock prices compared to the market. Bridgestone has the lowest beta of 0.9 followed by Michelin with beta of 1.59, and 1.78 for the industry benchmark.
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Valuation Analysis
Purpose
Based on preceding
Business and Industry Analysis of Goodyear Historical and Financial Analysis Competitor Comparison in the industry Future economic prospect for the firm and the industry
Conducting Valuation Analysis of Goodyear Rubber & Tire Over a 10 year time frame With the goal to determine ultimately the best estimate of current stock price per share Based on 3 economic scenarios
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Methodology for Valuation (DCF-Analysis) Using the Discounted Cash Flow Valuation Technique
Forecast essential financial statements
Income Statement Balance Sheet Cash Flows
Based on
Percentage of Sales method
And Assumptions about

Operational future performance of the firm Expected capital structure policy changes Expected cost of capital 3 General economic scenarios
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Objectives
Establish best estimate of Present Value:
Of the Firm
The Value of the Firm is obtained by discounting expected cash-flows to the firm Cash flow to firm: the residual cash-flows after meeting all operating expenses and taxes, but prior to debt payments and without the benefit of tax-shelter Discount rate: weighted average cost of capital (WACC)
Of Common Equity
The Value of Equity is obtained by discounting expected cash-flows to equity Cash flow to equity: the residual cash-flows after meeting expensed, meeting all tax obligations and interest and principal payments Discount rate: rate of required return by equity investors (CAPM)
Determine stock-price per share
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Variable Forecasting Control Parameters

Incremental Sales Growth Rate for each year Gross-Profit Margin
Indicating the companys ability to charge premium prices Lowering their costs of goods sold
Operating-Profit Margin
Operational efficiencies and ability to manage firm effectively
Total Asset-Turnover
Proxy for the ability of the firm to utilize assets and their infrastructure. The need for further investment in property, plant and equipment
Debt / Equity
How much leverage will the firm use in the future? What capital structure policy changes might influence the return of the firm?
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Variable Forecasting Control Parameters (cont.) Current Ratio

Coverage of short term liabilities with cash and equivalents
The Cost of Debt

Depending on economic scenario, inflation, company bond rating
The After Tax Cost of Debt The Cost of Equity

Depending on risk premium, beta for the firm, and country risk premium
Beta for the Firm

Based on historical movement of Goodyears stock vs. market
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Fixed Firm-Specific Parameters

The corporate tax rate for Goodyear assumed to be 35% Depreciation on PPE assumed to be 53%
Estimated using historic average percentage of PPE
Depreciation Expense per fiscal year assumed to be 4%

Estimated using historic average percentage of Sales
Current Liabilities portion assumed to be 24%

Approximated using historic average of Sales
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Fixed External Parameters

Based on Financial-Market Research Risk Free Rate assumed to be 4.5%
Computed based on 10 year average (1997-2007) of 10 Year Government T-Bonds
Expected Market Return assumed to be 8.3%

Historical arithmetic average of S&P 500 since 1928 (80 years).
Market Risk Premium assumed to be 3.8%

20-year arithmetic Average
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3 Economic Scenarios and Assumptions
Recession:
Sales are going to decrease Margins are decreasing due to price pressure Leverage going up due to need for borrowing to cover liquidity issues having low cf Beta estimated to be high due to bond grading, due to leverage, due to risk Cost of debt is high at 9% Cost of equity is about 15%
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Recession:
The market and economy are stagnate or in recession. GT struggles to grow sales revenue but maintains levels based on execution of their product mix and cost cutting strategy. Low margins result in the inability to de-leverage any further but the bad economy keeps interest rates low. The soft economy keeps raw material cost increases lower than in previous years. GT profit margin is flat via management execution of strategic plan. The cyclical nature of markets see improvements by 2011
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Recession (cont.)
Cost of Equity = 15.9% (including 2% country related risk) WACC for the 10 years forecasting period (to 2017)
Beta 2.47
RECESSION
2007 Value of Equity
5,386
Stock Price $ 25.51
Value of Firm
12,629
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Flat:
Sales increase initially a little due to positive effect of product mix and restructuring But then remain stable without much growth Decline slightly at the bottom of the period and will slight come back Margins decline slightly as the effect of products towards higher margin products do not materialize fully Leverage will remain lower as the strategy and policy changes manifest Yet borrowing will become necessary again mid of period in order to support lacking revenue streams Beta of 1.7 as rating improves due to restructuring then stable due to un-levered balance sheet Then increasing to 1.9 mid term to reflect the new borrowings
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Flat
The market and economy are estimated to be relatively flat. GT maintains a low growth in sales revenue based on execution of their product mix strategy. The soft economy keeps raw material cost increases lower than in previous years. GT profit margin increases slowly via management execution of strategic plan
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Flat (cont.)
Cost of Equity = 13% (including 2% country related risk) WACC for the 10 years forecasting period (to 2017)
Beta 1.7
FLAT
7,762
Stock Price $ 36.76
Value of Firm
18,002
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Boom
20 B to 28 B B Net Sales is a reasonable assumption based on
History steady increase rate in sales Increased prices due to higher raw materials higher margins Product mix and strategy objectives fully materializing Larger customer base Emerging markets, more infrastructure More international business Approaching competitor margins due to high margin products Un-levering the firm pays off and debt to equity is improved Mid term new expansion and borrowings in order to benefit taxshelter again and increase ROE Cost of debt decreases as bond rating will improve Beta at the 10-years historic price fluctuations
62
Boom
The market and economy continue to grow. GT increases sales revenue based on execution of their product mix strategy and strong global presence. The growing economy sees raw material costs continue to increase but they are offset by price increases and product mix. GT profit margin increases rapidly via management execution of strategic plan
63
Boom (cont.)
Cost of Equity = 12% (including 2% country related risk) WACC for the 10 years forecasting period (to 2017)
Beta 1.45
BOOM
14,249
Stock Price $ 67.48
Value of Firm
41,377
64
3 Sales Revenue Projections

Sales Revenue Forecast
30,000.00
28,000.00
26,000.00
24,000.00
$ MM
22,000.00
20,000.00
18,000.00
16,000.00
14,000.00 2007 2008 2009 2010 2011 2012 Time Boom Flat Recession 2013 2014 2015 2016 2017
65
3 Different Stock Prices

Future Economic Outlook 10 years
RECESSION FLAT BOOM
2007
2007
2007
Value of Equity
Value of Equity
Value of Equity
5,386
7,762
14,249
Stock Price
Stock Price
Stock Price
25.51
36.76
67.48
Value of Firm
Value of Firm
Value of Firm
12,629
18,002
41,377
66
Best Estimate based on Probability

Best Estimate
Probabilities Boom = 20% Flat = 50% Recession = 30%
2007
Value of Equity
8,346
Stock Price
40
Value of Firm
21,065
67
Best Estimates
Conclusion
Goodyear Tire and Rubber Company is well positioned to grow in profitability in the next ten years in either a boom, flat or bust scenario. This is because Goodyear has taken steps to align its corporate strategy with the changing competitive landscape for its products and has adjusted its financial strategy to fit this direction. Goodyear is changing from being essentially a highly leveraged mass low margin cheaper tire seller paying high dividends to shareholders to a more equity financed higher margin targeted seller of quality, differentiated tires. They will grow with this strategy because there is potential in the high margin differentiated market in the otherwise flat North American and European markets which comprise 75% of Goodyears sales. Goodyear can capture the growth in this market by leveraging both its brand and its superior R&D capability. Goodyear is supplementing this with a lower risk maintenance of low margin tire selling to emerging markets in Eastern Europe, Asia and Latin America. Odds are these markets will grow to become enamored of Goodyears higher margin tires over time. While there are risks due to increasing costs of raw materials and ever increasing competition from rivals, we feel Goodyear is a good buy for investors looking for a stable growth stock paying less dividends in the next ten years.
Appendix
Country Risk
To estimate country risk, find country rating (www.moody.com) and estimate default spread for rating over a default free government bond rate.
Basis: Traded country bonds. This becomes the added risk for the country and is added to historical risk premium for a mature equity market (U.S.) to get total risk premium. Multiply default spread by relative equity market volatility (STD DEV. in country equity market/STD DEV. in country bond.) Emerging market average = 1.5 (emerging equity markets approx. 1.5 X more volatile than bond markets.) Estimate of country Risk Premium. Add this to U.S. Historical Risk Premium of 3.8 to get the total risk premium.
70
Country Risk
Making Lambdas
Company has exposure to country risk different from exposure to all other market risk. Call this Lambda and, like Beta, scale around 1 (>1 = greater country risk; <1 = less country risk) The cost of equity for a firm in this market is written as: Expected Return = Rf + Beta (Mature Market Risk) + (County Risk)
71
Country Risk
Lambdas
Companys risk exposure to country risk reflects revenues it derives from the country. Goodyear can have exposure to country risk because it has revenues from and production facilities within these markets. Estimate Lambdas by revenues. A company getting a smaller % of its revenues from a market should be less exposed to country risk than one with a larger %. To get Lambda, scale % of revenue company gets from a country, dividing it by % of revenues all companies in the market get from the country, i.e. its local GDP. For example: Goodyear did approximately 0.018 (1.8%) of its business in Brazil compared to .92 (92%) for the average company (8% of Brazils GDP was in exports and 92% local), so we measure Lambda as 0.018 / 0.92 = 0.02 and we multiply this by the country risk premium (0.0486) 4.86% which is the difference between the mature equity risk premium of 0.038 (3.8%) and country premium of 0.0866 (8.66%). 0.0486 x .02 = 0.00097 and this is then added to the cost of capital. The process is repeated for each country Goodyear does business in that has risk beyond the mature market equity premium.
72
Country Risk for Goodyear

Estimate % business done in each country out of approx. $18.5 billion in net revenues. N.America: $10 billion: US: 6 billion = 30% Canada: 2 billion = 10% Mexico: 2 billion = 10% European Union: $5 billion in sales Average across 7 countries $.71 billion EA = 24.5% (3.5% EA) Eastern Europe, Mideast, Africa: $1.6 billion Average across all 3 countries $.53 billion EA = 7.2% (2.6% EA) Latin America: $1.8 billion Average across all 5 countries $.36 billion EA = 9% (1.8% EA) Asia Pacific: $1.6 billion Average across all 11 countries $.145 billion EA = 8% (.72% EA.)
73
Country Risk
(2.1%)
74

Goodyear Valuation Final

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Valuation Project BAFI 403 12/08/2007

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com

Gross Anticipated Savings: $1.8 - $2.0 Billion Over 4 Years

Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com

*Reduced LT debt from $7.2B in Dec 06 to $5.0B in Sept. 07

Source: Goodyear 3Q2007 Earnings Presentation, Goodyear.com

Competitive and Financial Analyses

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Competitor Analysis: Michelin

Competitor Analysis: Bridgestone

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Net Sales 25,000.00

-5,000.00 Figure 1: Profitability

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Figure 2: Gross-Profit Margin comparison

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Goodyear Tire & Rubber Company

Figure 3: Operating Profit Margi

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

-10.00 Goodyear Tire & Rubber Company Bridgestone Corporation Michelin

Figure 4: Net Profit Margin

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis

Figure 5: Cash Flows

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis

-1,500.00 Net Income(Loss) Net Cash Provision (Used) By Operations

Figure 6: Income and CFO

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis

WSOM BAFI 403 Goodyear Tire & Rubber Company Valuation

Cash Flow Analysis