Demand for tires is growing
Whether vehicles have internal combustion, are electric, or have hybrid technology embedded, they need tires. In addition to covering and protecting the rim of the wheel, the tire ensures grip on the road, dampens vibrations and drains the shocks perceived by the driver.
The automotive sector continues to experience issues with its supply chain, and the rise in the price of the raw materials could impact the production of tires. While these two factors have lowered the supply outlook, economists still expect the tire market to grow remarkably in terms of demand in the future thanks to the following three reasons:
- In emerging economies, the middle-income class keeps on growing. Therefore more people will be able to afford cars, driving the demand for tires to a higher level.
- In addition, tire companies are moving more of their production to low-income countries where labor is cheaper, which will keep production costs at a lower level.
- The replacement tire industry, one of the most thriving sectors on the market, will be a strong contributor to demand as operators continue to achieve high margins.
In July 2021, French market research firm ReportLinker estimated that the global tire market should grow at a compound annual growth rate (CAGR) of about 4.5% to nearly 3 billion units by 2027. Globally, tire producers made 2.1 billion units in 2020.
The Bridgestone opportunity
The publicly traded companies operating in the global tire industry are many. Investors interested in these stocks should, in my view, prefer multinationals with a significant portion of total output in emerging countries, as they will benefit the most from emerging economies and lower labor and materials costs.
Bridgestone Corporation (BRDCY, Financial) matches these criteria. This Japanese global manufacturer of tires for cars, motorcycles, scooters, public transport, heavy vehicles and aircraft has a strong presence in emerging economies. Of the total tire production, accounting for 1.45 million tons for the entirety of 2020, 35% to 40% were made for China, Russia and other countries in the Asia-Pacific, Middle East and Africa regions. The company also has operations in Japan, the United States and Europe.
Due to the Covid-19 crisis, total revenue and adjusted operating profit margin were both lower in 2020 compared to the year before. Total revenue was 3 trillion Japanese Yen (about $29 billion), down 14.6% year over year, and the adjusted operating profit margin was 7.4%, down 240 basis points year over year.
However, in the third quarter of 2021, these results improved as the progress of the mass vaccination campaign allowed governments to ease many of the Covid-19 measures that were previously affecting Bridgestone's operations.
In fact, the total revenue of ¥833 billion the company earned in the third quarter of 2021 increased 5% from the third quarter of 2020, while the adjusted operating profit margin of 12.2% increased by 340 basis points.
Despite negative free cash flow due to relevant spending on investing activities, Bridgestone's financial position appears much more solid and less dependent on debt. Shareholders' equity to total assets stood at 58.3% on Sept. 30, compared to 51.8% the year before. In addition, the interest coverage ratio of 16.94 means Bridgestone has no problem paying the interest charges on its outstanding debt.
The company aims to become more resilient to headwinds that may arise globally and to increase the profitability of its operations. To do this, the company has prepared a medium-term business plan in which it has precisely defined its next strategy, which mainly consists of achieving growth through diversification to implement across its portfolio.
In two years’ time, Bridgestone targets revenue at no less than ¥3.3 trillion (up 10% from 2020), and an adjusted operating profit ratio of 13% or above (up 550 basis points from 2020).
If this happens, the improvement will provide a strong foundation for additional dividend increases after last year's 11.5% hike. The willingness to give out more cash to shareholders usually leads the market to pay more attention to the stock.
Valuation
On Sept. 16, Bridgestone paid a semi-annual dividend of $0.385 (up 41% from prior distribution), determining a forward dividend of $0.77 and an annual yield of 3.56% as of the writing of this article.
The share price was $21.66 as of Dec. 22 for a market cap of $30.50 billion and a 52-week range of $15.94 to $24.90.
When compared to the 50-day moving average value of $21.83 and to the 200-day moving average value of $22.00, the current market valuation does not seem overly expensive. On Wall Street, the stock has a hold recommendation rating and an average target price of $23.76 per share. The 14-day relative strength index of 53 points to a stock that is neither oversold nor overbought.
