By Matt Robinson
and Sridhar Natarajan
Goodyear Tire & Rubber Co.’s speculative-grade credit ratings are poised to rise as the world’s third-largest tire company cuts pension costs and benefits from growing auto sales and falling rubber prices.
The 115-year-old company has decreased its pension obligations to $700 million, the lowest level in more than a decade, from $3.5 billion at the end of 2012. The highest U.S. new vehicle sales since before the financial crisis and the cheapest rubber prices in three years helped the Akron-based company post its best quarterly earnings since 2008 in the fourth quarter, propelling its bonds to return 1.5 percent since then, compared with 0.89 percent for its peers.
The improving balance sheet of the company that provided Henry Ford’s racing tires is driving analysts’ forecasts of positive free cash flow, money available to reinvest, rewarding shareholders with dividends and buybacks, and paying down debt, in 2015 for the first time in six years. The turnaround is moving Chief Executive Officer Richard Kramer closer to his target of investment-grade ratings, four steps above its current B1 status at Moody’s Investor’s Service and equivalent B+ from Standard & Poor’s.
“They’re absolutely headed for ratings upgrades,” said Hitin Anand, a New York-based analyst at debt-researcher CreditSights Inc., who has an “outperform” recommendation on the company’s debt. “Credit metrics will improve and they have a lot of room to clean up their capital structure.”
Goodyear has the most underrated debt of any automotive company in the Standard & Poor’s 500, according to Bloomberg financial data. The cash flow, debt and stock-market value of the largest U.S. tire maker indicate a 0.07 percent chance it will miss debt payments in the coming year. That level of default risk, which has fallen by more than half in the last year, is typically associated with companies rated investment grade.
“We demonstrated our ability to generate strong cash flow in 2013, which enabled us to fully fund the pension with cash,” said Tom Kaczynski, a Goodyear spokesman, in an email. The company is planning to expand operating income and “opportunistically addressing debt over time,” he said.
Suppliers are benefiting from an aging fleet of vehicles that require replacement parts. The average age of U.S. passenger automobiles increased to 11.4 years at the end of last year from 8.4 in 1995, according to R.L. Polk & Co.
Tire companies make more money selling to individuals than automakers, according to Kevin Tynan, senior automobile analyst at Bloomberg Industries.
“As people keep cars longer, you’re going to go through several cycles of tire replacement,” Tynan said. “That’s really where the margin is.”
Tire sellers have also received a boost from higher vehicle sales and increased miles traveled, according to the Rubber Manufacturers Association. The trade group said tire shipments in the U.S. are expected to have increased more than 4 percent last year after two years of little change.
Raw materials prices have dropped, reducing production costs at Goodyear by 13 percent in 2013, compared with the previous year, according to a Feb. 13 regulatory filing. Goodyear expects those expenses to fall even further in 2014.
By taking care of its pension obligations, which exceeded its market capitalization as recently as 2012, Goodyear is headed toward higher credit ratings, according to Evan Mann, a New York-based analyst with bond-research firm Gimme Credit LLC.
“This issue is now behind them and opens the door for potential upgrades,” he said. “When they are free-cash-flow positive, people will be very encouraged by it. That’s what everyone is looking for when you are talking about an upgrade.”
The company will report free cash flow of $263 million in 2015, turning positive for only the second time in a decade, according to analyst estimates compiled by Bloomberg.
Other data show that Goodyear had more than $1.6 billion in unused revolving credit lines and $3 billion of cash on hand, at the end of last year, which is considered as “good” liquidity by Moody’s.
Moody’s changed its outlook on the company’s credit rating to “positive” Feb. 14.