cooper tires - texas tech...
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Cooper Tires
Equity Valuation & Analysis
Valued at 7 January, 2007
Corporate Raider® Analysts:
Jason Cannaday: [email protected] Melody Hoglan: [email protected]
Marc Orgass: [email protected] Andrew Payton: [email protected]
Cynthia Ramirez: [email protected]
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COOPER TIRE Table of Contents Executive Summary……………………………..3-7 Company Overview………………………………7 Five Forces Model………………………………..7-12 Key Success Factors…………………………….13-15 Competitive Advantage Analysis……………15-18 Key Accounting Policies……………………….19-25 Ratio Screening Analysis……………………..25-33 Financial Ratio Analysis……………………….34-52 Forecast Financial Statements………………53-63 Valuation Analysis………………………………64-69 Intrinsic Valuation Models……………………69-73 Altman’s Z Score…………………………………73 Valuation Conclusion…………………………..74 References………………………………………..75 Appendices……………………………………….76-80
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Executive Summary Investment Recommendation: Undervalued, Buy 4/1/07
CTB - NYSE $19.10 EPS Forecast
52 Week Range $7.71-$20.00 FYE 4/1 2006 (A)
2007 (E)
2008 (E)
2009 (E)
Revenue (2006) $2,676,242,000 EPS (1.28)
(0.24) 0.42 1.20
Market Capitalization $1.22 Bil Shares Outstanding 61,396,135,000 Ratio Comparison CTB GT Dividend Yield 2.10% Trailing P/E n/a n/a 3 month average trading volume 1,158,660 Forward P/E n/a n/a Percent Institutional Ownership 91.40% M/B 1.19 1.95 Book Value Per Share @ 12/31/06 - $10.27 ROE - N/A (loss in 2006) Valuation Estimates ROA - N/A (loss in 2006) Actual Price (4/1/07) $19.10 Est. 5 year EPS Growth Rate - 1544% Ratio Based Valuations P/E Trailing n/a Cost of Capital Est. P/E Forward n/a Ke Estimated * 9.40% Enterprise Value n/a Published Beta 1.87 M/B $25.14 Estimated Beta (R2 = 0.3006) 2.15 Kd estimated 7.50% Intrinsic Valuations Est. PPS WACC estimated 6.50% Discounted Dividends $20.82 Free Cash Flows $9.45 Altman Z-Score (est.) 2.84 Residual Income $28.17 AEG $27.89
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Recommendation: Undervalued Firm (Buy)
Company, Industry, Economy Overview and Analysis Cooper Tire is America’s fourth largest tire manufacturer, and has been in
business since 1920 when the demand for cars created the need for tires. The biggest
challenge for tire manufacturers in recent years has been managing rising raw materials
costs, which are tied to petroleum prices. Some major trends occurring in the industry are
high performance tires and expanding into new international markets. The shift from
producing a few low cost types of tires to producing a wide variety of high performance
tires that suit the needs of the growing population of car customizers and enthusiasts is
increasing profit margins tire manufacturers. China and India’s booming economies mean
a growing middle class. This new middle class has created an increased demand for
automobiles and hence tires. Cooper Tire has established partnerships with Chinese
companies with hopes of gaining valuable marketshare during this crucial era.
Cooper Tire touts themselves as a pure tire company that focuses on producing a
high quality tire, pointing out that their competition are all conglomerates. Cooper has
recently undergone a massive restructuring strategy that costing the firm millions of
dollars and resulting in negative earnings for 2006, with those hopes the “new and
improved” Cooper Tire will be more efficient and competitive in the marketplace.
Cooper plans to beef up its high performance production as well as its international sales
while continuing to manage its long term supply contracts, with the hopes of generating
higher margins and earning greater returns for shareholders.
Accounting Analysis Every publicly traded company in the US must submit a 10-K document annually
to the SEC. This document is available to the public so that shareholders and potential
investors can examine the health of the firm. In its financial section, the 10-K contains
the most recent fiscal year’s income statement, balance sheet, and statement of cash
flows. Our accounting analysis consisted of a ratio screening analysis as well as an
examination of the 10-K in search of any accounting policies that would lead us to doubt
the reliability of the accounting numbers that were presented.
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In general we found Cooper’s accounting quality to be above average. We found
that they disclose a lot of information in the footnotes, and tend to provide both good and
bad news for investors. The one thing that bothered us about Cooper’s accounting was
how they accounted for their pension account. Pension accounting is based upon upwards
of 10 crucial estimates. In 2004 and 2005 Cooper’s project benefit obligation was greater
than the fair value of the plans assets, which means that the pension program was
unfunded. What shocked us was that Cooper was showing a positive number for the
program on its assets. Luckily, Cooper corrected its own accounting error in 2006 when it
adopted FSAS 158 which writes off unrecognized losses to other comprehensive loss as a
reduction to owner’s equity. We simply applied with accounting change in retrospect to
Cooper’s past five years balance sheets. In doing so Cooper realized a 10% reduction in
owner’s equity in 2004 and a 15% reduction in 2005.
Financial Ratio Analysis Financial ratio analysis consists of examining the accounting information
according to a set of ratios broken into three categories: liquidity, profitability and capital
structure. Overall we noticed a trend of poor numbers in 2004 and 2005 (the years that
the restructuring began) followed by what appears to a recovery in 2006. The liquidity
ratios look at the firm’s ability to pay its liabilities both over time and relative to its
competition. Cooper Tire turns over its inventory and receivables at a much higher rate
than its competition and maintains a favorable ratio of current and quick assets to current
liabilities. Profitability ratios examine the firms margins and how well expenses are
managed. Unfortunately, Coopers margins are sub par compared to the industry. Both
asset turnover and operating expense ratios are superior to the industry, which leads us to
deduct that Coopers inferior margins are the result of poor raw material costs
management as well as the effects of restructuring. Lastly, capital structure ratios analyze
how the firm is financed and how easily the firm can make the interest payments on its
debt load. Cooper took on a large debt load in 2006 associated with restructuring costs.
Cooper’s capital structure numbers in the past three years were below industry average
due to these costs.
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Intrinsic Valuation Analysis In order to begin the valuation of Cooper Tire, we first estimated the firms cost of
equity, cost of debt, and derived its weighted average cost of capital. We then used four
different valuation models in order to increase our confidence in our recommendation.
The intrinsic valuation models that we employed included the discounted dividends
model, the discounted free cash flows model, the residual income model, and the
abnormal earnings growth model. It should be stated that these models have differing
degrees of explanatory power. The residual income model has the highest R2 (35%-
90%), followed by the abnormal earnings growth model (30%-60%), then the free cash
flow model (5%-40%), and finally the discounted dividends model (up to 10%). Included
in the analysis of the results of each model was a sensitivity analysis that examined the
various intrinsic per share values based on varying growth rates and Ke (WACC) levels.
We then calculated the percentage of the results that provided us an implied overvalued
share price as well as the percentage that implied an undervalued share price. Given, the
percentages provided by the residual income model and the abnormal earnings growth
model, we are confident that Cooper Tire is in fact overvalued. We believe that the
market does not have as much confidence as we do that Cooper Tire will recover and
generate decent margins as the efficiencies associated with the restructuring come to
fruition.
Overvalued % Undervalued %
Discounted Dividends 60% 40%
Discounted Free Cash
Flows 30% 70%
Residual Income 0% 100%
Abnormal Earnings
Growth 20% 80%
The Altman Z-score is a firms credit score (similar to a FICO score for an
individual). Banks use this number to determine companies’ probability of bankruptcy. A
score of 1.8 or less indicates a very high probability of bankruptcy, while a score of 3.0
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indicated a very financially stable company that is not likely to go bankrupt. Cooper
scored a 2.84. This number is in the upper realm of the gray area for manufacturing
companies; however, we believe this number will improve in the coming years as Cooper
completes the transition associated with the restructuring.
Company Overview Cooper Tire, America’s forth largest tire manufacturer, has been in business since
1920 as high demand for tires developed along with the automotive industry. 90% of
their revenues are derived from the manufacturing and sales of passenger and light truck
replacement tires in North America. They operate 59 manufacturing, sales, distribution,
technical, and design locations in nine countries. Their international division is composed
of a manufacturing division in the UK, six distribution centers and five sales offices
across Europe, as well as two strategic alliances in China. The current trend at Cooper
Tire seems to gain market share in the rapidly expanding high performance market here
in the US as well as developing partnerships necessary to expand operations in Asia.
Worldwide, tire manufacturing is an $80 billion industry8. The replacement tire
industry in the U.S. alone accounted for $26.5 billion in sales during 2005. As of 2005,
Cooper Tire made up a 6% share of this market. Cooper Tires main competitors include
Goodyear, Michelin, Bridgestone/Firestone, and Pirelli. They do this with a market cap of
only $970M compared with $4.1B for Goodyear and $13.5 for Michelin. However, while
their competition has diversified and operates in various other business segments, Cooper
Tire prides themselves on being a pure tire company. They are also unique in that they
devote a lot of resources into training and developing their independent tire dealers.
Five Forces Model The first step in determining the value of Cooper Tire is to understand the tire
manufacturing industry. The five forces model determines the relative level of
competition and possible profits of the industry. Since this model is an outside-in
analysis, it shows how the industry can affect the firms within the sector and must be re-
evaluated if conditions are changed. Knowing and understanding the information that the
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five forces model requires allows us to classify the industry and determine what it takes
to be successful.
Five Forces
Summary
Rivalry Among Existing Firms
In any given industry, the degree to which the firms compete for market share can
say a lot about the profit margins that firms experience. The following sectors analyze the
intense rivalry that exists in the tire manufacturing industry.
Industry Growth:
When an industry grows, it gives firms an opportunity to compete for new market
share. When it doesn’t, the only way a firm can gain market share is to take it from a
member of their competition through a superior product and/or a competitive pricing
model. According to figures given on www.moderntiredealer.com, in the last five years
replacement tire sales dollars in the U.S. have risen 26.6%. However, during this same
time period average prices that consumers pay for tires has risen approximately 15%.
Taking these two figures into account (adjusting for inflation) it would seem that the
market has actually been growing slightly more than 2% per year. This industry growth
rate shows a competition rate at higher levels leaving the firms fighting for market share,
which could lead to price wars.
Concentration and Balance of Competitors:
An industry with a few large players is less competitive than a highly fragmented
industry. The largest players tend to set the tone for the price in any particular industry. In
the North American passenger and light truck replacement tires markets, which are the
primary markets that Cooper Tire competes in, the top three players (Goodyear,
Rivalry Among Existing Firms Medium/High
Threat of New Entrants Low/Medium
Threat of Substitute Products Low
Bargaining Power of Buyers High
Bargaining Power of Suppliers Low
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Michelin, Bridgestone/Firestone) currently hold 51.7% of the replacement tire market
share8. This reduces competitive pressure relative to what it would be if the industry was
more fragmented.
Replacement Tire Market Share 2005
17%
19%
16%
48%BridestoneGoodyearMichelinOther
*www.moderntiredealer.com
Degree on Differentiation and Switching Costs:
If all tires are of the same quality and match each other in performance then what
is to keep the consumer from purchasing Cooper Tires when he/she is making a
replacement decision? Price is the only thing left. This creates a higher level of
competition in the tire market. Sure there are different degrees of quality and
performance but; in general, all tire manufacturers produce a range of tires that fall into
each available category. Some categories would include tires designed for environments
such as: snow, rain, harsh terrain, or even tires that create little noise for those who spend
quite some time traveling.
One way that tire manufacturers do attempt to differentiate themselves is varying
way they get their product to the end user. Tire manufacturers can sell to large retailers,
Original Equipment Manufacturers (OEM’s), independent tire dealers, and even directly
to the end user (online). Nevertheless, even though a large auto manufacturer like Ford
would incur significant costs by switching tire manufacturers, switching costs are still
low in this industry. Therefore, the customer is in control and the level of competition is
increased.
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Ratio of Fixed to Variable Costs:
When an industry as a whole has a high fixed to variable cost ratio it tends to be
more competitive due to the pressure to increase production and cover those fixed costs.
Although tire manufacturers spend millions of dollars on equipment, they also spend
millions on raw materials and labor costs. “More than 50% of a tire’s cost is in raw
materials.”8 This puts their fixed to variable cost ratio at less than one. This mean some
scaling back of production is possible during economic crisis and therefore competitive
pressures are reduced in this area.
Exit Barriers:
If a firm cannot easily get out of a particular business, the only thing left to do is
stick around and compete. This is not the case in the tire industry. Acquisitions in the tire
businesses are common because rival firms are eager to gain market share; therefore, it
would be quite easy to sell out of the tire business if a company chose to do so. This
reduces the overall level of competition within the tire industry.
Although the tire industry is concentrated, the firms within have few exit barriers
along with a favorable fixed/variable cost ratio, which is counterbalanced by low industry
growth and low differentiation and switching costs. With these factors under
consideration, the current overall rivalry among competitors remains high.
Threat of New Entrants
The potential for abnormal profits make an industry appealing to new entrants.
However, a variety of other factors can discourage them. In the tire industry fairly large
economies of scale exist. Unless you are in a small niche market you will have to invest
hundreds of millions of dollars to get started. A first mover advantage does exist with
regards to emerging markets. The first tire manufacturer in a region will be the first to
gain valuable market share and customer loyalty. New entrants will struggle in gaining
access to distribution channels due to long standing relationships between tire
manufacturers, suppliers, and retailers. Therefore, the threat of new firms entering the tire
industry is not very high. However, as the tire industry becomes more global, the low cost
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Asian manufacturers are trying to gain market share in Europe and the U.S. and vice
versa. The threat of a totally new tire manufacturer emerging is little, but the threat of a
manufacturer foreign to your region of operation moving in to compete does exist. If the
players in an industry believe that new entrants will be competing they might adjust their
prices accordingly; therefore, competition is increased.
Threat of Substitute Products
If a consumer has the option of choosing a product from a different category that
will serve the same function, then competitive pressures within the industry will increase.
Everyone who owns a car needs tires. There are no substitutes. Since neither cars, nor
tires will ever go out of style, the probability of a substitute product is next to none and
competitive pressure is reduced.
Bargaining Power of Buyers & Suppliers
The relative power of buyers and suppliers will largely affect the profitability of
any given firm. In order to compete effectively, the firm must be able to negotiate the
prices it pays for raw materials as well as the price it receives for the finished goods.
Buyers:
Tire manufacturers sell to a variety of publics: end users, independent tire dealers,
auto makers (OEM’s), and large retailers. The two factors that determine the bargaining
power of buyers are price sensitivity and relative bargaining power. A large degree of
price sensitivity is present because tires are for the most part undifferentiated and
switching costs are low. Relative bargaining power varies from high to very high
depending on whether the buyer is an individual customer or a large automotive/tire
retailer. The power is mainly in the hands of the large retailer because they are
purchasing a large order of tires that they could just as easily purchased from another tire
manufacturer; however, if a large number of their customers provide a demand for
Cooper Tire specifically then their bargaining power would be reduced.
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Suppliers:
Rising raw materials cost was listed as a factor contributing to lower earnings in
all of the tire manufacturers annual reports that we reviewed. Supply costs are a principal
cost driver in the tire industry and must be managed in order for any given firm to be
successful. Luckily, the bargaining power held by suppliers is relatively low. Rubber
(synthetic and natural), chemicals, and wire reinforcing components are all commodities.
There are a large number of rubber suppliers who supply the quality of rubber that tire
manufacturers are looking for; therefore, switching costs are low. In addition, in 2001,
nine tire manufacturers joined RubberNetwork.com which is a sourcing and supply chain
management firm that allows them to join together and make even larger orders
increasing their cost savings even more. This helps a smaller tire manufacturer like
Cooper Tire because they can be in the same order as Goodyear and Michelin.
Despite the industry power over its suppliers, petroleum prices largely dictate the
cost of the majority of these raw materials; therefore, when prices skyrocket like they did
in 2005; it puts tire manufacturers in a crunch. They either have to increase the volume
sold or pass the cost on to the customer. Luckily, Cooper Tire realizes that they do not
have the same level of bargaining power relative to Goodyear or Michelin and have put
the emphasis on maintaining supplier relationships. They attempt to minimize the affects
of these price fluctuations through long-term supply contracts. Cooper Tire established a
purchasing office in Singapore solely dedicated to working with suppliers in the Far East.
In conclusion, a large number of suppliers and low switching costs give the suppliers
little bargaining power which reduces competitive pressure in this area.
Conclusion:
The five forces model does show evidence that the tire industry is quite
competitive; nevertheless, several industry trends and a simple refection upon personal
experience proves tires are not a “pure” commodity. Most people don’t just throw the
cheapest tires they can on their vehicle without asking some questions. People want to
know how many miles they can expect to get out of the tire, how safe it is, and maybe
how it will perform in various road conditions.
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Taking this into account, we have identified several key success factors. We
believe that any given tire manufacturers relative level of failure or success is mainly
attributable how it performs in these various areas.
Value Creation Analysis: Key Success Factors
Slightly Differentiated trends
High Performance:
Movies and shows like Fast and Furious and Pimp my Ride serve as a reminder
of the current hype in the younger market: vehicle customization. In the past ten years,
the high performance/ultra high performance market has grown by almost 10%. “That
trend is expected to continue. Groupe Michelin estimates half of the consumer tire market
worldwide will be H-rated or higher by 2010.”
HP/UHP tires as a %
of total units
Year % Units 2006 22.60 45.10 2005 21.00 43.20 2004 20.00 40.00 2003 18.70 36.40 2002 15.50 29.50 2001 13.00 25.00
*www.moderntiredealer.com
Developing a Global Brand Image:
As the more and more tire manufacturers expand their operations across the
globe, the importance of establishing their brand in the minds of the consumer is
increasing. As new players step into emerging markets, advertising helps introduce them
to the public and establish brand recognition, possibly before their competitors have the
chance. The high performance craze also adds to the advertising mix. Consumers likely
to buy high performance tires are often lured by magazine, TV ads, and even product
placement in movies and TV shows.
Being a Cost Leader
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Efficient Production:
Despite the fairly recent trend toward increased differentiation, to compete in the
tire industry you still have to be a cost leader. After 62 people were killed due to faulty
tires in 2000, the Firestone recall resulted in National Highway Traffic Safety
Administration passing the TREAD Act increasing test standards, labeling requirements,
pressure monitoring and reporting standards.
Lower Input Costs:
Managing raw material costs will allow any given tire manufacturer to increase
profits over their competition. The recent rise in natural gas and petroleum prices has
placed an increased burden on this aspect of the business. Using e-business technology
has also allowed certain manufacturer to obtain their raw materials at lower costs. Long-
term supply contracts also serve as a common industry strategy to reduce costs.
Outsourcing manufacturing, especially of the lower end, economy tires, has been a
strategy recently employed as well. Labor costs are another critical cost driver. Properly
executed management and commission structures can help ensure efficiency in the
workplace.
Low Cost Distribution:
To be low cost distributor in the tire industry any tire manufacturer might
consider downsizing their distribution centers, if at all possible, this will lower their cost
distribution. Many companies also eliminate their outside storage—therefore reducing
any unnecessary costs. Tire companies typically adjust their inventory on a quarterly
basis to prevent them from backlogging and loosing money. Also, the smaller firms in
this industry may be too small and are usually spread out all over the world, which causes
them to work together in order to produce efficiently while still maintaining low costs.
Tight Control System:
The overall goal of many of these firms is typically to be highly competitive while
also being a low cost producer. It is very obvious that there is a great opportunity to
capitalize on the growing demand for the American-made tire on an international basis.
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Employees are also working hard on expanding their company’s production capabilities,
improving productivity and increasing the overall manufacturing that is involved. Tires
demand high-tech innovations; these are expenses that only few tire companies can
afford. Also, many tire manufacturers prefer to produce their automobile tires in the U.S.
because of the political instability and country volatility. These are some of the main
concerns that discourage manufacturing in countries other than the U.S and because
transport costs for tires are typically bulky relative to their prices.
Cooper Tire Competitive Advantage Analysis Now that we have identified what it takes to be successful in the tire industry we
will take a closer took at how well Cooper Tire performs in these areas.
High Performance:
Cooper Tire has been increasing its production of high performance tires to keep
up with the rapidly increasing demand. Part of this expansion resulted in outsourcing of
Cooper’s economy lines to Asia (shown in the graph below) in order to produce more
high performance tires here in the U.S.
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
2003 2004 2005 2006
Cooper Tire Asian Production In Millions
* data derived from Cooper Tires’ 2003-2005 10-K documents
** 2006 figures were estimated in the 2005 10-K
Advertising:
Cooper Tire expanded their advertising program in 2004 with an array of new ads
as well as an online toolkit designed to help their dealers step up their efforts. “By
focusing on the emotional considerations of buying tires, rather than product features, the
advertisements help claim the brand's stake in becoming the most sought after
replacement tire in the rapidly growing ultra high performance product market as well as
a solid choice for family car and light truck tire buyers.” Coopers’ tag lines are “Don’t
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Give Up a Thing” and “Get Everything You Want.”2 Their main strategies are their
association with College Athletics and motorsports programs. They are the exclusive tire
of A1 Grand Prix.
Low Cost Distribution
Since the majority of Cooper’s business generates from the east half of the United
States, locating most of the distribution centers and all the manufacturing plants closer to
the east coast decreases the cost of distribution (as seen below). Although the
manufacturing facilities are not equally distanced to the distribution centers, the fact that
Cooper receives raw materials from within the U.S. helps with speedy delivery and
cheaper shipping costs. Another advantage is the direct communication with the
suppliers.
Tight Cost Control
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By managing inventory costs, a company can reduce waste. Cooper produces
products according to monthly orders given by the consumers. If the order is large, then
the company produces a large amount. Cooper relies on primary sources, the consumers,
to manage their inventory costs. Another way to reduce costs is to manage long-term
debt. Interest rates can either increase or decrease the actual amount of debt. In 2005,
Cooper’s long-term debt payment was considerably less than the year 2004. This is due
to the fact that in 2004 Cooper paid a payment on the account; the next payment is due in
2009. Predicting future costs is not always accurate, especially in foreign markets due to
the foreign currency exchange rate. Cooper plays the caution card in this risky market by
entering contracts that develop in less than a year. In order to soften the damage of a
10% fluctuation rate, derivative financial instruments are used regularly in order to
evaluate effectiveness. To this date, according to Cooper, only positive results have
occurred. Companies save money by closely managing several segments.
Efficient Production:
Although Cooper Tire is a large company, economies of scale tend to work
against it. Since Cooper Tires is one of the smaller manufacturers they are at a
disadvantage when comparing to one of the larger tire companies that has a larger market
share. Some of the larger companies can spread their fixed costs out over a larger
production. This larger production also gives them slightly more bargaining power over
certain suppliers.
COGS / Sales
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
2002 2003 2004 2005
GoodyearCooper Tire
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Lower Input Cost:
Cooper Tire has been trying to lead the industry and stay on the edge by leading
in cost management. Of the tires Cooper sold in the United States in 2005, 1.2 million
were passenger tires manufactured in China. China has become an extremely beneficial
location to manufacture passenger and lower-end tires.
The Company has sources world-wide in order to reduce cost and assure supplies
for its manufacturing operations. E-business technologies like RubberNetwork.com are a
fairly new trend in cost management. Engaging in long-term contracts with
manufacturers that allow them to purchase materials at discounted price, as well as
buying up supplies when the market is cost-effective are other strategies that Cooper
Tires uses to keep costs low.
In 2003, the North American division started a restructuring plan that cost them
millions up front. Over 2.1 million was paid out to employee severance costs. The
process continued in 2004 when the company implemented two more plans. These plans
cost the Company over 1.8 million in the second quarter and 7.3 million in the third.
These plans required the discontinuation of redial medium truck tires and the
consolidation of retread operations. Although the restructuring that took place in 2004
did not affect employees, it did take the value of the equipment down in value.
Key Accounting Policies Now that we understand what it takes to be successful in the tire industry and the
nature of Cooper Tire’s business, we can take a look at the accounting. In analyzing
Cooper’s financials, our first task was to determine the reliability of these numbers. If the
numbers are unreliable, then using them to value to company would lead to inaccurate
conclusions.
Key Success Factors Key Accounting Policies
High Performance Research and Development
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Developing Global Brand Image Advertising
Efficient Production Operating Leases
Lower Input Costs Inventory and Pension
Liabilities
Tight Control System Warrantee Liabilities
Coopers’ key success factors gave us a big hint as to what their key accounting
policies are (see chart). Cooper follows a set of standards that are common place in the
tire industry. Key policies to look for in the tire industry are: research and development,
pension liabilities, and warrantee liabilities. Research and development has become
increasingly important due to the trend in high performance tires. Several tire makers
have defined benefit plans which can easily be underestimated if a company wants to
reduce its liabilities. All these tires typically carry at least some type of warrantee on
them; therefore, how a tire company accounts for these liabilities is important. It is also
important that a company maintains the same inventory recognition method over time.
For Cooper, we will also look at advertising, operating leases and goodwill.
Accounting Flexibility vs. Actual Accounting Policies
In the United States, certain accounting policies can be chosen from a variety of
flexibility granted by GAAP. When a large amount of accounting flexibility is given,
firms can sometimes choose among a spectrum of policies, some of which would be
aggressive and lead to higher reported net income and others which would be
conservative and lead to lower reported net income. Since management determines the
policies used in the reports, they have control over where their company will fall in this
spectrum. As a general rule, corporations tend to use accounting flexibility to their
advantage in two basic ways: overstating assets and/or understating liabilities (see chart).
Common Ways Corporations Cheat the Books
(Overstated)Assets = (Understated)Liabilities + Owners Equity
Excessive intangible assets Defined benefit
plans/pension liabilities
Leads to overstated net
income
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Failure to write-off
inventory
Operating leases
With this understanding, we will now examine each of Coopers’ key accounting
policies. First we will determine the amount of flexibility granted by GAAP, and second
we will determine where Cooper lies on the spectrum (conservative vs. aggressive).
R&D
Research and development plays a large role in the world of Cooper Tires and the
tire industry as a whole. GAAP does not give corporations any discretion regarding
R&D, it must all be expensed. Therefore, Coopers’ entire R&D is expensed as it is
incurred and is included in the cost of goods sold.
Pension Liabilities
Any company that has a defined benefit plan has a wide degree of flexibility
regarding the following assumptions they must use to calculate their pension liabilities:
life expectancies, retirement rates, discount rates, long term rates of return on plant
assets, future compensation levels, future health care costs, and the maximum level of
company covered benefit costs. Therefore, any company with a defined benefit plan has
the flexibility to drastically reduce its pension liabilities by playing with some of these
factors. For example; in Cooper Tire, a 1% increase in the assumed future cost of health
care increases their pension liabilities by over five million dollars.
Disclosure regarding some of these estimates is poor across the board. We found
very little disclosure regarding estimates of any of the companies’ retirement rates and
life expectancies. Cooper Tire assumes the annual growth rate of medical costs will be
7% per year through 2008 and 6% per year after that. Prescription drug costs are
estimated to rise at a rate of 11% per year through 2008 and 6% per year after that.
Goodyear, the only other competitor that disclosed their assumptions on this matter, says
that health care costs will rise 11.5% next year and decline at a steady rate until
bottoming out at 5% in 2013.
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We were able to obtain disclosure of pension liability discount rates and the
estimated long term rate of return on plant assets across the board (shown below). We are
somewhat concerned that Cooper is on the high end of both of these estimates. These
rates enable Cooper to state their pension liabilities at a level slightly lower than the
industry, while stating the value of their future assets to cover these liabilities at a value
that might be too high.
Key Estimates used in calculating Pension Liabilities
After looking further into this issue, we discovered that Cooper has done some
strange things with its pension numbers. As you can see below, the fair value of the plans
in both 2004 and 2005 is not sufficient to cover the expected future liabilities (which may
already be slightly understated). Not only that, but they somehow made over $100M in
under-funded pension liabilities turn into a positive $5M on the balance sheet.
Cooper Tires Under-funded Pensions Come Up Positive?
(* amounts in thousands USD) 2004 2005
Projected Benefit Obligation 920,564 1,011,099
Fair Value of Plans Assets 819,054 871,174
Funded Status of Plans (101,600) (139,925)
Net Amount Recognized on Balance Sheet 5,884 8,359
So how does this $100M+ of understated liabilities affect Coopers’ balance sheet?
Cooper Tire Goodyear Bridgestone/Firestone Michelin
Discount rates
5.75% 5.50% 5.2-6.0% 5.45%
Rate of return on plant assets
9% 8.5% 7-9% 8.36%
22
The company’s’ total liabilities were approximately $1.4B and $1.2B in 2004 and 2005
respectively; therefore, in 2005 Coopers’ liabilities were understated by approximately
12%. These understated liabilities translate to understated expenses and overstated net
income. This overstated net income translates to overstated owners equity on the balance
sheet and higher earnings per share for stockholders. We will take a greater look at this
accounting discrepancy in the undo-accounting distortions section.
On a positive note, Cooper Tire was also able to sell off the pension liabilities
associated with Cooper Standard Automotive. “In connection with the divesture of the
Company’s automotive operations, defined benefit plans relating to automotive
operations were assumed by the buyer except those relating to previously closed plants.”
Although this statement does not explicitly state that the liabilities were sold without
recourse, we believe it is implied.
Warrantee Liabilities
Cooper Tire pays more per dollar of sales on warrantee payments compared to
Goodyear. What this means is that Cooper reimburses their customers more often than
Goodyear, a major competitor. With this data, it can be concluded that the quality of
Cooper’s products are not up to standards with their competitor Goodyear and/or
Cooper’s warrantee policy is more lenient compared to Goodyear’s. What matters here is
that the number that Cooper is reporting on the balance sheet is conservative and reliable
because it is higher than their competitors. If Cooper were more aggressive in their
determination of warrantee liabilities they would be apt to claim that they pay less than
their competitors, not more.
Inventory
When valuing inventory on the balance sheet, GAAP gives management the
option to choose between LIFO, FIFO or average of the cost of inventory. These
different policies allow management to possibly under or overstate assets or costs. For
Cooper Tires, inventories are valued at cost or market, whichever is less. Inventories in
the U.S are determined by the last-in, first-out method (LIFO), while the first-in, first-out
(FIFO) method has been used for all others. In using the LIFO method, total inventory
23
has decreased by nearly 26% and 29% at December 31, 2004 and 2005, respectively.
Basically, had Cooper continued to use the old method of inventory reporting, they would
have had to claim over $210,000 in inventories for the years 2004 and 2005. By using the
LIFO method Cooper takes the risk of understating inventory and it is typical to overstate
inventory with the FIFO method. In Cooper using a combination of the two and
maintaining a high inventory turnover, it will help keep the inventories accurate.
Advertising
Cooper Tire’s expense their advertising costs such as production and media when
they are incurred. Dealer earned cooperative advertising expense is recorded when
earned. Research shows that Cooper does spend on average about the same on
advertising as their competitors, which is roughly around 3% of revenue. Over the past
three years, Cooper’s advertising expense has generally increased parallel with revenue.
Recently there has been no dramatic change in advertising expense.
Off Balance-Sheet Items
Although, the sale of Cooper-Standard Automotive has already taken place, the
Company has been trying to release the specified guarantees but has failed to do so. A
variety of operating leases used in the operations of Cooper-Standard Automotive were
guaranteed by the Company. If Cooper-Standard does not abide by these leases, these
guarantees, requires the Company to perform the specified terms in the ongoing leases.
The Company has a variety of ongoing leases but the most significant has a remaining
term of 11 years with a remaining $12.5 million of total payments. Other leases have a
remaining life from 1 to 8 years amounting to $5.9 million of total payments. Although,
this may seem like a large amount of money, the Company doesn’t believe that they will
be called upon making these payments anytime soon. The company rents certain
manufacturing facilities and equipment under long-term leases and since 2002 the total
amount for operating leases have been decreasing at a steady pace.
Quality of Disclosure
24
Qualitative
Quality of disclosure includes footnotes, which explain the financial statements,
and management discussions, which give their opinion of the company and the industry.
These notes are critical to the quality of the 10-K and give the common investor an idea
of how to break down so much information. Since most investors are not aware of
common lingo, this is the area where management can impress these investors with a
great amount of detail. Along with the actual financial data, one should be able to obtain
a relatively good idea of how to invest in a certain company.
Cooper Tire has a high level of disclosure in all of the filings and footnotes of the
financial statements. They provide a great detail in the footnotes about most liabilities
and debts, as well as literally providing both good and bad news. The company is very
detailed in the business of the company and future intentions. They provide discussion
on the overseas plan of action and the consequences of not following the plan. Cooper is
a small company when compared to the industry leaders and they offer the details of how
the larger companies with larger capital can dominate in this highly competitive industry.
While many companies provide limited disclosure regarding inventory, Cooper
did a good job in breaking down inventory, as well as detailing out the life of assets. In
general, Cooper has done an excellent job in providing investors with relevant and useful
information in all of their previous filings. However, compared to the industry Coopers’
disclosures are about average. While in some areas of pride they offer more detail, the
general information is consistent with the industry.
The one area where Cooper falters is in disclosing their pension liabilities. They
disclose a large amount of information; however, some very important details are left out
of the equation. We were never able to determine what the $150M in other assets were
that Cooper used to bring its net amount recognized for pension up to a positive number
when its funded status was ($100M+).
Ratio Screening Analysis
Simple ratios can tell you a lot about where a company has been, where they
might be headed, and where they stand compared to their competition. Ratios are also a
25
tool that we used in order to analyze the credibility of Cooper’s accounting. Often times,
ratios will raise a red flag that will help uncover hidden liabilities or overstated assets.
The first two sales manipulation diagnostics shown below are designed to
determine whether a company is generating enough cash flow from sales (Net Sales/cash
from sales), and whether they are using an appropriate credit policy (Net Sales/Net A/R).
The last one (Net Sales/Inventory) can sometimes uncover a high level of inventory per
level of sales according to the industry. This is sometimes caused by a company’s failure
to write-off stale/obsolete inventory. The numbers in the table below are further analyzed
in the line graphs to follow.
Sales Manipulation Diagnostics
Cooper Tire 2001 2002 2003 2004 2005 Net Sales/ cash from sales 0.97 0.92 1.09 1.01 1.00 NS/ Net A.R. 6.35 3.78 5.71 6.11 6.36 NS/Inventory 10.29 6.21 9.76 8.37 7.05
Goodyear Net Sales/ cash from sales 1.02 1.00 1.00 1.02 1.00
26
NS/ Net A.R. 9.60 9.49 5.77 5.40 6.25 NS/Inventory 5.95 5.91 6.12 6.59 6.89
Bridgestone Net Sales/ cash from sales 1.01 1.02 1.02 1.02 1.02 NS/ Net A.R. 4.35 5.09 5.76 5.43 5.75 NS/Inventory 6.25 6.93 6.59 6.47 6.37
Michelin Net Sales/ cash from sales 1.00 1.00 1.00 1.01 1.07 NS/ Net A.R. 4.65 4.97 4.81 5.16 4.76 NS/Inventory 4.78 5.47 5.55 4.94 4.78
Net Sales/Cash from Sales
0.80
0.85
0.90
0.95
1.00
1.05
1.10
1.15
2001 2002 2003 2004 2005
Years
Out
put
Cooper TireGoodyearBridgestoneMichelin
The Net Sales/Cash from Sales ratio is a way of showing how much a company
receives in cash compared to the total sales. The goal is to maintain an average of 1.0 in
order to keep cash flowing into the business as well as keep liquidity high and credit low.
Compared to its competitors, Cooper has not managed a stable history of incoming cash.
This may leave investors skeptical about the company. The competitors, however, have
developed a successful strategy of achieving around 1.0, except for Michelin in 2005.
27
Net Sales/Accounts Receivable
0
2
4
6
8
10
12
2001 2002 2003 2004 2005
Years
Out
put
Cooper TireGoodyearBridgestoneMichelin
Net Sales/Accounts Receivable has improved for Cooper. It is best to have a
high/increasing ratio because it means an increase in liquidity for the company. This
shows a higher number of collections and a lower chance of liability to unpaid accounts.
Cooper over the last 4 years has increased the amount of account receivables while
keeping net sales rather constant. Goodyear has recovered from a dramatic fall and since
constantly increased receivable turnover with the remaining competitors.
Days Supply of Receivables
2001 2002 2003 2004 2005 Average
Cooper 58 97 64 60 58 68
Goodyear 38 39 64 68 59 54
Bridgestone 84 72 64 68 64 71
Michelin 79 74 76 71 77 76
Days Supply of Receivables shows how long sales go uncollected. The lower the
number, the better. Goodyear has the lowest average of 54 days, which shows they have
a lower risk of unpaid accounts. Cooper is next with 68 days supply of receivables. This
shows that Cooper has managed account receivables well compared to Bridgestone and
Michelin
28
Net Sales/Inventory
0
2
4
6
8
10
12
2001 2002 2003 2004 2005
Years
Out
put
Cooper TireGoodyearBridgestoneMichelin
Net Sales/Inventory has been highly volatile over the last 5 years. Cooper on
average has had a higher ratio than its competitors, which means that cooper makes more
sales with fewer inventories than competitors.
Expense Manipulation Diagnostics are a tool that we used to determine whether
Cooper Tire might be understating their expenses. Asset turnover examines the level of
current assets relative to current liabilities. Decline asset turnover is an indication that
liabilities need to be looked into; however, it can also be the result of a company that is
trying to become more efficient. Operating cash flow per operating income gives us an
idea of how much income is cash vs. on account. Operating cash flow per net operating
assets tells us how much money is being generated per dollar of machinery and
inventory. Total accruals/change in sales tells us how much new expense has been
created due to a change in sales level. We left the pension expense diagnostic out
considering the circumstances.
Expense Manipulation Diagnostics
Cooper Tire 2001 2002 2003 2004 2005
29
Asset Turnover 1.14 0.64 0.64 0.78 0.86 CFFO/OI 1.33 2.86 3.61 1.61 0.82 CFFO/NOA 0.18 0.22 0.27 0.10 0.05 Total Accruals/Change in Sales 0.70 1.08 1.07 0.47 1.35
Goodyear Asset Turnover 1.03 1.06 1.01 1.14 1.26 CFFO/OI 5.12 1.94 1.09 0.95 0.82
CFFO/NOA 0.18 0.09 0.04 0.10 0.11 Total Accruals/Change in Sales 0.00 0.23 0.12 0.21 0.25
Bridgestone
Asset Turnover 0.87 1.05 1.04 1.04 0.99 CFFO/OI 1.24 1.46 1.41 1.21 0.64 CFFO/NOA 0.13 0.28 0.25 0.21 0.11
Michelin Asset Turnover 0.91 0.96 0.95 0.94 0.92 CFFO/OI 1.21 1.25 1.35 1.07 0.66
Asset Turnover
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
2001 2002 2003 2004 2005
Years
Out
put
Cooper TireGoodyearBridgestoneMichelin
Sales divided by assets measures the revenue productivity of resources employed
by a company. We need this ratio in order to evaluate the revenue productivity for
Cooper Tire and its’ competitors. Asset productivity is measured by a ratio called asset
turnover. Asset productivity allows us to evaluate how fast the company converts their
30
assets into profits. The asset turnover ratios indicate that each dollar of assets produced
$1.14 of sales in 2001 and $.64 of sales in 2002 and etc. for Cooper Tire. Asset turnover
is around the same with the competitors, but Cooper Tire seems to be quite a bit lower.
As you can tell from the graph Cooper’s competitors were able to keep a constant ratio
from 2001 through 2005. In 2002 Cooper’s ratio fell from $1.14 to $.64—cutting the
price in half.
CFFO/OI
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
5.00
6.00
2001 2002 2003 2004 2005
Years
Out
put
Cooper TireGoodyearBridgestonMichelin
Cash flow from operations divided by operating income measures how much
more cash flows are coming from direct activities instead of investing for financing
activities. Overall, the industry had a constant ratio for the year of 2004 and since then
this ratio has been decreasing. Cooper’s cash flow and operating income has been
decreasing since 2001. The decrease in this ratio shows that Cooper Tire’s cash flow
from operations can be explained by its operating income. Having a lower output
number allows us to understand that the company is using much more of their cash flows
from direct activities.
31
CFFO/NOA
-0.10
-0.05
0.00
0.05
0.10
0.15
0.20
0.25
0.30
2001 2002 2003 2004 2005
Years
Out
put
Cooper TireGoodyearBridgestoneMichelin
In general, cash flow dollars increase at a fairly similar rate along with operating
assets. This is due to the principle that as a company invests more money in operating
assets, their cash flows should increase. In this graph we can see that since 2003 each
dollar of net operating assets is producing much less operating cash flow. This trend
seems to be affecting Michelin and Bridgestone as well. This decrease in operating cash
flow is largely attributed to increased raw materials costs. Unfortunately, during this
same period Goodyear has been becoming more efficient and squeezing more operating
cash out of their operating assets.
Total Accruals/Change in Sales
-1.00
-0.50
0.00
0.50
1.00
1.50
2001 2002 2003 2004 2005
Years
Out
put Cooper Tire
GoodyearMichelin
Total Accruals/Change in Sales has dramatically increased and is currently higher
than all competitors. This ratio is stating that when liabilities increase, it is good to have
a change in sales that increase. Currently it is unfavorable to have such a high ratio and
this either means that sales have decreased or liabilities have increased.
32
Potential “Red Flags”
Although Cooper-Standard Automotive does not exist, they still have contracts
outstanding. Cooper Tire is still liable for the leases amounting to over $17 million.
Total assets amount to approximately $2.2 billion; therefore, $17 million is nothing more
than a peanut. Cooper has not been reporting these figures on the financial statements,
rather just in the “off-balance sheet” section of 10-k.
Undo Accounting Distortions
In order for our time series comparisons and forecasts to be correct in the future
we must recast Cooper’s financial statements for the years 2002 – 2005. Luckily, Cooper
corrected their own pension accounting error, in a manner consisted with what we were
planning to do anyway, when they adopted SFAS No. 158. Therefore, we simply recast
Cooper’s balance sheet according to the provisions given in SFAS No. 158. We believe
these recast financials will give us the most accurate picture of the past financial position
of the company.
We took the following 4 steps to recast Coopers’ balance sheet:
1. reduce other assets by the amount attributed to pensions*
2. reduce other long-term liabilities by the amount attributed to pensions**
3. increase other long-term liabilities by the unfunded status of the pension plan
4. make an adjustment to other comprehensive loss to account for unrecognized
losses (net of tax)
33
* & ** These amounts are found on the significant accounting policies page addressing pension liabilities under the heading
“Amounts Recognized in the balance sheets:”
Net Effects of Restating Financials 2002 2003 2004 2005 2006Other assets 180,246 159,134 201,431 305,498 164,951Restated Other Assets 97,588 71,407 48,032 138,471 164,951Total Assets Reduced by: 82,658 87,727 153,399 167,027 0Percentage Change in Total Assets: -3.00% -3.10% -5.80% -7.80% Other long-term liabilities 241,137 255,580 178,282 220,896 217,743Restated Other long-term liabilities 232,898 231,651 132,367 202,153 217,743Total Liabilities Reduced by: 8,239 23,929 45,915 18,743 0Percentage Change in Total Liabilities -0.50% -1.30% -3.10% -1.50%
Cumulative other comprehensive loss -
149,230-
109,679 -74,085 -86,323-
282,552
Restated Cumulative other comprehensive loss -
223,649-
173,477-
181,569 -
234,607-
282,552Total Stockholders' Equity Reduced by: 74,419 63,798 107,484 148,284 0
Percentage Change in Total Stockholders Equity: -7.90% -6.20% -9.20% -
15.80% Unrecognized Prior Service Costs (Net of Tax) 14,236 13,597 11,901 8,626 14,990Unrecognized Actuarial Loss (Net of Tax) 188078 196050 172836 204140 319310Actual Losses: 202,314 209,647 184,737 212,766 334300Losses Written Down: 74,419 63,798 107,484 148,284 197,211Yearly Net Unrecognized Loss: 127,895 145,849 77,253 64,482 137089 Total Unrecognized Loss Assuming no loss occurred prior to 2002: 552,568
Even after recasting the balance sheet, we are still left with over half a billion dollars in
cumulative unrecognized losses. For simplicity, we have decided to amortize this amount
as a continued 55,257 reduction to stockholders’ equity over the next 10 years in our
forecast.
34
Ratios Analysis and Forecast Financials Now that we have a set of accounting numbers that we are confident in, we can
begin to look deeper into Cooper’s performance in the last five years. We will do this
using a set of 14 key ratios that will examine liquidity, profitability, and capital structure.
In order to understand how Cooper stacks up in the industry, we will run these ratios on
Cooper’s competitors as well. We will also compute an industry average for each of these
ratios which will help us as we move into the forecasting section. Based on our
interpretation of these ratios, Cooper’s key success factors, and other key movements
within the industry, we will forecast Cooper’s income statement, balance sheet, and
statement of cash flows for the next 10 years.
Trend (Time Series) Analysis/Cross Sectional Analysis
A company’s ability to pay its debt as it comes due is a critical indicator of its
overall financial health. Poor liquidity ratios are usually an indicator of cash flow
problems. We have computed these ratios for 5 years; therefore, we will elaborate on any
pertinent trends effecting Cooper and/or the industry. The first liquidity ratio we will look
at is the current ratio. The current ratio is calculated by dividing the firm’s current assets
by its current liabilities.
Current Ratio = current assets/current liabilities
2001 2002 2003 2004 2005 2006
Cooper 1.47 1.98 2.15 5.26 3.49 1.91
Bridgestone 1.53 1.68 2.06 1.67 1.54
Goodyear 1.53 1.31 1.90 1.65 1.80
Coopers’ current ratio is above industry average. This could be a sign of
inefficiency. Cooper is not fully utilizing its assets to generate cash flow. Sometimes a
company can have a lot of inventory sitting around and this will inflate their current
assets. Analysts frequently utilize the quick asset ratio to measure a firm’s ability to pay
its current debts in an emergency. Only the most liquid current assets are included.
35
Current Ratio
0
1
2
3
4
5
6
2001 2002 2003 2004 2005 2006
Ye a r
Series1
Series2
Series3
Series4
Series5
Quick Asset Ratio = (cash + A/R + securities)/current liabilities
Cooper’s quick ratio has been increasing over the past five years and again
Cooper is above industry average in every year. The quick asset ratio indicates whether
or not the company is using their current assets efficiently. The chart above shows that
Cooper’s quick ratio increased $0.27 from 2002-2003 and $2.49 from 2003 -2004, this
increase is due to a larger investment in marketable securities. The companies
restructuring and transformation that began with the sale of Cooper Standard Automotive
in 2004 was the main the reason for the abnormally high ratios in ’04 and ’05.
2001 2002 2003 2004 2005 2006
Cooper 0.88 1.16 1.43 3.92 2.23 1.21
Bridgestone 0.88 0.95 1.23 0.99 0.85
Goodyear 0.71 0.60 1.14 1.03 1.11
36
Quick Asset Ratio
0.000.501.001.502.002.503.003.504.004.50
2001 2002 2003 2004 2005 2006
Year
Out
put
Cooper
Bridgestone
Goodyear
avg w /o cooper
This graph above depicts the industry trend and allows us to compare Cooper’s
trend with that of the industry as a whole. As you can tell from the graph, Cooper has the
highest quick asset ratio for all five years. Considering ’04 & ’05 as outliers, Cooper
seems to maintain an efficient level of quick assets that is right around the industry
average.
Inventory Turnover = Cost of Goods Sold/Inventory 2001 2002 2003 2004 2005 2006
Cooper 8.89 10.12 10.90 7.43 6.43 7.05
Bridgestone 4.03 4.33 4.12 4.11 3.77
Goodyear 4.75 4.82 5.06 5.28 5.51
Days Supply of Inventory: 365/Inventory Turnover
2001 2002 2003 2004 2005 2006
Cooper 41.06 36.07 33.47 49.12 56.77 56.77
Bridgestone 90.52 84.23 88.50 88.89 96.87
Goodyear 76.81 75.74 72.17 69.17 66.23
37
Cooper appears to be far superior in this metric as well. It clears out inventory at a
rate of almost double than its competitors. (Could this be because Cooper is smaller and it
just sells tires?) The more inventories a firm sells, the more revenue it generates.
Therefore, this would lead Cooper tire to generate more revenue.
Notice that Cooper’s current inventory supply will hold them over for about 50
days; whereas, Bridgestone is close to double that. In this respect, Cooper is more
efficient by keeping storage costs at a level much below than that of its competition.
Cooper’s overall average for the five years is at 8.754—this number indicates that Cooper
is doing a good job at clearing out inventory and reordering. This also puts Cooper’s days
supply of inventory at a low level, compared to Bridgestone and Goodyear. The overall
average days supply of inventory for Cooper is right at 43.30—this number indicates that
Cooper is handling their inventory efficiently. Cooper has been able to keep their
inventory turnover and their days supply of inventory at competitive levels.
38
Days Supply of Inventory
0.00
20.00
40.00
60.00
80.00
100.00
120.00
2001 2002 2003 2004 2005 2006
Ye a r
Cooper
Bridgest one
Goodyear
Michelin
avg w/ o cooper
Inventory Turnover
0.00
2.00
4.00
6.00
8.00
10.00
12.00
2001 2002 2003 2004 2005
Ye a r
Cooper
Bridgest one
Goodyear
avg w/ o cooper
The graph above indicates the inventory turnover per year for Cooper and its
competitors. This allows us to depict the industry trend of inventory turnover and
compare it to Cooper. Once again Cooper is above average compared to Bridgestone and
Goodyear. Goodyear also manages to stay above the industry average in their inventory
turnover. Bridgestone is the only competitor that is well below the industry average when
it comes to their inventory turnover.
39
Receivables Turnover: Sales/Accounts Receivable 2001 2002 2003 2004 2005 2006
Cooper 6.35 7.23 5.73 6.11 6.36 6.46
Bridgestone 4.35 5.09 5.76 5.43 5.23
Goodyear 9.59 9.63 5.77 5.40 6.25
Michelin 4.81 5.12 5.35 5.15 4.76
Days Supply of Receivables: 365/Recievables Turnover 2001 2002 2003 2004 2005 2006
Cooper 57.48 50.52 63.69 59.77 57.38 57.38
Bridgestone 83.85 71.71 63.41 67.18 69.84
Goodyear 38.06 37.88 63.23 67.58 58.44
Michelin 75.96 71.26 68.19 70.83 76.63
On a company's balance sheet, accounts receivable is the amount that customers
owe a business and they are classified as current assets. The receivables turnover ratio
measures how efficiently a firm uses this asset. A high ratio indicates that a company
operates on a cash basis and that the collection of accounts receivable is efficient. When
a company has a low ratio, the company needs to reconsider its credit policies to ensure
the timely collection of accounts receivable.
Cooper appears to collect its receivables at a healthy rate as well as have sales to
support its credit policy. In the past three years, Cooper has beaten all of its competitors
in turning over its receivables. This speeds up Cooper’s cash-to cash cycle. Out of all the
competitors only Goodyear had a higher receivables turnover ratio but only for the years
of 2001 and 2002—after those two years Goodyear’s ratios went to a an average of about
5.
DSO (Days Sales Outstanding) ratio is directly tied to the receivables turnover.
The DSO ratio shows both the average time it takes to turn the receivables into cash—in
terms of days. The average DSO for Cooper is 57.77, which is relatively low compared
to its competitors. This indicates that Cooper is able to collect its receivables in a timely
40
manner. Part of this is due to Cooper’s large network of independent dealers who strive to
pay on time and maintain positive relationships.
Receivables Turnover
0.00
2.00
4.00
6.00
8.00
10.00
12.00
2001 2002 2003 2004 2005 2006
Ye a r
Cooper
Bridgest one
Goodyear
Michelin
avg w/ o cooper
Days Supply of Receivables
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
2001 2002 2003 2004 2005 2006
Ye a r
Cooper
Bridgest one
Goodyear
Michelin
avg w/ o cooper
Working Capital Turnover: Sales/ (Current Assets – Current Liabilities) 2001 2002 2003 2004 2005 2006
Cooper 10.37 7.82 6.42 1.56 3.12 5.55
Bridgestone 4.86 4.90 3.85 5.05 5.85
Goodyear 7.79 11.29 4.59 5.44 5.10
This measure shows how many dollars of sales are created per dollar of working
capital. A company typically uses working capital to fund operations and purchase their
entire inventory. Coopers sales took a big hit in 2004 and 2005 due to the sale of Cooper
Standard Automotive. In 2006, the company’s restructuring resulted in an almost 20%
41
increase over the previous years sales. This put its working capital turnover at what
appears to be close to the industry average.
Working Capital Turnover
0
2
4
6
8
10
12
2001 2002 2003 2004 2005 2006
Y ear
CooperBridgestoneGoodyearavg w/o cooper
The graph above shows the comparison of the working capital turnover in the
industry trend. All of the competitors seem to have very dynamic numbers in output. In
2001 Goodyear had the highest output followed by Cooper and then Bridgestone. In
2002, all three competitors took a major hit and all three hit a peak leading into a huge
decrease in working capital turnover. By 2003, all of the competitors started to increase
the working capital turnover.
42
Liquidity Analysis
2001 2002 2003 2004 2005 2006 Opinion Current Ratio
1.47
1.98
2.15
5.26
3.49
1.91
Positive
Quick Ratio
0.88
1.16
1.43
3.92
2.23
1.21
Positive
Inventory Turnover
8.89
10.12
10.90
7.43
6.43
7.05
Positive
Days Supply of Inventory
41.06
36.07
33.49
49.13
56.77
51.77
Positive
Receivable Turnover
6.35
7.23
5.73
6.11
6.36
6.46
Positive
Days Supply of Inventory
57.48
50.48
63.70
59.74
57.39
56.50
Positive
Working Capital Turnover
10.37
7.82
6.42
1.56
3.12
5.55
Positive
Liquidity Summary:
Cooper Tire maintained current and quick ratios right around the industry average
during each year (excluding ’04 & ’05 for restructuring). They also manage to turn over
their inventory and collect their receivables at much higher rates than the industry,
speeding up their cash to cash cycle. Lastly, working capital turnover performance has
been superior in the past, and after the restructuring is at par with the industry. As the
company becomes more efficient in managing this newly designed firm, working with
new equipment and product lines, we expect working capital turnover to increase over the
next year.
43
Profitability Ratios Profitability ratios are used to analyze how well a company can manage its
expenses, so that sales dollars will lead to acceptable returns for shareholders. A
company’s profitability is to a large degree determined by its level of efficiency. If one
company can produce a product and sell it more efficiently than another company, then it
will be more profitable. Many of these ratios help us answer questions about efficiency
which can lead to a determination about profitability.
Gross Profit Margin: Gross Profit / Sales 2001 2002 2003 2004 2005 2006
Cooper 13.63% 14.72% 12.40% 11.19% 8.69% 7.00%
Bridgestone 35.49% 37.48% 37.43% 36.56% 34.91%
Goodyear 20.03% 18.40% 17.36% 19.95% 20.03%
Michelin NP NP NP 32.14% 30.50%
A company’s gross profit is calculated by subtracting the cost of goods sold from
net sales. If all the costs that go into producing Cooper Tires cannot be managed more
effectively, then Cooper will be forced to further increase its pricing levels. Petroleum
and gas prices largely dictate the cost of raw materials for tire manufacturers. According
to Cooper’s most recent quarterly report (Q1 ’06) they were already increasing prices;
however, cost increases during that quarter unfortunately outweighed the increases.
Cooper earns gross margins far below that of the industry.
Gross Profit Margin
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
2001 2002 2003 2004 2005 2006
Ye a r
Cooper
Br idgest one
Goodyear
Michelin
avg w/ o cooper
44
Operating Expense Ratio: SG&A Expense/Sales
This ratio tells us how many dollars of operating expenses are generated per sales
dollar. Coopers expenses are about half that of Goodyear and less than a third of
Bridgestone’s. The main reason that Cooper has low expenses relative to its competition
is that Goodyear and Bridgestone are much larger companies that produce a wider range
of tires and even other automotive products. Far more employees and increased
bureaucracy lead to a higher SG&A expense for these companies. Cooper appears to be
doing a great job in managing these expenses.
Op erat ing Expense R at io
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
2001 2002 2003 2004 2005 2006
Y ear
Cooper
Br idgestone
Goodyear
avg w/ o cooper
2001 2002 2003 2004 2005 2006
Cooper 0.07 0.07 0.07 0.08 0.07 0.07
Bridgestone 0.30 0.29 0.29 0.28 0.27
Goodyear 0.16 0.16 0.16 0.15 0.15
45
Net Profit Margin: Net Income / Sales
Net Profit Margin shows how much of each dollar of sales is translated into
earnings. Cooper’s was able to lead the industry in 2004 only due to an extraordinary
gain from the sale of Cooper Standard Automotive. Then, in 2005 and 2006 the company
earned a loss due to new equipment purchases and acquisitions that were part of the large
scale transformation the company undertook. We believe that Cooper will come to see
the benefits of this transformation in the coming years. This will be analyzed further in
our forecasting section.
Net Profit Margin
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
2001 2002 2003 2004 2005
Ye a r
Cooper
Bridgest one
Goodyear
Michelin
avg w/ o cooper
Asset Turnover: Sales / Total Assets 2001 2002 2003 2004 2005 2006
Cooper 1.14 1.27 1.26 0.83 1.09 1.20
Bridgestone 0.87 1.05 1.04 1.04 0.99
Goodyear N/A N/A N/A 0.01 0.01
Michelin 0.94 0.99 0.99 0.93 0.92
2001 2002 2003 2004 2005 2006
Cooper 1.00% 3.36% 2.10% 9.67% N/A N/A
Bridgestone 0.81% 2.02% 3.85% 4.74% 6.72%
Goodyear N/A N/A N/A 0.63% 1.16%
Michelin 2.22% 4.08% 4.23% 4.35% 5.70%
46
This ratio tells us that per dollar of assets, Cooper is able to generate above
industry average sales levels. This indicates that Cooper is being more productive with its
assets than its competition. It appears that the large investment in new, more efficient
equipment that to produce more racing and high performance tires has already had a
positive impact on sales. We expect this ratio to increase even further into the future as
the company gets better at using its new equipment.
Asset Turnover
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
2001 2002 2003 2004 2005
Year
Out
put
Cooper
Bridgestone
Michelin
avg w /o cooper
Return on Assets: Net Income / Total Assets 2001 2002 2003 2004 2005 2006
Cooper 1.00% 4.25% 2.65% 8.01% N/A N/A
Bridgestone 0.71% 2.12% 4.00% 4.90% 6.67%
Goodyear N/A N/A N/A 0.71% 1.46%
Michelin 2.08% 4.03% 4.18% 4.04% 5.27%
Return on assets is an indicator of how well the company’s management uses the
firms’ assets to generate earnings. Coopers’ recent loss is not an indicator of poor asset
management. Again, a large part of the loss is due to restructuring and rising raw material
prices. It appears that prior to the restructuring, the firm performed slightly below
average in ’01, above average in ’02, and below average again in ’03.
47
Return on Assets
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
2001 2002 2003 2004 2005
Ye a r
Cooper
Bridgest one
Goodyear
Michelin
avg w/ o cooper
Return on Equity: Net Income / Total Stockholders’ Equity
2001 2002 2003 2004 2005 2006
Cooper 2.00% 12.90% 7.64% 18.94% N/A N/A
Bridgestone 2.08% 5.70% 9.99% 12.24% 16.02%
Michelin 9.03% 15.20% 15.61% 14.21% 19.71%
Return on Equity is a measure that reveals how much profit a company
generates with the money shareholders have invested. When the equity of a firm
decreases while maintaining a stable net income, the ratio increases because the company
is able to earn the same returns with less shareholder investment. In 2004, we already
know that the firm’s net income rose due to extraordinary gain associated with the sale of
Cooper Standard automotive. This justifies the large increase in ’04 over ’03. Then in
‘05, Cooper’s equity decreased here by almost 40% due to the large write off of
unrecognized losses associated with the company’s pension program; however, rather
than increasing the return on equity, the company earned a loss in 2005.
48
Return On Equity
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2001 2002 2003 2004 2005
Year
Out
put
Cooper
Bridgestone
Michelin
avg w /o cooper
Profitability Analysis
2001 2002 2003 2004 2005 2006 Opinion Gross Profit Margin
0.14
0.15
0.12
0.11
0.09
0.07
Negative
Operating Expense Ratio
0.07
0.07
0.07
0.08
0.07
0.07
Positive
Net Profit Margin 0.01 0.03 0.02 0.10 0.00 N/A Negative Asset Turnover 1.14 1.27 1.26 0.83 1.09 1.20 Positive Return on Assets 0.01 0.04 0.03 0.08 0.00 N/A Neutral Return on Equity 0.02 0.13 0.08 0.19 N/A N/A Negative
Profitability Summary:
Cooper tire does a great job generating sales dollars given their assets,
unfortunately, they do a poor job of efficiently managing their costs in order to earn a
competitive return. We believe that these sub-par returns were what caused Cooper to
begin its restructuring program. Hopefully, as the firm adjusts to its new equipment,
product lines, management structure, and Asian acquisitions it will begin to increase
these margins to a level that is more in line with the industry.
CAPITAL STRUCTURE RATIOS A firm’s capital structure determines its cost of debt. This cost of debt is reflected
on the income statement in the form of interest expense. A firm that can maintain an
appropriate capital structure and thereby obtain favorable borrowing rates will tend to
49
earn a higher net margin than a company that cannot. It is important to monitor how
much cash and operating income is available to pay interest expense.
Debt to Equity: Total Liabilities / Total Stockholders’ Equity 2001 2002 2003 2004 2005 2006
Cooper 2.04 2.03 1.88 1.37 1.51 2.49
Bridgestone 1.88 1.64 1.46 1.46 1.37
Michelin 2.28 1.93 2.02 1.85 2.56
The debt to equity ratio represents the method a company uses to finance their
assets. A high ratio reflects aggressive financing and if too high, could possibly cause
high borrowing costs and puts the firm in financial distress. In general, Cooper has been
reducing its total liabilities relative to stockholders equity since 2002; however, a recent
increase in long-term liabilities (acquisitions and investment in PP&E) coupled with a
reduction in owners’ equity (due to a large write off of unrecognized losses associated
with the companies pension plan) are the causes of the large increase in 2006. We
hypothesize that as the company’s returns from these investments materialize, they will
pay off this debt in order to protect future borrowing costs and reassure shareholders.
Debt to Equity
0.00
0.50
1.00
1.50
2.00
2.50
3.00
2001 2002 2003 2004 2005
Year
Out
put
Bridgestone
Goodyear
Michelin
Average
Cooper
50
Times Interest Earned: Operating Income / Interest Expense 2001 2002 2003 2004 2005 2006
Cooper 1.17 4.30 3.45 3.70 0.48 N/A
Bridgestone 4.40 11.35 15.32 17.45 14.04
Michelin 2.24 3.71 4.08 5.27 5.62
This ratio displays how much operating income is generated per dollar of interest
expense. This leads us to a determination of how reliable a company’s debt payments are
in the future. Coopers’ operating income took a big hit in ’04 and ’05 as the large
reduction in sales dollars resulting from the divesture of Cooper Standard Automotive
made its way down the income statement. Sometimes low times interest earned indicates
reinvestment (which increases interest expense). On the other hand, the exceptional high
outcome of Bridgestone could show a lack of reinvestment. We can see the effect of the
restructuring manifest itself in 2005. All the new equipment and acquisitions resulted in a
larger interest expense and a low ratio in 2005. Despite the fact that interest expense may
remain high for some time, operating income should increase in the coming years
bringing this ratio back up to an acceptable level.
T i mes I nt er est E ar ned
0
24
6
8
1012
14
1618
20
2001 2002 2003 2004 2005 2006
Y e a r
Cooper
B r i dgestone
M i chel i n
avg w/ o cooper
Debt Service Margin: Cash Flow from Operations / Current Notes Payable 2001 2002 2003 2004 2005 2006
Cooper 16.95 14.80 N/A N/A N/A 0.70
Bridgestone 0.98 3.32 outlier 2.60 10.00
Goodyear 6.22 2.42 N/A 3.47 3.80
51
The debt service margin ratio shows the amount of cash flow available to pay off
debt. A negative ratio means that the company isn’t able to pay off the debt and must
find another way to finance. In 2006, Cooper kept a relatively small margin right above
zero. However, this was due to a large portion of long-term debt that came due. Cooper’s
’03 – ’05 figures were omitted because Cooper had such a low level of current notes
payable that the ratio skyrocketed. Competitors experienced a sporadic year in 2003, but
returned to their steady margin in 2004. Cooper’s debt service margin should be back up
above the industry average next year.
Debt Service Margin
-5.00
0.00
5.00
10.00
15.00
20.00
2001 2002 2003 2004 2005
Year
Out
put
Cooper
Bridgestone
Goodyear
Average
Capital Structure Analysis
2001 2002 2003 2004 2005 2006 Opinion Debt to Equity Ratio
2.04
2.03
1.88
1.37
1.51
2.49 Neutral
Times Interest Earned
1.17
4.30
3.45
3.70
0.98
N/A Neutral
Debt Service Margin 16.95 14.80 N/A N/A N/A 0.70 Positive
Capital Structure Summary:
The company drastically increased its debt financing level in 2006. We found
Cooper’s debt to equity ratio to be something to watch in the future, but not a current
cause for concern. In the 5 of the past 6 years Cooper has been able to generate plenty of
cash flow to pay its obligations. Prior to the restructuring, Cooper’s times interest earned
levels were below industry level; however, this did not justify a red flag. Its recent
52
reinvestment makes it hard to compare Cooper to the industry. It would be great if
Coopers operating income were higher relative to interest expense, but we do not feel that
Cooper will have a problem with this in the future.
Sustainable Growth Rate:
2001 2002 2003 2004 2005 2006Dividends 3,047 30,810 30,952 31,103 26,643 25,781 Net Income 18,166 111,845 73,835 201,372 (9,356) (78,511)Dividends/NI 0.17 0.28 0.42 0.15 (2.85) (0.33) IGR 0.77% 5.43% 3.77% 9.24% 0.87% N/A SGR 2.33% 16.45% 10.84% 21.87% 2.19% N/A
The sustainable growth rate is the maximum rate at which a firm can grow, given
its level of assets and reinvestment strategies. Cooper has not had a steady SGR over the
past 6 years; however, the average has been 10.74%. This means that our forecast sales
should not increase at a rate higher than that. Cooper’s SGR may increase in the coming
years given as its recent investment in new assets begins to materialize itself on the
income statement.
53
Forecast Financial Statements A set of forecast financial statements based on research findings and ratio analysis
are a valuable tool that we will use to value the firm. Many of our assumptions are based
on the underlying assumption that Cooper Tire’s recent re-engineering will result in
increased efficiencies in the years to come. We also used several of our own ratios as
well as industry benchmarks as guides. We encourage you to be critical of our analysis
and perhaps create a mini forecast of your own.
Income Statement
We began our forecast with an assumption regarding future sales growth. We took
the average of the past 6 years annual sales growth (removing ’04 as an anomaly) which
yielded just under 9.4%. We then made an assumption regarding Cooper’s cost of sales.
We shrunk the cost of sales using a three tiered approach. 90.91% of sales (the rate for
’07-’09) was derived from the average rate in ’05 & ’06. The second tier’s rate of 87.23%
(for ’10 – ’12) is equal to the previous 5 year average, and the last tier (83.00%) was a
rough estimate based on increased efficiencies in the long term due to the restructuring.
This moves our long-term gross profit margin to 17%. We feel that this is still a
conservative number given that it is lower than the lowest competitor’s 5 year average
gross profit.
We were even more conservative with our operating income, assuming that a
large amount of operating expenses will continue to work their way out at the
restructuring matures. We based these assumptions both on common size rates during
previous years and on averages of these rates. Operating income grows along with gross
profit up to a level of 7% of sales in the final four years included in the forecast. Net
income follows a similar pattern, except its percentages are lower to reflect gains and
losses as well as any extraordinary items that may occur. We grew Cooper’s net margin
at a -0.50% in 2007 because we believe they will continue to lose money for one more
year as they finalize their restructuring. They then move to a slight gain in ’08 followed
by a larger gain in ’09 and then grown at a constant rate of 5%. This rate was the average
of Cooper’s net margins from ’02-’04 and it is also close to the industry average.
54
Income Statement
31-Dec Actual Growth Projected Growth
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Net Sales 3,329,957 3,514,399 2,081,609 2,155,185 2,676,242 2,676,242 2,676,242 2,676,242 2,806,200 2,942,469 3,085,356 3,235,181 3,392,281 3,557,010 3,729,739
Cost of Products Sold 2,839,757 3,078,761 1,848,616 1,967,835 2,478,679 2,368,271 2,394,284 2,465,568 2,480,648 2,601,105 2,727,418 2,721,176 2,853,316 2,991,873 3,137,158
Gross Profit 490,200 435,638 232,993 187,350 197,563 307,971 281,958 210,674 325,552 341,365 357,938 514,005 538,965 565,137 592,580
SG&A 237,239 247,416 171,689 161,192 192,737 194,619 196,757 202,615 212,454 222,771 233,588 244,932 256,825 269,297 282,374
Operating Income 248,396 177,130 63,224 26,435 (9,749) (9,378) 34,238 78,651 147,309 154,462 161,963 229,497 240,641 252,327 264,580
Interest expense 75,587 67,936 27,569 54,511 47,166
Interest income (2,068) (18,541) (10,067)
Income before taxes 177,197 114,110 35,006 (14,351) (91,954)
Income taxes 65,352 40,274 7,560 704 (9,727)
Income continuing operations 27,446 (15,055) (82,227)
Net income/ (loss) 111,845 73,836 201,372 (9,356) (78,511) (13,025) 21,069 56,954 143,456 150,422 157,727 165,386 173,417 181,838 190,668
55
ProForma Income Statement
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% 90.91% 90.91% 90.91% 87.23% 87.23% 87.23% 83.00% 83.00% 83.00% 83.00%
Cost of Products Sold 85.28% 87.60% 88.81% 91.31% 92.62% 9.09% 9.09% 9.09% 12.77% 12.77% 12.77% 17.00% 17.00% 17.00% 17.00%
Gross Profit 14.72% 12.40% 11.19% 8.69% 7.38% 7.47% 7.47% 7.47% 7.47% 7.47% 7.47% 7.47% 7.47% 7.47% 7.47%
SG&A 7.12% 7.04% 8.25% 7.48% 7.20% -0.36% 1.30% 2.90% 5.18% 5.18% 5.18% 7.00% 7.00% 7.00% 7.00%
Operating Income 7.46% 5.04% 3.04% 1.23% -0.36%
Interest expense 2.27% 1.93% 1.32% 2.53% 1.76%
Interest income 0.00% 0.00% -0.10% -0.86% -0.38%
Income before taxes 5.32% 3.25% 1.68% -0.67% -3.44%
Income taxes 1.96% 1.15% 0.36% 0.03% -0.36% Income continuing operations 0.00% 0.00% 1.32% -0.70% -3.07% -0.50% 0.80% 2.10% 5.04% 5.04% 5.04% 5.04% 5.04% 5.04% 5.04%
Net income/ (loss) 3.36% 2.10% 9.67% -0.43% -2.93%
56
Balance Sheet
We began our balance sheet forecast using asset turnover which linked it to the
income statement. We then forecast out Cooper’s current assets assuming the 5 year
average common size rate of 45.57% of total assets will be maintained. From this we
derived total long-term assets to be the difference between total assets and total current
assets. We were also able to reliably forecast out inventory and accounts receivable using
inventory turnover and receivables turnover.
Moving on to the liabilities section, we assumed that Cooper will fluctuate around
its average capital structure over the past 5 years. We began with current liabilities using
our average current ratio (2.96). We then attached the 5 year average common size rate to
current liabilities and used that to derive a rate for total liabilities. We then subtracted
Total Assets from total liabilities to come to our total equity forecast. Forecast retained
earnings numbers are a function of each year’s previous year’s retained earnings plus the
net income for that particular year.
57
Balance Sheet
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
ASSETS
Current assets:
Cash and cash equivalents 44,748 66,426 927,792 280,712 221,655
Accounts receivable 460,879 613,269 389,667 338,793 414,096 418,872 423,473 436,080 457,257 479,461 502,744 527,157 552,755 579,597 607,743
Inventories 280,641 282,352 248,782 306,046 351,687 285,970 289,111 297,718 312,176 327,335 343,230 359,898 377,374 395,699 414,915
Prepaid expenses 74,260 62,362 65,425 42,850
Assets of discontinued operations 10,813 400
Total current assets 860,528 1,024,409 1,642,479 968,801 987,438 1,052,565 1,064,126 1,095,808 1,149,020 1,204,817 1,263,322 1,324,669 1,388,995 1,456,445 1,527,170
PP&E 1,197,975 1,207,898 729,420 786,225 991,816 933,248 943,499 971,590 1,018,770 1,068,241 1,120,115 1,174,508 1,231,542 1,291,346 1,354,054
Goodwill 427,895 429,792 48,172 48,172 24,439
Intangibles 45,565 47,634 34,098 31,108 37,399
Restricted cash 12,484 12,382 7,550
Other assets 97,588 71,407 48,032 138,471 186,637
total 571,048 548,833 142,786 230,133 234,339
Total Non-current Assets 1,769,023 1,756,731 872,206 1,016,358 1,226,155 1,252,809 1,266,570 1,304,279 1,367,615 1,434,026 1,503,662 1,576,680 1,653,244 1,733,525 1,817,705
Total Assets 2,629,551 2,781,140 2,514,685 1,985,159 2,235,279 2,305,374 2,330,696 2,400,087 2,516,635 2,638,843 2,766,985 2,901,350 3,042,239 3,189,970 3,344,875
58
LIABILITIES AND SE 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Current liabilities:
Notes payable 21,956 2,770 459 79 164,330
Accounts payable 206,638 267,224 182,061 157,785 238,181
Accrued liabilities 189,662 197,169 108,197 99,659 117,005
Income taxes 1,326 6,549 1,320 15,390 4,698
Liabilities 19,928 4,684 3,038
Current portion of long term debt 14,994 3,015
Total current liabilities 434,576 476,727 311,965 277,597 527,252 355,596 359,502 370,205 388,182 407,033 426,798 447,523 469,255 492,042 515,936
Long-term debt 875,378 871,948 773,704 491,618 513,213
Postretirement benefits 205,630 220,723 169,484 181,997 258,579
Other long-term liabilities 232,898 231,651 132,367 202,153 217,743
Long-term liabilities 23,116 14,407 8,913
Deferred income taxes 13,772 13,500 41,000 21,941
Minority interests 4,954 69,688
Total non-current liabilities 1,327,678 1,337,822 1,139,671 917,070 1,068,136 1,635,378 1,875,177 2,083,664 2,190,760 2,306,779 2,432,552 2,568,987 2,717,079 2,877,916 3,052,691
Total Liabilities 1,762,254 1,814,549 1,451,636 1,194,667 1,595,388 1,990,974 2,234,679 2,453,869 2,578,942 2,713,812 2,859,350 3,016,511 3,186,334 3,369,959 3,568,627
Stockholders’ equity:
Preferred stock
Common stock 84,862 85,268 86,322 86,323 86,323
Capital in excess of par value 18,981 24,813 38,072 37,667 38,144
Retained earnings 1,184,115 1,226,999 1,397,268 1,361,269 1,256,971 1,216,549 1,256,179 1,303,472 1,422,504 1,439,958 1,459,096 1,480,075 1,503,071 1,528,272 1,555,888 Cumulative other comprehensive loss (223,649) (173,477) (181,569) (234,607) (282,552)
1,064,309 1,163,603 1,340,093 1,250,652 1,098,886 Less: common shares in treasury at cost (197,012) (197,012) (277,044) (460,160) (458,995)
Total stockholders’ equity 867,297 966,591 1,063,049 790,492 639,891 599,469 598,677 645,178 810,711 993,698 1,195,823 1,418,927 1,665,027 1,936,328 2,235,245 Total Liabilities and Stockholders'
Equity 2,629,551 2,781,140 2,514,685 1,985,159 2,235,279 2,590,443 2,833,356 3,099,047 3,389,653 3,707,510 4,055,174 4,435,438 4,851,361 5,306,286 5,803,871
59
ProForma Balance Sheet
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
ASSETS
Current assets:
Cash and cash equivalents 1.70% 2.39% 36.89% 14.14% 9.92% Accounts receivable, less allowances 17.53% 22.05% 15.50% 17.07% 18.53% 18.13% 18.13% 18.13% 18.13% 18.13% 18.13% 18.13% 18.13% 18.13% 18.13% Inventories at lower of cost or market: 10.67% 10.15% 9.89% 15.42% 15.73% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37% 12.37%
Prepaid expenses 2.82% 2.24% 2.60% 2.16% 0.00% Assets of discontinued operations 0.00% 0.00% 0.43% 0.02% 0.00%
Total current assets 32.73% 36.83% 65.32% 48.80% 44.18% 45.57% 45.57% 45.57% 45.57% 45.57% 45.57% 45.57% 45.57% 45.57% 45.57%
PP&E 45.56% 43.43% 29.01% 39.61% 44.37%
Goodwill 16.27% 15.45% 1.92% 2.43% 1.09% Intangibles, net of accumulated amortization 1.73% 1.71% 1.36% 1.57% 1.67%
Restricted cash 0.00% 0.00% 0.50% 0.62% 0.34%
Other assets 3.71% 2.57% 1.91% 6.98% 8.35%
total 21.72% 19.73% 5.68% 11.59% 11.45%
Total Non-current Assets 67.27% 63.17% 34.68% 51.20% 55.82% 54.43% 54.43% 54.43% 54.43% 54.43% 54.43% 54.43% 54.43% 54.43% 54.43%
Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
60
LIABILITIES AND STOCKHOLDERS’ EQUITY 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Current liabilities:
Notes payable 0.83% 0.10% 0.02% 0.00% 7.35%
Accounts payable 7.86% 9.61% 7.24% 7.95% 10.66%
Accrued liabilities 7.21% 7.09% 4.30% 5.02% 5.23%
Income taxes 0.05% 0.24% 0.05% 0.78% 0.21% Liabilities related to the sale of automotive operations 0.00% 0.00% 0.79% 0.24% 0.14%
Current portion of long term debt 0.57% 0.11% 0.00% 0.00% 0.00%
Total current liabilities 16.53% 17.14% 12.41% 13.98% 23.59% 15.40% 15.40% 15.40% 15.40% 15.40% 15.40% 15.40% 15.40% 15.40% 15.40%
0.00% 0.00% 0.00% 0.00% 0.00%
Long-term debt 33.29% 31.35% 30.77% 24.76% 22.96%
Postretirement benefits other than pensions 7.82% 7.94% 6.74% 9.17% 11.57%
Other long-term liabilities 8.86% 8.33% 5.26% 10.18% 9.74% Long-term liabilities related to the sale of automotive operations 0.00% 0.00% 0.92% 0.73% 0.40%
Deferred income taxes 0.52% 0.49% 1.63% 1.11% 0.00% Minority interests in consolidated subsidiaries 0.00% 0.00% 0.00% 0.25% 3.12%
Total non-current liabilities 50.49% 48.10% 45.32% 46.20% 47.79% 63.13% 66.18% 67.24% 64.63% 62.22% 59.99% 57.92% 56.01% 54.24% 52.60%
Total Liabilities 67.02% 65.24% 57.73% 60.18% 71.37% 76.86% 78.87% 79.18% 76.08% 73.20% 70.51% 68.01% 65.68% 63.51% 61.49%
Stockholders’ equity:
Preferred stock 0.00% 0.00% 0.00% 0.00% 0.00%
Common stock 3.23% 3.07% 3.43% 4.35% 3.86%
Capital in excess of par value 0.72% 0.89% 1.51% 1.90% 1.71%
Retained earnings 45.03% 44.12% 55.56% 68.57% 56.23% 46.96% 44.34% 42.06% 41.97% 38.84% 35.98% 33.37% 30.98% 28.80% 26.81%
Cumulative other comprehensive loss -8.51% -6.24% -7.22% -11.82% -12.64%
40.47% 41.84% 53.29% 63.00% 49.16%
Less: common shares in treasury at cost -7.49% -7.08% -11.02% -23.18% -20.53%
Total stockholders’ equity 32.98% 34.76% 42.27% 39.82% 28.63% 23.14% 21.13% 20.82% 23.92% 26.80% 29.49% 31.99% 34.32% 36.49% 38.51%
Total Liabilities and Stockholders' Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
61
Cash Flow Statement
Net income was taken straight from the income statement. Then we ran ratios to
attempt to find a close relationship between operating cash flows and sales, net income,
operating income, gross profit, total assets, and even income before taxes. Unfortunately
we found no close relationship and do not feel comfortable with these numbers, but for
the sake of an extremely rough estimate we chose to link operating cash flows to sales at
an annual rate of 5.63%. We then assumed that Cooper will continue investing at the
previous 5 year average level (minus ’04 due to the divestiture). This puts our forecast
free cash flows to the firm at a loss for ’07, but recovering to a level of generating over
$100M a year in free cash flows starting in 2013.
62
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Operating activities:
Net income 111,845 73,836 201,372 (9,356) (78,511) (13,025) 21,069 56,954 143,456 150,422 157,727 165,386 173,417 181,838 190,668
Adjustments Income from discontinued operations (173,926) (5,677) (7,379)
Depreciation 177,867 185,295 109,805 108,340 132,860 Amortization of goodwill and intangibles 4,959 4,439 4,792 7,327 5,513
Deferred income taxes 33,221 1,678 (12,296) (16,522) (18,056)
Changes in operating assets and liabilities
Accounts receivable 23,668 (89,378) (8,379) (2,952) (30,823)
Inventories 33,709 13,216 (55,823) (62,715) (1,557)
Other current assets (24,765) 28,156 3,981
Prepaid expenses (10,174) 17,310
Accounts payable 6,523 42,504 44,154 (21,329) 14,779
Accrued liabilities (28,355) (26,388) 1,106 15,931 4,532
Other non-current items (28,210) 19,326 (91,335) 30,100 24,788
CFFO 325,053 234,582 101,972 53,617 115,717 146,649 148,259 152,673 160,087 167,861 176,012 184,560 193,522 202,919 212,773
CFFI (128,715) (162,027) 921,614 (172,900) (230,599) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560)
CFFF (234,422) (60,841) (205,081) (486,240) 62,889 Free Cash Flows to the Firm 196,338 72,555 1,023,586 (119,283) (114,882) (26,912) (25,301) (20,887) (13,473) (5,699) 2,452 10,999 19,962 29,359 39,213
63
Forecasting Conclusion
Our forecasts basically say that we believe that Cooper Tire’s restructuring will
begin to earn shareholders a decent return in the marketplace in about three years.
Investors are likely to lose a little in the coming year due to the unraveling of new
processes, management structures, and new equipment; however, as the efficiency
associated with these changes develops we believe investors will see a sustained increase
in net income.
64
Valuation Analysis With this set of forecast financials for Cooper Tire, we can begin to look into
what the firm is worth. Valuing a firm is crucial for a variety of reasons: investors want to
know if the price they are paying is good, bad, or fair, banks want to know how much
money they can safely lend to the firm, suppliers want to know how big the risk of a long
term contract would be, and retailers want to know how long the firm will be continuing
to provide goods to them, and at what price. Firm valuation helps those constituents with
all of those things.
Cost of Equity Estimation:
First, we looked into how much it costs Cooper to use outside capital to grow the
business. We attempted to use the traditional Capital Asset Pricing Model to determine
our cost of equity; however, this model provided an extremely unrealistic Ke for our firm. We were, however, pleased with the Beta that was calculated using CAPM. Beta is a
measure that describes a firms risk relative to the market (in this case the S&P 500). For
instance, a firm with a beta of 2 is twice as risky as the market and a firm with a beta of 1
has a risk level equal to the market. In order to calculate Cooper’s beta, we gathered the
most recent 90 months of historical closing price and dividend data for our firm. For our
risk free rate we used data gathered from http://research.stlouisfed.org/fred2/ for 3
months, 1 year, 5 year, 7 year, and 10 year constant maturities. For our expected return
on the market, we gathered 90 months of historical returns for the S&P 500. Subtracting
the risk free rates from these returns gave us our market risk premiums. We then ran a
regression using the data from each risk free and its corresponding market risk premium
series using the following time horizons: 24 months, 36 months 48 months, 60 months,
and 72 months. From this data we estimated our beta to be 2.14. We found that this beta
was acceptable to use because it yielded an adjusted R squared (explanatory power) of
30.06%. Cooper’s published beta was 1.87; therefore, our estimates say that Cooper is
even more risky than the market relative to what yahoo finance analysts believe.
Once we got our beta we then used the most current months risk free data for each
series along with the corresponding betas to yield the cost of capital at each point on the
yield curve. The cost of equity is an important number because it is also the rate that
65
investors require for their investments. Our monthly cost of equity was calculated as
follows:
Ke = rf + B(MRP)
2.5% = .00421 + 2.14609 (.00985) We found this to be unacceptable because this monthly Ke would yield a yearly Ke of
30.0%. In order to derive a number that we would have more confidence in, we used a
formula that is based on the residual income model. The model that we used says that
subtracting 1 from the price/book ratio should equal the firm’s return on equity less its
cost of equity, all divided by its cost of equity less the firms growth rate. This model
yielded a Ke of 9.4%. Although we had expected a number that was a few percentage
points higher than this (due to the firms risk level), we were much more confident using
9.4% than 30.0%.
Ke Calculation using Residual Income variation (P/B) - 1 = (ROE - Ke)/(Ke - g)
PPS @ 12/31/06 $14.30 BPS @ 12/31/06 $10.27
Approx. Average ROE (2001-2004) 10.00%Assume Estimated Growth 8.00%
(14.30/10.27) - 1 = (0.10 - Ke) / (Ke -
0.08) 1.39 - 1 = (0.10 - Ke) / (Ke - 0.08)
0.39 * (Ke - 0.08) = 0.10 - Ke 0.39Ke - 0.0312 = 0.10 - Ke
0.39Ke + Ke = 0.10 + 0.0312 1.39Ke = 0.1312
Ke = 0.1312 / 1.39 Ke = 0.94388
Ke = 9.4%
Cost of Debt
Next we took a weighted average of each of Cooper Tires different forms of debt
in order to derive a weighted average cost of debt for the firm. After doing so, we found
Coopers Kd to be 7.5%.
66
Weighted Average Cost of Debt Calculation
Source Amount 2006
Interest Rate Weight
Notes payable Est. 112,803 0.0625 0.070705684 0.004419105Accounts payable Est. 238,181 0.0625 0.149293463 0.009330841Accrued liabilities Est. 171,570 0.0625 0.107541238 0.006721327Income taxes FED 4,698 0.0497 0.002944738 0.000146353
Total current liabilities 527,252 0.330485123 Long-term debt 10k 513,213 0.0761 0.321685383 0.024480258Other long-term liabilities Est. 554,923 0.085 0.347829494 0.029565507
Total non-current liabilities 1,068,136 0.669514877 Total Liabilities 1,595,388 1
0.074663392 Kd = 7.5%
Weighted Average Cost of Capital (WACC)
WACC is Cooper’s average borrowing rate from any source. WACC is simply a
weighted average of the respective debt and equity financed proportions of the firm
multiplied by their individual rates. Debt financing is tax deductible, therefore, the
WACC formula accounts for this as well. Our estimated WACC came out to be 6.5%.
We will use this number later when to determining the present value of Cooper’s free
cash flows.
Summary
Ke 9.4%
Kd 7.5%
WACC 6.5%
Comparables Valuations
The method of comparables was not a big help in our analysis. A lot of the
information was not available to us which of course made it extremely difficult to have a
justifiable decision about the value of these companies. By using the method of
comparables we were unable to identify a measure that was value-relevant. In calculating
the industry average we decided to not include Cooper Tires in our average calculation.
67
2001 2002 2003 2004 2005
PPS 15.96 15.34 21.34 21.55 15.32 EPS 0.25 1.52 1 2.87 -0.15
EPS Growth 508.00% -34.21% 187.00% -105.23% BPS 12.5 11.79 13.05 15.15 12.89 DPS 0.315 0.42 0.42 0.42 0.42
Market/Book 1.28 1.3 1.64 1.42 1.19
Bridgestone 2001 2002 2003 2004 2005
PPS N/A N/A N/A N/A N/A EPS 0.15 0.45 0.97 1.29 1.8
EPS Growth 200.00% 115.56% 32.99% 39.53% BPS 7.45 7.81 9.75 10.56 11.25 DPS
Goodyear 2001 2002 2003 2004 2005
PPS 22.4 8.24 12.75 17.2 16.8 EPS -1.16 -7.13 -4.61 0.66 1.3
EPS Growth 514.66% -35.34% -114.32% 96.97% BPS 27.95 30.27 30.26 32.18 31.55 DPS
Market/Book 1.37 5.64 -37.01 30.36 1.95
Michelin 2001 2002 2003 2004 2005
PPS N/A N/A N/A N/A N/A EPS 2.52 4.6 4.72 4.57 6.22
EPS Growth 82.54% 2.61% -3.18% 36.11% BPS 16.37 1.46 -0.184 0.42 0.41 DPS
Market/Book
CTB 1.19 BRDCY N/A GT 1.95
Industry 1.95 CTB BPS 12.89
Est. Share Price $25.14
68
The Market/Book ratio estimates the share price to be $25.14. This ratio shows
that the current share price for Cooper Tires is undervalued at $15.32. We were unable to
calculate the Market/Book ratio for Bridgestone and Michelin because the information
was not provided. These numbers were derived by dividing the price per share by the
book value of equity per share. After these numbers were derived we took the industry
average and multiplied it by Cooper’s earnings per share for the current period in order to
get the estimated share price.
Dividend/Price
We were unable to calculate this ratio because we were unable to get the
dividends per share for all of the companies. We failed to get the dividends per share for
Michelin because it’s not an American company. The information for Goodyear and
Bridgestone was not available to us. But if the information was available to us we would
calculate this ratio by dividing the dividends per share by the price per share. Then we
would divide Cooper’s dividend per share by the industry average and that would give us
the estimated share price. Then we would have to determine if Cooper is undervalued or
overvalued by comparing the estimated share price to Cooper’s current price per share.
Trailing P/E
We were unable to calculate this ratio because we will not get Q1 until May 2.
But if the information was provided to us we would calculate this ratio by dividing the
price per share for that period divided by the earnings per share from the last period.
After these numbers are derived we would then take the industry average and multiply it
by Cooper’s earnings per share in order to get the estimated share price. Then we would
have to determine whether or not the current share price is undervalued or overvalued by
comparing the current share price to the estimated share price.
Forward P/E
We were unable to calculate this ratio because the forecasted earnings per share
for Cooper’s first year was a negative number. But if the information was different then
we would calculate this ratio by taking the price per share for that period divided by the
69
projected earnings per share for the next period. After these numbers are derived we
would then take the industry average and multiply it by Cooper’s earnings per share in
order to get the estimated share price. Then we would have to determine whether or not
the current share price is undervalued or overvalued by comparing the current share price
to the estimated share price.
P.E.G. Ratio
We were unable to calculate this because the growth rate for Cooper is greater
than 100% and that would lead to a negative ratio. This ratio is calculated by taking the
P/E divided by subtracting one from the earnings per share growth rate. After these
numbers are derived we would then multiply the industry average subtracting one from
the earnings per share growth times Cooper’s earnings per share in order to get the
estimated share price. Then we would have to determine whether or not the current share
price is undervalued or overvalued by comparing the current share price to the estimated
share price.
Intrinsic Valuation Methods: Discounted Dividends Valuation Model
The first model that we used is the discounted dividends model. We began by
discounting each of our forecast dividends for the next 10 years by their respective
present value factors. Next, we determined the value of the dividend in year 11 and used
that as the perpetuity value. We calculated that value of this perpetuity by dividing it by
the cost of equity less the growth rate. The result of this calculation must then be
discounted by the year 10 present value factors to yield the PV of the terminal value
perpetuity. Adding the present value of Cooper’s forecast dividends to the present value
of the terminal value perpetuity yields its intrinsic share price. We then calculated a
variety of share prices based upon varying growth rates and cost of equity levels.
70
Sensitivity Analysis g 0 0.05 0.08 0.09 0.09 $5.78 $8.91 $21.52 67.76 Ke 0.094 $5.63 $8.65 $20.82 65.44 0.1 $5.41 $8.28 $19.82 62.12 0.11 $5.08 $7.70 $18.27 $57.00 0.12 4.78 7.18 16.86 52.35
( 60% overvalued/40% undervalued)
As you can see, we are left with a number of estimated share prices that range
from $4.78 to $67.76. Given that the firms actual share price was $19.10 on the valuation
date we calculated the percentage of the valuations that implied an overvalued share price
and an undervalued share price. Statistically, this model says that Cooper Tire is
overvalued.
Discounted Free Cash Flows Valuation Model
The next model we used values the firm based on the forecast statement of cash
flows. We determined the firms free cash flows by reducing forecast operating cash flow
by the forecast investing cash flow and then discounted each of these figures by their
respective present value factors. Again, we estimated a perpetuity value. The present
value of the perpetuity was derived by dividing it by the weighted average cost of capital
less an estimated growth rate. This number was then discounted by the year 10 discount
factor. We then added the present value of the year by year cash flows to the present
value of the perpetuity. In order to derive the market value of equity (estimated share
price), we subtracted off the book value of debt from this figure and divided it by the
number of shares outstanding. The main problem with this valuation method is that cash
flows are notoriously difficult to forecast and have a fairly low explanatory power.
Nevertheless, our calculations yielded the following results:
71
Sensitivity Analysis
g 0 0.04 0.05 0.06
WACC 0.05 $23.74 $185.87 N/A N/A
0.065 $9.45 $52.89 $99.96 335.27
0.07 $6.11 $38.22 $66.32 150.63 0.08 $0.74 $19.99 $32.83 $58.49 0.09 N/A $9.16 $16.20 $27.93
(30% overvalued/70% undervalued)
Once again, Cooper’s actual share price is $19.10; therefore, our sensitivity
analysis yields a 30% probability that the firm is overvalued and a 70% probability that
the firm is undervalued.
Residual Income Valuation
This valuation model is based on the concept of discounting any earnings that are
over a benchmark level. It also links balance sheet information with income statement
numbers. A “normal income” benchmark is established by multiplying investors’
expectations (Ke) by the previous years ending book value of equity. Each year’s book
value of equity is derived using last years ending value as a starting point and then adding
the net income for the period and subtracting the dividends. This yields an ending book
value of equity which is the beginning book value for the next period and so on and so
forth. Once all normal income numbers are calculated, net income is subtracted from
them. Any net income that is over the normal income is then discounted by the respective
present value factor. A terminal value perpetuity was then determined and discounted
using the same method as the previous models; however, theoretically you would not
continue to beak your benchmark forever, so a negative growth rate is used which allows
us to shrink Coopers terminal value perpetuity to zero (it actually approaches zero but
never gets there). The present value of the year by year residual earnings and the present
value of the terminal value perpetuity were then divided by the number of shares. These
72
numbers are added to the beginning book value of equity per share at 12/31/06 (the last
balance sheet date) to determine the intrinsic share price.
Sensitivity Analysis g
-0.1 -0.2 -0.3 -0.4 -0.5
Ke 0.9 $28.98 $28.98 $28.98 $28.98 $28.98 0.094 $29.80 $28.71 $28.17 $27.85 $27.64 0.1 $29.57 $28.58 $28.09 $27.79 $27.59 0.11 $29.22 $28.39 $27.97 $27.71 $27.53
0.12 $28.94 $28.23 $27.86 $27.63 $27.48
(100% undervalued)
The range of growth rates and cost of equity that we used for this model,
combined with the actual share price of $19.10 yields a 100% undervalued conclusion
using this model. Of all the models we use, the residual income model has the highest R2
(explanatory power); therefore, if we assume that our forecasts are fairly accurate, we
should be confident that the firm is undervalued.
Abnormal Earnings Growth
Abnormal earnings growth is based upon the same general premise that the
residual income model is based on: beating a benchmark. This model assumes that
dividends are reinvested at the rate that investors require (Ke). Therefore multiplying the
forecast dividends by Ke gives you a DRIP earnings. Net income is added to the DRIP
earnings to yield the cumulative dividend earnings. This number is then reduced by the
normal income (previous period net income multiplied by the cost of equity) to determine
the year by year abnormal earnings growth. These numbers are then discounted. The
perpetuity in this model is treated in a similar manner as the one in the residual income
model. We use a negative growth rate to shrink the abnormal earnings to zero because we
do not expect to continue to beat our benchmark forever. The intrinsic share price for this
model is found by adding to present value of the year by year to the present value of the
perpetuity and the core EPS (forecast EPS in for 4/1/08).
73
Sensitivity Analysis g -0.1 -0.2 -0.3 -0.4 -0.5
Ke 0.09 $30.35 $30.10 $29.98 $29.91 $29.86 0.094 $28.23 $28.00 $27.89 $27.83 $27.79 0.1 $25.41 $25.22 $25.12 $25.07 $25.03 0.11 $21.50 $21.35 $21.28 $21.23 $21.20 0.12 $18.36 $18.25 $18.19 $18.15 $18.12
(20% overvalued/80% undervalued)
This model looks to say that if the firms cost of equity are approximately 11.5% it
would be correctly valued; however, statistically under this model Cooper tire is again
undervalued. The means that investors are not seeing the same growth prospects that our
analysts our seeing.
Altman Z-score Credit Analysis
The Altman z-score is a measurement of financial health and an indicator of the
probability of bankruptcy for a company. A score of 1.8 or less would forecast a
bankruptcy. Cooper Tire has an average score of 2.84 from 2002-2006. Although Cooper
technically lies in the gray area, this number is just slightly below 3.0 which is the
benchmark of a financially secure company; therefore, we do not feel that it is low
enough to raise concern.
74
All numbers are in 1000's of $ number of shares 61400.00 2002 2003 2004 2005 2006 Total Assets 2629551 2781140 2514685 1985159 2235279 Retained earnings 1184115 1226999 1397268 1361269 1256971 Total current assets 860528 1024409 1642479 968801 1009124
Total current liabilities 434576 476727 311965 277597 527252 Working Capital 425952 547682 1330514 691204 481872 Net Sales 3329957 3514399 2081609 2155185 2676242 Total Liabilities 1762254 1814549 1451636 1194667 1595388 Market Value of Equity 1261770 1080026 1412200 1235368 1172740 Earnings before intrest and taxes 252784 182046 62575 40160 -44788 Z-Score 0.82 0.85 1.41 1.38 1.05 0.32 0.22 0.08 0.07 -0.07 0.43 0.36 0.58 0.62 0.44 1.27 1.26 0.83 1.09 1.20 Avg.Total 2.84 2.69 2.91 3.15 2.62 2.84
Valuation Conclusion
Analysis of the combined results of the valuation models leads us to believe that
Cooper Tire is undervalued. The discounted free cash flows, residual income, and
abnormal earnings models all say that Cooper is undervalued. Residual income, the best
model in terms of explanatory power, gave us share prices that all say Cooper is
undervalued. We were also pleased with the amount of the share price that was included
in the terminal value perpetuity in the residual income and AEG models. Terminal value
forecasts are the most unknown and are often referred to as “wishful thinking” therefore;
having only a small amount of Cooper’s estimated share price based on this number is a
good thing. In conclusion, with reasonable estimation say that Cooper Tire is an
undervalued firm.
75
References 1. Bridgestone/Firestone Website www.bridgestonetire.com
2. Cooper Tire Website www.coopertire.com
3. Goodyear Tire Website www.goodyear.com
4. Michelin Website www.michelin.com
5. Palepu, Healy and Bernard, Business Analysis and Valuation (Ohio:
Thomson-Southwestern, 3rd Edition, 2004)
6. Yahoo Finance www.finance.yahoo.com
7. www.edgarscan.pwcglobal.com
8. www.moderntiredealer.com
76
Appendix I
10 Year Beta R^2 Ke 72 0.983501 0.13381 0.01389 60 1.103196 0.128029 0.01510 48 2.151025 0.298959 0.02571 36 1.665799 0.137335 0.02080 24 2.795223 0.276764 0.03224 7 Year Beta R^2 Ke 72 0.982879 0.133687 0.01389 60 1.103162 0.128013 0.01510 48 2.149708 0.299235 0.02571 36 1.668785 0.137541 0.02084 24 2.79431 0.276109 0.03224 5 Year Beta R^2 Ke 72 0.983771 0.133895 0.01389 60 1.104782 0.128321 0.01512 48 2.148253 0.299673 0.02570 36 1.672928 0.137981 0.02088 24 2.7934 0.275616 0.03223 1 Year Beta R^2 Ke 72 0.989849 0.135524 0.01396 60 1.115492 0.130514 0.01520 48 2.146094 0.300624 0.02535 36 1.68856 0.138948 0.02084 24 2.781553 0.270612 0.03161 3 Month Beta R^2 Ke 72 0.98952 0.13562 0.01162 60 1.11725 0.13094 0.01257 48 2.14815 1.11725 0.02020 36 1.68820 0.13821 0.01679 24 2.77432 0.26744 0.02483
77
Appendix II
Discounted Dividends Valuation Model
Assume a WACC = 0.09 and a cost of Debt = 0.06
The Estimated Dividends after 2017 are $0.15 per share with no growth
Years from value date 1 2 3 4 5 6 7 8 9 10
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Perp
DPS 0 0.420 0.430 0.440 0.451 0.462 0.473 0.484 0.496 0.508 0.520 0.600
Present Value Factor 0.914 0.836 0.764 0.698 0.638 0.583 0.533 0.487 0.445 0.407
PV of Future Dividends 0.384 0.359 0.336 0.315 0.295 0.276 0.258 0.242 0.226 0.212
Total PV of Forecast Future Dividends $2.97
Continuing (Terminal) Value $42.86
PV of Terminal Value $17.85
Estimated Value per Share @ 4/1/07 $20.82
Actual PPS @ 4/1/07 $19.10
EPS -0.24 0.42 1.20 3.15 3.44 3.77 4.12 4.50 4.93 5.39
DPS 0.420 0.430 0.440 0.451 0.462 0.473 0.484 0.496 0.508 0.520
Book Value Per Share @ 12/31/06 $10.27
Sensitivity Analysis
g
Ke 0.094 0 0.05 0.08 0.09
growth rate 0.08 0.09 $5.78 $8.91 $21.52 67.76
Ke 0.094 $5.63 $8.65 $20.82 65.44
0.1 $5.41 $8.28 $19.82 62.12
0.11 $5.08 $7.70 $18.27 $57.00
0.12 4.78 7.18 16.86 52.35
78
Appendix III
Discounted Free Cash Flow Valuation Model
* 61.328 million shares outstanding
*Assume Free Cash flow from 2017 on will be 200 million.
Cooper Tire Company (Amounts in 1000's of $ except per share data)
1 2 3 4 5 6 7 8 9 10
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Perp
CFFO 164,782
180,234
197,135
215,621
235,841
257,956
282,146
308,603
337,542 369194
400,000
CFFI (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (173,560) (200,000)
Free Cash Flow (to firm) (8,778)
6,674
23,575
42,061
62,281
84,396
108,585
135,043
163,981
195,634 200000
discount rate 0.939 0.882 0.828 0.777 0.730 0.685 0.644 0.604 0.567 0.533
Present Value of Free Cash Flows (8242) 5884 19517 32695 45457 57839 69875 81597 93035 104219
Total PV of Annual Cash Flows 509,842 Continuing (Terminal) Value (assume no growth) 3,076,923 Sensitivity Analysis
PV of Continuing (Terminal) Value 1,665,168 g
Value of the Firm (4/1/07) 2,175,009 0 0.04 0.05 0.06 Book Value of Debt and Preferred Stock $1,595,388 WACC 0.05 $23.74 $185.87 N/A N/A
Value of Equity (12/31/07) 579,621 0.065 $9.45 $52.89 $99.96 335.27
Est. Value per share @ 4/1/07 9.45 0.07 $6.11 $38.22 $66.32 150.63
Actual PPS (4/1/07) $19.10 0.08 $0.74 $19.99 $32.83 $58.49
0.09 N/A $9.16 $16.20 $27.93
WACC 0.065
terminal growth 0.00
79
Appendix IV
Residual Income Model
Assume a cost of Equity = 0.094
All data is stated in 1000's of $ except per share data
change In RI 44,049.24
48,001.28
115,309.29
2,558.75
2,617.09
2,676.55
2,737.12
2,798.80
2,861.59
1 2 3 4 5 6 7 8 9 10 perp
Forecast Years
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Beginning BE (per share) 639891 599469 598677 645178 810711 993698 1195823 1418927 1665027 1936328
net income $ (14,636) $ 25,614 $ 73,540 $ 193,221 $ 211,340 $ 231,158 $ 252,834 $ 276,543 $ 302,475 $ 330,839
Dividends per share 25,786 26,405 27,039 27,688 28,352 29,033 29,730 30,443 31,174 31,922
Ending BE (per share) 639891 599469 598677 645178 810711 993698 1195823 1418927 1665027 1936328 2235245
Ke 0.094
"Normal" Income 60149.75 56350.05 56275.63 60646.76 76206.85 93407.65 112407.37 133379.16 156512.52 182014.82
Residual Income (RI) (74,785.76) (30736.51) 17264.76 132574.05 135132.79 137749.89 140426.44 143163.56 145962.37 148823.95 1.50
Discount Factor 0.836 0.764 0.698 0.638 0.583 0.533 0.487 0.445 0.407
Present Value of RI (25681.48) 13185.86 92552.73 86233.13 80350.27 74873.41 69774.05 65025.69 60603.77
ROE 0.043 0.123 0.299 0.261 0.233 0.211 0.195 0.182 0.171
BV Equity (per share) 12/31/06 10.42 gr 187.5% 143.8% -13.0% -10.8% -9.1% -7.8% -6.8% -5.9%
Total PV of RI (4/1/07) 16.16
Continuation (Terminal) Value 3.81 Sensitivity Analysis
PV of Terminal Value (4/1/07) 1.59 g
-0.1 -0.2 -0.3 -0.4 -0.5
Estimated Value (4/1/07) $28.17 Ke 0.9 $28.98 $28.98 $28.98 $28.98 $28.98
Actual PPS @ 4/1/07 $19.10 0.094 $29.80 $28.71 $28.17 $27.85 $27.64
0.1 $29.57 $28.58 $28.09 $27.79 $27.59
0.11 $29.22 $28.39 $27.97 $27.71 $27.53
Growth -0.3 0.12 $28.94 $28.23 $27.86 $27.63 $27.48
Ke 0.094
80
Appendix V
Abnormal Earnings Growth Valuation Model
All data is stated in 1000's of $ except per share data
1 2 3 4 5 6 7 8 Perp
Forecast Years
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Net Income $ (14,636) $ 25,614 $ 73,540 $ 193,221 $ 211,340 $ 231,158 $ 252,834 $ 276,543 $ 302,475
DPS 25,786 26,405 27,039 27,688 28,352 29,033 29,730 30,443 31,174
DPS invested at 9.4% (Drip) $2,424 $2,482 $2,542 $2,603 $2,665 $2,729 $2,795 $2,862
Cum-Dividend Earnings $28,037 $76,022 $195,762 $213,942 $233,823 $255,563 $279,337 $305,337
Normal Earnings ($13,260) $28,021 $80,453 $211,384 $231,206 $252,886 $276,600 $302,538
Abnormal Earning Growth $41,298 $48,001 $115,309 $2,559 $2,617 $2,677 $2,737 $2,799
PV Factor 0.914 0.836 0.764 0.698 0.638 0.583 0.533 0.487
PV of AEG $37,749 $40,107 $88,067 $1,786 $1,670 $1,561 $1,459 $1,364 $1,500
RI check fugure $44,049 $48,001 $115,309 $2,559 $2,617 $2,677 $2,737 $2,799
aeg - check figure ($2,752) $0 $0 ($0) $0 $0 $0 ($0)
Core EPS $ (0.24)
Total PV of AEG $2.83
Continuing (Terminal) Value $0.02
PV of Terminal Value $0.03 Sensitivity Analysis
Total PV of AEG $2.86 g
Total Average EPS Perp (t+1) $2.62 -0.1 -0.2 -0.3 -0.4 -0.5
Capitalization Rate (perpetuity) 9.40% Ke 0.09 $30.35 $30.10 $29.98 $29.91 $29.86
0.094 $28.23 $28.00 $27.89 $27.83 $27.79
Est. Value Per Share @ 4/1/07 $27.89 0.1 $25.41 $25.22 $25.12 $25.07 $25.03
Actual Price per share @ 4/1/07 $19.10 0.11 $21.50 $21.35 $21.28 $21.23 $21.20
Ke 0.094 0.12 $18.36 $18.25 $18.19 $18.15 $18.12
g -0.3
81