Cooper Tire & Rubber Company
Q4 2016 Earnings Call Transcript

Published: 17 Feb 2017

[Operator:]

Good morning and welcome to Cooper Tire & Rubber Company's Fourth Quarter and Full Year 2016 Earnings Call and Webcast. At this time, all participants on the call are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Jerry Bialek. Please go ahead.

[Jerry Bialek:]

Good morning, everyone, and thank you for joining the call today. This is Jerry Bialek, Cooper's Director of Investor Relations and Strategic Planning, and I am here with our Chief Executive Officer, Brad Hughes; and Ginger Jones, our Chief Financial Officer. During our conversation today, you may hear forward-looking statements related to future financial results and business operations of Cooper Tire & Rubber Company. Actual results may differ materially from current management forecasts and projections. Such differences may be a result of factors over which the company has limited or no control. Information on these risk factors and additional information on forward-looking statements are included in the earnings release we issued earlier this morning and in the company's reports on file with the SEC. During this call, we will provide an overview of the company's fourth quarter and full year 2016 financial and operating results, as well as the company's business outlook for fiscal 2017. Our earnings release includes a link to a set of slides that summarize information included in the news release and in the 10-K that will be filed with the SEC later today. Following our prepared remarks, we will open the call to participants for a question-and-answer session. Now, I'll turn the call over to Brad.

[Bradley E. Hughes:]

Thanks, Jerry, and good morning, everybody. This morning, I will begin with a brief overview of our full year 2016 financial results, along with an update on Cooper's progress towards our strategic priorities. After that, I will turn the call over to Ginger for a discussion of our fourth quarter and full-year financial performance, the current business environment and capital allocation. I'll then return to present our business outlook for 2017. And then, we'll take your questions. With that, I am happy to report that Cooper delivered another excellent quarter, providing a strong finish to 2016. Our financial achievements for the year include net sales of $2.92 billion, down slightly from last year. This is primarily due to net price reductions related to lower raw material costs and negative currency impact. Unit volumes increased 2.6% year-over-year, including an almost 8% year-over-year unit volume increase in the fourth quarter, driven by strong growth in Asia and Latin America. Operating profit reached $384 million and operating profit margin was 13.1% of net sales. That's a new full year record for operating profit margin for Cooper, a great achievement by our teams around the globe. Excluding $12 million in non-cash pension settlement charges, operating profit would have been $397 million or 13.6% of net sales. This essentially matches our record full year operating profit achieved in 2012. Diluted earnings per share were $4.51. Cooper continued to return cash to shareholders through our capital allocation plan, which Ginger will discuss in more detail later, including the announcement we made earlier today regarding our increased and extended share repurchase program. I'm also pleased to report we achieved an impressive 18.9% return on invested capital for the year. We are proud of our performance. And again, I want to thank all of our employees around the world for their hard work and strong execution of our strategic plan. Now, let's talk about how we arrived at this level of performance. Nearly three years ago, we outlined a multi-year business transformation strategy. The strong results I just talked about are directly attributable to that plan. And I'm excited to say that we are only in the middle innings of this strategic transformation as we continue to execute our priorities of driving top line profitable growth, developing a highly competitive cost structure, and building even stronger organizational capabilities. Significant changes to our business model have allowed us to structurally improve operating margins over time. For example, we continue to leverage our global manufacturing footprint and near source supply strategy while maintaining a focus on reducing cost to secure our value proposition and enhance profit margins. In the U.S., our manufacturing teams continue to modernize our facilities to support growth and demand for tires with larger rim sizes and other higher margin products. We are also continuing to add automation at our facilities to strengthen our long-term competitiveness. In Europe, we are investing in new tire building equipment at our Serbia plant to expand capacity and build larger diameter tires, leveraging this cost-effective facility for future growth not only in Europe but also in the Middle East and other markets around the world. In Asia, we continue to upgrade plant capabilities to meet the rigorous requirements of our original equipment, or OE, customers and are now serving more than 10 OE accounts. In total, domestic China unit volumes were up 44% in 2016. In Latin America, we transitioned our plant in Mexico to a seven-day operating schedule and developed tires specifically for the Latin America region across three major brands

[Ginger M. Jones:]

Thank you, Brad. I'd like to start by addressing issues in the current business environments, beginning with raw material cost. As noted during our third quarter call, we anticipated that our raw material index would be up modestly in the fourth quarter. Our actual index increased more than we expected from 141.2 in the third quarter to 147 in the fourth quarter, as shown on slide six of the supplemental slide deck. This is a sequential increase of over 4%. On a year-over-year basis, the index is up approximately 1% from the same quarter in 2015. As we look forward, we anticipate a double-digit sequential increase in raw material costs in the first quarter of 2017, followed by more modest increases sequentially through the reminder of the first half, and then leveling off in the second half. To put that into better context for you, this translates to a roughly 25% increase in the first half of 2017 compared with the first half of 2016. As a reminder, in the United States, we use the LIFO accounting method, charging the most recent costs against sales, which impacts profits more quickly than other inventory accounting methods. More specifically, we are seeing significant cost increases for both synthetic and natural rubber. The increase in synthetic rubber pricing is driven primarily by a forecasted reduction in supply of butadiene, a feedstock used to make synthetic rubber. This reduction is the result of some production facilities being out of service for maintenance. We believe that the increase in natural rubber pricing is being driven by both increased investment and speculation in the commodities markets as well as increased demand from China. Crude oil costs have remained in line with our projections over the past quarter. With these recent increases in raw material costs, we expect to see increases in tire prices as well. We have seen widespread price increase announcements in all regions where we do business. In the U.S., most of those price increases will start on March 1, as will ours. Brad will cover implications for 2017 in more detail when he talks about our outlook in a few minutes. Moving to the TBR tariff, in January, the Department of Commerce announced the final amounts for prospective countervailing, CVD, and antidumping, AD tariffs and offsets that, in effect, make the AD rate zero for all companies. This leads only the CVD tariff, which were Cooper and most other importers, is now at 42.16% as recently announced by Commerce when ministerial errors were corrected and reductions were made in the previously announced CVD. Remember, this is not the end of the process. The next phase is for the International Trade Commission, the ITC, to complete its own investigation. The ITC is scheduled to make this decision next week. If the ITC finds material injury or threat of material injury to the domestic truck and bus tire industry, the final tariffs will become effective. If the ITC does not find material injury or threat of material injury, the investigations will be terminated and no tariffs will be collected. Regardless of the outcome, we remain committed to continuously delivering high-quality tires and superior value to our TBR customers and to remain competitive. Beyond the Chinese TBR tariff situation, there has been much talk about potential tax and trade reform. Broadly speaking, our global footprint, including our three U.S. plants, and our near sourcing strategy position us well. Cooper supports tax and trade reform that will make the U.S. more competitive on a global basis, but we won't speculate beyond that. Before I discuss our 2016 results, I'll give a short update on the January 22 tornado that damaged the Albany, Georgia warehouse that we leased. The facility sustained significant damage and is not currently operational. There were no injuries at the facility, which is operated for Cooper by a third-party logistics firm. We immediately activated our logistics contingency plan and began to reroute customer orders to other facilities in our network to minimize disruption. As of today, we believe that we can serve our customers from other Cooper warehouses. We are evaluating the damage to the inventory in the warehouse and the costs from responding to the situation. While some of these costs will likely be offset by our insurance, it is too early to provide an estimate of cost that we will incur, but we can say that there will be costs related to this event in our first quarter 2017 results. I'll now move to results. As Brad mentioned, our fourth quarter and 2016 performance was strong. Beginning with the fourth quarter, sales were $784 million, up from $776 million in 2015. This 1.1% increase was driven primarily by the impact of higher unit volume, which was partially offset by unfavorable price and mix, primarily due to net price reductions related to raw material costs as well as negative currency impact. Operating profit was $105 million or 13.4% of sales compared with $103 million or 13.2% of sales in 2015. Fourth quarter operating profit compared with 2015 was positively impacted by the following factors, which are summarized on page seven of the supplemental slide deck

[Bradley E. Hughes:]

Thanks, Ginger. In summary, Cooper had another excellent year, putting us in very strong position as we head into 2017. Our performance reflected continued great results in the Americas segment from both a volume and an operating profit perspective. We see very positive unit volume growth in our fast-growing markets of Latin America and Asia, and we're encouraged with the turnaround of our international segment moving from a loss in 2015 to a profit in 2016. Looking ahead, we expect global tire markets will remain highly competitive. For the full year 2017, we expect unit volume growth in each of our four segments. Our strong track record of investments, new product development and improving mix of sales for higher value, higher margin tires gives us confidence in this outlook. Raw material costs have been increasing rapidly and, as Ginger said, we've seen widespread pricing announcements, including our own, but these price increases will lag the material cost increase for Cooper. Therefore, our operating margins will likely be lower than 2016 levels. With raw material costs leveling off during the first half of 2017 and pricing actions by Cooper and competitors beginning to take place, we anticipate that full year 2017 operating profit margin will be at the high end of our previously projected 8% to 10% range. This is based on operating profit margins around the low end of this range in the first half of the year as pricing lags raw material cost increases and operating profit margins above the high end of the range in the second half of the year when we expect raw material cost increases to level out and pricing to catch up. We remain confident in the strength of the Cooper business model and believe significant levers remain to further improve our business based on continued execution of our strategic plan. These levers include cost reductions in the way we design and manufacture our products, including automation and process improvement and in how we procure materials. Mix enhancement, a continued shift to larger, more premium HVA tires driven by trends in OE vehicles, growth in scale particularly in Asia and Latin America, optimization of our global manufacturing footprint and continuing to expand margins in the international segment. With these opportunities and others, we are confident that as price increases are implemented and raw material costs stabilize, further improvements in operating profit are achievable. The increase in extended share repurchase program we announced today demonstrates our commitment to return cash to shareholders and reflects our confidence in the financial strength and long-term outlook for the business. Our results in 2016 show that Cooper is making the right investments in the business to help us compete effectively in a volatile economy and industry. With that, let's move to your questions. Operator, will you take the first question, please?

[Operator:]

We will now begin the question-and-answer session. Our first question comes from Rod Lache with Deutsche Bank. Please go ahead.

[Rod Lache:]

Good morning, everybody. I had a couple of questions. First, just on the price increases, you mentioned that they're going to be in place around March 1. So I would assume that they're basically all in for this full second quarter. But it sounded like you thought raw materials would not be fully offset during the second quarter. So could you just maybe give us a sense of is there a phase-in of the pricing, or do you feel that additional price increases are going to be required beyond what you've already announced?

[Bradley E. Hughes:]

Rod, thank you. A couple of comments. One is that, as always, as we look at price increases, our intent is to remain market-facing, and that's both in terms of the magnitude of the price increases and also the timing of the price increases. So, as we watch what was happening in the market, we began to implement or we will begin to implement price increases beginning March 1. It can take a little bit of time to implement those price increases, but I think that they will go into effect relatively quickly. Having said that, as we look at raw materials, the other part of the equation, we believe that those will only begin to level off as we get into the second quarter. So there will be some movement upwards from where we're at today in terms of raw material cost, and we'll continue to monitor. Again, we'll watch what competition is doing in making sure that we've got competitive pricing for our customers. At the same time, we'll be looking at our cost structure and doing everything we can to drive margins.

[Rod Lache:]

Okay. Just to clarify, your price increases are fully in effect by the end of Q1, so are you saying that Q2 still won't reflect full benefit of those price increases or are you expecting to fully offset the raw material headwinds by Q2 with the pricing that you've already announced?

[Bradley E. Hughes:]

So we think that the vast majority, I don't know if it'll be every element of the pricing, but the vast majority of the pricing action should be in place by the end of the quarter. However, our outlook is that raw materials will be a bit higher in the second quarter than they are in the first quarter, and that will sequentially, that will be reflected in the second quarter at this point. So we'll have the pricing that we've announced now. We'll begin to implement that March 1. It should be largely in place by the end of the quarter. But we're expecting our outlook for a little bit of incremental growth in the raw material index going into the second quarter.

[Rod Lache:]

Okay. And...

[Bradley E. Hughes:]

But, Ginger, do you want to add something to that?

[Ginger M. Jones:]

Yeah, Rod. I just wanted to add. So we think that raw material cost will still be a bit of a headwind in the second quarter. And it is still a dynamic raw material environment today. So, we, along with the rest of the industry, will be watching those raw material pricing. And, as Brad said, we will be market-facing and consistent with our competitors.

[Rod Lache:]

Got it. And I was hoping you could just address a question that – obviously, everybody is characterizing the tire industry as having different dynamics at the high end versus the low end, or HVA versus broadline. And clearly, the supply/demand dynamics are really, really good at the HVA side of the business. When we look at the composition of Cooper's business, how are you guys sort of broken down in terms of the higher end versus the broadline today? And is the fact that your light vehicle shipments were somewhat lower than the broader market during Q4 and also during the full-year 2016, is that reflective of the exposure to the broadline, which is a bit of a drag?

[Bradley E. Hughes:]

No, I wouldn't characterize it that way. Let me go in the reverse order of the way that you asked the question, Rod. In the fourth quarter, we did see a continuation of the decline in our private brand distributor business. But that isn't necessarily a type of tire discussion, it's a channel discussion. And so, that one is more reflective of just that part of the business is becoming smaller for us, and we're growing in the rest of the business and, in particular, in our branded business. As I mentioned, we were up 1.6%, if you exclude that private brand distributor business, and we look at that more as a channel versus a type of tire discussion. When you get to the makeup of our business right now, we are probably, based on the information that we have – and we've shared this at conferences recently, we're a bit behind the industry in terms of the percentage of our business that's higher value-add. We actually look at that as a positive, Rod, because we are growing in that area, like the industry. We just have more room to grow at this point relative to where the rest of the industry is. So, we look at that down the road as a net positive contributor to Cooper.

[Rod Lache:]

Okay. So my last question then is, to the extent that you do have exposure to the broadline, which I would imagine broadly is shrinking, just given how much the HVA is growing, do you think that that represents a bit of a challenge in terms of supply/demand in that part of the market? What's the overall perspective on pricing dynamics for the broadline market?

[Bradley E. Hughes:]

We still are very positive in our outlook around the supply/demand equation in aggregate, so including the entire market on HVA. Within that, we think it's more challenged if there is more demand than there is supply. But even in aggregate – and it is shifting, Rod; it is changing. There is some of the tires that are smaller rim diameters or lower speed ratings, those are reducing in terms of their contribution to the market. But as we and others convert our capacity to provide the types of tires that our customers want to provide on – that shift, and as we're looking at that happening, total demand, if you look at it on a global basis, still seems to be pretty well balanced. Within that balance overall, there's actually a shortage at the HVA segments within that. So, from our perspective, that suggests that there's still going to be a positive dynamic for the market as we look forward.

[Rod Lache:]

Great. Thank you.

[Operator:]

Our next question comes from Christopher Van Horn with FBR & Company. Please go ahead.

[Christopher Van Horn:]

Good morning, guys. Congrats on the quarter and thanks for taking my call.

[Bradley E. Hughes:]

Hey, Chris.

[Christopher Van Horn:]

Hey. I just want to jump a little bit deeper, if we can, on the non-U.S. markets because the growth seems to be accelerating pretty rapidly there. And I just want to get a little more color, if you don't mind, on, are you seeing market share gains? Is it better product mix? Are there just industry tailwinds in places like Latin America and Europe that are driving some of the growth there, because it's really been impressive?

[Bradley E. Hughes:]

I think that it's more Cooper on driven right now. I mean, those markets are in general on – as we look at them, when we look down the road, especially we do think they will grow faster than some of the more mature markets, U.S., Western Europe. But right now, the performance that we're seeing there is based on things that Cooper is doing. In Asia, we have terrific growth going on in our original equipment business, which is at least 50% of the market over there. So it's important that we be a player in that market. It also creates demand in the replacement market. Consumers there are more likely to go to the tire brand that was on the vehicle than they are in other markets around the world when they make that first replacement cycle. And our team has just done a terrific job of demonstrating to vehicle manufacturers in China specifically that we're very competitive and we have terrific products to offer to them at a competitive price. So that's driving a lot of what's going on in Asia. In Latin America, as I mentioned in my comments on – we've done a couple of things. One is, we have developed products that are more specifically tailored for the markets that we're competing in, in Latin America. We have gone to a different – a slightly different distribution approach than we have been following previously down there, and that is helping us to penetrate some of the markets where we believe that we have an opportunity in, and there's some runway left there as well. So that combination of better distribution approach in Latin America and a better product portfolio is helping us there. So, I'd say that, in this case, while those markets are growing faster than some of the more mature markets that a lot of this is specifically what Cooper is doing.

[Ginger M. Jones:]

Yeah. And Chris, I would add also in International, it was not just Asia that did well. We also saw unit volume increases for Europe, and they also contributed to the better operating margin improvement that we saw across 2016. So, I think, as Brad said, it's a very positive message about all three of those markets for us.

[Christopher Van Horn:]

Okay, great. Thanks for the color. And then, on the timing of GRT, I think you kind of indicated 2018 as profitability contributing to the P&L. Is there any flexibility in that timing? And what are kind of couple of milestones that you might indicate here that gets you there? And again, is there any flexibility in the timing of that, i.e. could it happen earlier?

[Bradley E. Hughes:]

So, yes, we're projecting it's going to be accretive to operating profit as we enter 2018. Our expectation is that the financial performance of that partnership will improve as we move through 2017. Frankly, increasing the volume of tires that we're producing at that facility is going to be a key contributor to that happening. So to the extent that we get ahead of what we're projecting right now in terms of the growth and the production there and the benefits from that scale improvement, I guess, it could affect the timing. But right now, our best estimate, Chris, is that it will be accretive beginning in 2018.

[Christopher Van Horn:]

Okay. Thanks, again.

[Bradley E. Hughes:]

Thank you.

[Operator:]

Our next question comes from Ryan Brinkman with JPMorgan. Please go ahead.

[Ryan Brinkman:]

Hi. Great. Thanks for taking my question. How should we think about the guidance today for raw mats up 25% in 2017 relative to the announced price hikes of up to 8%? What level of price hikes would you say are needed to roughly offset the 25% increase in raw material price? And I understand that there's lag effect, so even the amount needed of price hikes would not offset it in 2017. But over time, is 8% sufficient, do you think, to offset 25% rise in raws or would you need to raise more?

[Bradley E. Hughes:]

Well, what we've communicated, Ryan, to our customers is that we were going to price up to 8%. And now our plan is that we're going to begin to implement that – start those price increases in March. And as we've highlighted, our approach to this is that we're going to watch and make sure that we are market-facing and that we're keeping our customers competitive with the pricing that we're offering to them, that we're watching what's happening with raw materials, and that we're responding as we can, given what the competition does with regard to pricing. We still – all of us are going to be monitoring what happens with raw materials. Do they continue to move up a little bit from where we are right now, which is what we're projecting as we go into the second quarter, and then essentially leveling off for the balance of the year? Might they come down a little bit from these levels? Might they go up a bit more? A lot of this is going to be dependent upon what happens with raw materials over the next several months. And right now, there has been a good step forward. We believe that Cooper with the pricing that we announced, it will begin to offset the raw material increase, especially as we get into the second quarter, but not fully as we've advised. And so, we will continue to monitor it. It's up sharply. And at this point, I think, we are just in a – we're in a situation where there has been a – we've made a good step forward talking about Cooper with the pricing that we've announced, and we'll see what the industry does and how we need to respond to that as we look forward.

[Ryan Brinkman:]

Okay. That's helpful. Thanks. And then, just my last question is about mix in the context of price, right? So, assuming that the tire manufacturers are successful in passing on the raw mat price increases, what do you think the impact will be to mix? Are the consumers going to find that the tires are more expensive, and so they'll look to downshift to lower value-add tires? Or are the prices of raw mats, the amount of raw mats is more or less the same in low cost – low value-add and high cost HVA tires such that the price differential between them becomes compressed, thus maybe incrementally incentivized for somebody to step into higher technology tire?

[Bradley E. Hughes:]

Ryan, I think that the demand for the type of tire is going to be largely driven by what's happening in the vehicle market and what people have on the vehicle today and what they need to replace it with going forward. I think where you might start to – where we did see some implications from pricing back on in the 2011 and 2012 timeframe when raw materials were at much higher levels than they are today, but it did affect the price of tires – was – where people shifted away to products that they thought were going to perform, the way they wanted them to perform and, last, the way they wanted them to last but maybe at a better price point. And we feel like that's a place where we fit very well that our value proposition as prices move up puts us in a very good place. We've got great products that we offer to our customers at a slightly lower price than some of the other large competitors out there. And as we maintain that and continue to deliver these great products that that may be some benefit down the road, depending on what happens with the price of tires.

[Ryan Brinkman:]

Okay. Very helpful. Thank you very much.

[Operator:]

Our next question comes from Bret Jordan with Jefferies. Please go ahead.

[Bret Jordan:]

Hi. Good morning, guys.

[Bradley E. Hughes:]

Hi, Bret.

[Ginger M. Jones:]

Good morning.

[Bret Jordan:]

Sort of a follow-up on that question. And I guess, as we look at the non-RMA members picking up some unit share last year it would seem, what's your visibility as far as their pass-through on pricing? Do you think that they are going to take the cost of goods pass-through or are they going to use this opportunity to try to underprice and pick up more share?

[Bradley E. Hughes:]

Well, we'll see how it plays out here, Bret. But if you look at the markets that you might consider their home markets, the pricing that's been taking placing, and this is not unusual – this is the way those markets work in Asia – typically respond even more quickly to increases in raw material prices because the raw materials make up a larger percentage of the total cost relative to what it might cost for a tire to be produced in a different market. And in the past, we've seen those folks in most of their markets respond more quickly. We'll see if that happens again. But if you look back at what happened in 2011, 2012, 2013 timeframe, there were price increases from competitors across the board. And what you saw is, in different markets, they happened more quickly or more slowly, and a lot of the Asian markets respond more quickly. Again, we believe because it's a bigger component of their cost base and it affects them more dramatically than it would in a higher cost production location.

[Bret Jordan:]

Okay. And then, a housekeeping. I guess, on the profit walk, you were mentioning lower incentive comp and SG&A reduction. Is that is a timing issue? Or was there absolutely lower SG&A spend from a comparable standpoint?

[Ginger M. Jones:]

Bret, yes. It was lower incentive compensation year-over-year. So, it was an asset (43

[Bret Jordan:]

Okay, great. Thank you.

[Bradley E. Hughes:]

Thank you.

[Ginger M. Jones:]

Thank you.

[Bradley E. Hughes:]

Operator, if that's all for the questions, I'll maybe just make some closing comments here, and we can go about our business for today. So I want to thank everybody for being on the call with us this morning. Again, just to reiterate, we think Cooper is positioned to do well in what will be a more challenging 2017. But as we continue to execute our strategic plan and leverage the strength of our business model, we're confident that we are going to be in a good position as we work through some of those challenges and look forward to talking to you in a few months. So, thanks again, everyone, and have a great day.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.