Earnings Call Transcript - GT Q4 2022

Operator, Operator

Good morning. My name is Ashley, and I will be your conference operator today. At this time, I would like to welcome everyone to Goodyear's Fourth Quarter 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After some opening remarks, there will be a question-and-answer session. Today on the call, we have Rich Kramer, Goodyear's Chairman and Chief Executive Officer; Christina Zamarro, Chief Financial Officer; and Darren Wells, Chief Administrative Officer. During this call, Goodyear will refer to forward-looking statements and non-GAAP financial measures. Forward-looking statements involve risks, assumptions, and uncertainties that could cause actual results to differ materially from those forward-looking statements. For more information on the most significant factors that could affect future results, please refer to the important disclosures section of Goodyear's fourth quarter 2022 Investors letter and their filings with the SEC, which can be found on their website at investor.goodyear.com, where a replay of this call will also be available. A reconciliation of the non-GAAP financial measures that may be discussed on today's call to the comparable GAAP measures is also included in the investor letter. I will now turn the call over to Rich Kramer, Chairman and CEO.

Richard Kramer, Chairman and CEO

Great! Thanks, Ashley. And good morning, everyone. Thanks for joining us today. We released our fourth quarter Investor Letter after the market closed yesterday and received very good feedback from investors on both our letter and our Q&A call format following our third quarter release. So as we did last quarter, we will focus solely on your questions. Now, just before opening the line, I want to acknowledge, as you've heard earlier, that both Christina and Darren are joining me on the call today. Christina became our Chief Financial Officer as of January 1, replacing Darren who moved into a new role of Chief Administrative Officer. Congratulations to both of them, and again they’re joining me here. I'm excited to continue to partner with both of them in their new roles. Given the transition, Darren is joining us on the call today, but Christina and I will take the lead in responding to your questions on these calls going forward. So with that, Ashley, let's open up the call for the first question.

Operator, Operator

Certainly. We'll take our first question from Emmanuel Rosner with Deutsche Bank. Please go ahead.

Emmanuel Rosner, Analyst

Good morning. Thank you so much for the questions, and I agree with the feedback on the call format. Very much in favor of it. Great. First question, maybe I think last year, around the same time, I think you helped us out with sort of framing a base case scenario for what could happen to free cash flow for you guys for the full year ahead under certain conditions. So will we be able to go into this discussion for 2023? Obviously, appreciate all that in this slide. Just curious knowing all you know, what this request will look like for you?

Christina Zamarro, Chief Financial Officer

Sure. So Emmanuel, hi, this is Christina. And let me start by saying thank you for the comments on the Investor Letter. And I have to send out thanks to our teams; this has been a great push by our Investor Relations Team, FP&A, and our controlling teams who put that together. And again, we've received really great feedback on that. As far as free cash flow in 2023, if you look through the drivers we've laid out as part of our letter, and if you were to take the assumption that our EBIT was going to be flat in 2023 with our EBIT in 2022, which was about $1.1 billion, you should get to a level of free cash flow in the range of about $400 million. That's just reflecting the year-over-year improvement in working capital. Emmanuel, what I'd add to that is, it's not that we're targeting flat earnings. Our goal is to improve earnings. And after a really tough setup in the first quarter, as you read in the letter, the trajectory should improve meaningfully as we move to the remainder of the year. In the second quarter, our goal is for segment operating income to approach 2022's levels, with volume stabilizing and given lower year-over-year raw material cost increases that we're expecting in the second quarter. Assuming a relatively stable economic outlook, then we would begin to see the benefits in the second half of higher volume on either comparables, strong growth in Asia-Pacific driven by a recovery in China, and lower inflation levels that we're expecting in the first half of the year. We would also expect the benefits from our recent cost actions that we've announced, and then of course, at current spot prices, tailwinds in our raw material cost. Historically, this has been the time in the cycle where we've seen growth in earnings and growth in our margins as well.

Emmanuel Rosner, Analyst

Okay, that's helpful. And then I guess, following up on some of the pieces of the free cash flow guidance. I think CapEx was gathered at $1 billion for 2023. This compares to maybe a $1.2 billion to $1.3 billion framework that you discussed previously, in terms of the investments you need to make in growth. What is enabling you to sort of keep it around the $1 billion? And is that roughly just maintenance CapEx? Are you cutting back at, I guess, where are you cutting back?

Christina Zamarro, Chief Financial Officer

Yeah. Good question, Emmanuel. As we went through 2022, we scaled back our plans for capital expenditures, just given the outlook for the global macroeconomic environment. As we look at 2023, we expect to continue to invest in the Americas and in Asia-Pacific, although investment levels in EMEA will decline, just given the current macroeconomic outlook there. We continue to allocate capital to high-return projects that will improve our overall competitiveness over time.

Richard Kramer, Chairman and CEO

Yeah, Emmanuel, I'll just jump in and echo Christina's points. I think we take a lot of time to go through those capital plans. We've worked through a lot of cycles, and you can count on us to adjust CapEx to the environment we're in. When we do that, we really don't shortchange ourselves on what we see as long-term growth projects that we have to do. So we are comfortable with what we spend. And I would just tell you, even if you see things like what we did at CES around intelligent tires and sustainable tires, those are growth projects, industry-leading technological projects that we're going to continue to move forward within our current capacity of spend, and we feel comfortable knowing how to do that.

Emmanuel Rosner, Analyst

Okay. Yeah, I appreciate the color. And then just very finally, since you're mentioning the environment, can you maybe just provide a little bit of your perspective on some of the drivers of this market—demand weakness that seems to be across every major region, I guess. What is driving this? How will you see that potentially evolve through 2023 on the demand side? And then any implications for how to think about pricing?

Richard Kramer, Chairman and CEO

Yeah, I think there's a lot there. Maybe I'll just start with the Americas. We did see a weaker market in the fourth quarter, and we see a little bit of slowdown coming into Q1. We reacted not only to the Americas, but Europe as well, as you saw in our Investor Letter, by taking production down with a focus on making sure we don't have excess inventory amidst a bit of a slowing market to focus on cash, as Christina mentioned. But as Emmanuel, as I think about the Americas going forward, you also saw in our letter that our channel inventories are up about 10%. But what I would tell you is that's pretty healthy. Our distributors are really rebuilding their inventory; we didn't see any buy-ahead, so I'd say in anticipation of any price reductions or anything like that. It's a pretty healthy place and I would say in line with the expectations of where the market is going in 2023. We feel pretty good about North America. It's a little slow to start, but I think we have a stronger second half coming, a little slow to start because we're bringing some of those costs on the balance sheet of unobserved inventory into the first quarter as well. But we feel pretty good about the demand picture. Sellout was about flat in Q4, year-over-year in the fourth quarter, and we don’t see any big changes going into the year. Europe is a little bit of a different story, obviously more challenging. I would take a step back and say we feel really good about the initiatives we’ve put in place in Europe. Aligned distribution is working. In the quarter, we got volume, we got price mix ahead of raw materials, again, and we had share gains in a down market for what I think is the 11th or 12th quarter in a row. So, things are working in Europe. We also took a lot of actions there to get our costs in line. I would say we feel really good about those things. But in Europe, we’ve witnessed big energy inflation in Q4 driven by the war. And we saw in anticipation of these high energy costs, really a reduced consumer demand out there, specifically in the consumer replacement business, in November and December, where we saw a consumer base thinking about big energy bills, and the channel slowing down on wanting to buy more inventory. So Europe is a different case. We know that's going to continue for a little bit into 2023, especially in the first half; second half, again, as Christina said, should be better. We're taking the appropriate actions to ensure we don't build that excess inventory and make sure we focus on cash while continuing to look at more cost areas. And remember, in Europe, we've done a lot in restructuring our footprint and full value, so we did in the UK and Belgium. We've restructured a business in South Africa, and we did some restructuring to add volume and improve efficiencies in France. So we'll continue down that path. Then in Asia, particularly focusing on China, it's tough right now because of COVID, but we really see that reversing and we see that reversing in our favor in two areas. One is the OE business which was strong in Q4 and will continue to be. We've doubled our win rate in OEs in 2022 to about 70%. We have a higher mix into EVs, a high EV win rate, and a high luxury SUV and truck win rate as well with domestic or Chinese OEMs. That's higher profitability and will create good pull in the replacement market. As COVID subsides, and I can say that toward the second half, we foresee a stronger pull in the replacement aspect as well. To prepare for that, we continue to invest in distribution in the key markets in China and in India as well. So overall, we've got to get through Q1, the first half if you will, as we see some tumultuousness. But beyond that, we do see some upside and feel relatively good.

Emmanuel Rosner, Analyst

Thanks for the color.

Richard Kramer, Chairman and CEO

Thank you.

Operator, Operator

We'll take our next question from Rod Lache with Wolfe Research. Please go ahead.

Rod Lache, Analyst

Good morning. Two quick questions. First, are you seeing anything that would indicate anything other than stable pricing as you're entering this year just in the context of the weak demand? And can you clarify your expectations for the other tire-related businesses, as it looked a bit soft in the fourth quarter?

Richard Kramer, Chairman and CEO

Sure. Rod, from how we're looking, I guess I'll say price mix and how we're looking at the raw material environment that's obviously related to that. You know that sort of the essence of your question is the earnings pressure and margin compression we've seen over the last quarters because of escalating raw materials. That's true for Goodyear and true for the industry as well, and we need to recover that. I would tell you, our momentum has been very good. Our teams across all our businesses have offset all the raw material headwinds with price and mix. In two of the businesses, in Europe not being one of them, we also offset some of the other cost increases we had as well. So the team has done a really good job. Now as Christina mentioned, we see this potential decrease in raw materials. Our plan is to capture the benefits of those raw materials and see that reflected in margin improvements as we continue to capture our value proposition out in the marketplace. I'd say historically, in a period of declining raw materials, we're able to grow margins; we're able to translate those benefits into our earnings. I think we see that as still the plan and our way forward. Also telling you what can help them is we see the OE business coming back, which means there will be a pull on the capacity that the industry is making. That's good for the supply-demand equation out there as well as we think about how to manage the demand in the replacement market. Finally, Rod, in terms of what we're seeing in the marketplace, we have not seen any decreased demand or trade down in our Tier 1 volumes at all. We've seen a little in Tier 2 moving towards the lower-tier brands. I’m not sure that's a trade down or price issue as much as it is all those imported tires that were backordered and paid upfront in cash by the distribution, particularly in the U.S. I'm talking here that hit the docks in the past quarters; that obviously drove the industry numbers. All that came late, it was paid for. I think what you see is a lot of push of those tires to turn it back into cash. I think that's a dynamic we're dealing with. That doesn't really impact our Tier 1 tires or the value proposition for those. So I hope that helps.

Christina Zamarro, Chief Financial Officer

Yeah. But I'll jump in on the non-tire business performance in the fourth quarter. That was principally driven by our chemical business, as you know. That's a pass-through margin business. When they're buying inputs at higher prices and then the inputs dropped in the fourth quarter pretty precipitously, that means they're adjusting their pricing real-time in the market. So it's more of a timing issue. Looking to 2023, I expect good growth in these areas, really driven by our aviation business, seeing and expecting strength in volumes, strength in pricing and mix. I'm seeing that across the portfolio, especially given the reopening and demand pull out of China.

Rod Lache, Analyst

Thanks for that. And just one more thing, if I can ask. Just taking a step back, could you elaborate a little bit on what it will take to close the gap, obviously, on a mix-adjusted basis versus your peers? Presumably some of the capital spending that you were planning was aimed at doing that. Maybe you could just provide a little bit of color on what you're shooting for here in the next year or two?

Christina Zamarro, Chief Financial Officer

Yeah. I'll go ahead and start. We talked a little bit earlier on the call about the plans for CapEx for 2023. A lot of that is influenced by the European macroeconomic outlook. I must say, over the last two to three years, we feel that we've made significant progress on closing our conversion cost per tire gap versus our competitors. A couple of years ago, we estimated that gap to be around $4 per tire. Today, we have said that with the closure of a very high-cost facility in Gaston in the U.S. and a big restructuring in EMEA, and of course, many of our competitors had low-cost supplies coming into Western Europe out of Russia. These factors have led us to believe our current disadvantage is nearly half of what it was two or three or four years ago. So we're feeling well positioned on a relative basis. That said, we're not going to stop moving forward. The investments we planned last year and are continuing into 2023 in the Americas and Asia-Pacific are all high-return projects. These are expansionary rather than greenfield type plants, which will help improve our low-cost percentage as part of our footprint and increase our overall competitiveness as we move forward.

Rod Lache, Analyst

Okay. Thank you.

Operator, Operator

And we'll now hear from John Healy with Northcoast Research. Please proceed.

John Healy, Analyst

Thank you. Rich, I wanted to ask a big picture question about the changes in the C-suite recently. Just love to get your perspective on the move with Darren into the more strategy-centric elements of the business. What might we expect from you guys over the next couple of years? Like what are the areas where you think that change is going to have the biggest impact on the DNA of the organization?

Richard Kramer, Chairman and CEO

Well, I think the way I'd answer that, John, is one thing I would say is we operate as a team. The pride I take in leading the Goodyear team is that it's not reliant on one person. Whether Darren is in the CFO role or assisting with strategy, Christina and Darren have worked together for so long, I think this was a really natural and elegant transition. I look to the leaders of our business units as well as our CTO, Chris Helsel. The value lies in the team, not any individual. From a strategic perspective, I’d highlight what Christina just mentioned, that we are keenly focused on ensuring our cost structure aligns continuously, not only relative to competitors who also improve, but just the trends we see in the marketplace of transparency regarding pricing and availability of inventory, which pressures margin compression across every business and industry. We are acutely aware of that, and we need to ensure that our operations continue to get more efficient each day. This involves our factories' conversion costs, where our factories are located. We have taken footprint actions, and you can count on us to continue with more of those and then make the high-value-added return investments that will help drive both our cost structure and enhance the efficiency of our products. So that will be ongoing. We will also continue to push, Darren, on how we ensure that we're creating efficiencies. There's a lot of manufacturing capacity in this industry, and like we did with Cooper, we need to think about how we can utilize that capacity more wisely as we move ahead. Secondly, I always emphasize that we must have the best products in this industry. Our product innovation engine has been effective; we have been top in every product category in Europe, and we have the freshest product portfolio we’ve ever had in Asia, Latin America, and the U.S., both in commercial and consumer categories. We will ensure our innovation engine continues serving its purpose. We should note that although we don’t discuss it often, many of the things we have working are performing very well. We are also excited about technological trends in our industry that are not revenue-generating immediately, but the changes we are witnessing in mobility are critical. We're transitioning from making a typical tire to an intelligent tire, which has a role in an intelligent vehicle, and this connected tire can improve safety and performance, becoming part of the operating system in vehicles. We're deeply considering what mobility's future holds and how Goodyear fits into that landscape. That is a significant focus area for us.

John Healy, Analyst

Thank you. That's super helpful. And just one other question I had just on distribution. It sounds like the Cooper and Goodyear portfolios are starting to be a bit more connected in terms of dealer availability. We would love to get your thoughts on access to super productive Goodyear dealers and vice versa. Are we at a point where maybe 1 plus 1 can start to equal 3? Or is it kind of going to continue to be somewhat separated in terms of how each goes to market?

Richard Kramer, Chairman and CEO

I actually think it’s a little bit of both. For instance, our retail stores now include Cooper products, and that has resulted in those stores operating with a 1 plus 1 equals 3 mentality regarding performance, customer service, and product offerings. Conversely, there are specific distribution elements in how Cooper goes to market and sells to distributors. That process significantly motivated our decision to combine Cooper with Goodyear. They are proficient in those areas, and we won't interfere with those successful practices. We will ensure we maintain their best practices while integrating where it makes sense. I think this dynamic allows for both integration and further development of synergies, with the run-rate synergies we targeted. We’ve been cautious not to rush into immediate changes, and you can expect to see continued progress on how Goodyear and Cooper integrate into the market together in 2023. I’m pleased with where we currently stand.

John Healy, Analyst

Okay. Thank you.

Operator, Operator

And we'll take our final question from James Picariello with BNP Paribas. Please go ahead.

James Picariello, Analyst

On the second quarter color of SOI approaching year-ago levels potentially, what would be some of the key assumptions to get there? Correct me if I'm wrong here, but the second quarter should have a similar overhead absorption impact in the first quarter, and maybe that's $60 million to $70 million. And then from there, the three key buckets as I see it would be unit volumes, price mix versus raws, and then the non-raw materials inflation piece. Any color on that would be super helpful.

Christina Zamarro, Chief Financial Officer

Yeah, sure. James, it's Christina. I guess I would start by saying that in the second quarter, we see volumes stabilizing. We have announced a 5% plus price increase in Europe consumer replacement beginning January 1. We expect Europe to begin to catch up to the increases in raw materials throughout the first and second quarters. There is a significant drop in raw material price increases from Q1 to Q2, which should benefit us as well.

James Picariello, Analyst

Okay. And then how do you foresee the elevated channel inventories in Europe, which are about 30% above year-ago levels? With the price increase and with replacement sell-in demand down for the industry, a mid-teens entering '23. How do you see that unfolding? Are we catching up?

Christina Zamarro, Chief Financial Officer

Yeah. It’s a great question, James. The elevated channel inventory is actually all reflective of winter. In the first quarter, we see a shift from winter tire sell-in during the fourth quarter. In the first quarter, we shipped into a summer tire sell-in season. The inventory in this channel is much more balanced and even healthy. Energy prices in Europe have also abated significantly since the third and fourth quarters as well, and we're expecting that to support consumers through the first and second quarters.

James Picariello, Analyst

Thanks.

Christina Zamarro, Chief Financial Officer

Sure.

Operator, Operator

And there are no further questions at this time, and this will conclude today's Goodyear fourth quarter 2022 earnings call. You may disconnect your line at this time, and have a wonderful day.