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Kevin Kersten's Analyst Insights

Options Analyst Writer
Kevin Kersten
Author Bio

September 17, 2012 - Can You Get More Traction with Tire Stocks?

Have you ever been out with Uncle Ned somewhere and he decided to take a shortcut home? Maybe you were out in his pickup truck and were trying to be just as polite as you could and not say anything while he was driving; but you thought to yourself, is this really a good idea? He shot down though the ditch and took a dirt road or path that kept getting narrower with deeper ruts? He said "Hang on, I think we can make this!" as you bumped around for your dear life until the tires started to spin and the truck got stuck. You almost made it; you just needed a little more traction. Well, you might need to a push a little or grab some chains?

The financial market feels a lot like that today. The markets are jumping up and down, and the rattling can provide indigestion. A car wreck is a good comparison for the GM bankruptcy a few years ago.  Many investors are wondering whether this is all a good idea. Maybe they should have just gotten completely out at the last stop? Even with full commitments and hanging on completely, their investments seem to be spinning tires and not getting enough traction to pull them forward. It is close and the car is almost moving, but just not enough.

The auto industry is doing much better these days. New car purchases are up, the economy has been slowly growing and credit is available to buy cars. GM is out of bankruptcy and the entire industry has seen a turnaround. This is a marked improvement from a few years ago. Is it now the right time to invest in auto stocks?

While auto stocks look a lot better than they have in the past, there is still uncertainty. The economy could stumble and one good crisis could cause auto sales to slip again. It is almost as if we need an all-weather auto company that does good no matter how the economy does.

While it might be tough to find a car company that does good in bad times, one might consider one of the related companies. Car parts can do well if consumers repair older cars instead of buying new ones. When the car breaks down it is usually critical to fix it as soon as possible and get it back on the road. Tires are another crucial industry. If new car sales are up, then tire sales -- on those new cars -- rise. If people continue to drive older cars, those tires need to be replaced as well. Only if the total miles driven fall or if people travel via another method do the tire companies lose out.

Goodyear Tire (GT) is one of the biggest domestic tire companies and its chief competitor is Cooper Tire and Rubber (CTB). More and more tires have been made overseas in China, and a September 2009 tariff was slapped on Chinese tires, which helped protect US makers. Commodity-type tires are made overseas with domestic production focusing on premium tire markets. The tariffs are set to expire in 2012; but Goodyear has also invested in Chinese tire factories so it can compete by making tires in China and shipping them in. Regulations are also changing in Europe and many experts think the US will follow with new required labeling on tires. Tires will be tested and quantifiably rated on road noise, rolling resistance, and wet grip. This new information should help differentiate the products of premium tire companies from the low cost competitors and allow consumers to make more informed choices.

Cheap tires from overseas and pension benefits are two of the bigger worries for Goodyear. Like other older companies with defined-benefit pension plans, the cost has been a concern on the operation.  The company could run low on cash or see unfavorable exchange rates. Recent labor concessions seem to have the pension problem under control. Sales are looking up at the company with 2012 expected to see growth of 6-7% and 2013 to see sales of 8%.  Raw material and oil costs have been falling, helping margins. Earnings per share have been rising with 2011 seeing 1.26 per share and 2012 expected to see 1.99 per share. These are big improvements over 2008, 2009 and 2010 when the company lost money. The company has a four STARS S&P buy rating.

Take a look at a covered call on Goodyear Tire.  The April 2013 13 covered call is at the money and has a 13% assigned return with 12% of downside protection. An investor can buy the stock and sell the covered call for a net debit of 11.42. GT is not paying dividends at this time. The 13% assigned return is only over 7 months, so it actually comes out to a 23% annualized return (for comparison purposes only).

With the market going up and down it can seem like you are losing traction with stocks and your investments are sitting in one place. The extra return that you get from a covered call is a bonus that could provide the extra traction to bring you extra performance in your portfolio. When winter weather hits, having the right tires or putting chains on your tires can make a huge difference in traction. Putting some option chains around your stocks can help as well. It is a strategy to help ensure you go slow and steady and keep moving forward; but as always, check with your financial advisor if the trade is right for you.

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