Leading manufacturer and distributor of automotive interiors Lear Corporation (NYSE:LEA) is scheduled to announce its Q2 results on July 25. The company’s business has been divided into two segments: seating and electrical power management system (EPMS). While the seating division offers complete automotive seating systems including individual component parts, the EPMS division includes wire harness, terminals and connectors, junction boxes and wireless remote control devices installed in a vehicle. Lear’s stock has grown by over 20% in the last six months, reflecting the investor confidence in the company’s business growth. With rising vehicle demand and consequently increasing global production levels, Lear’s business is also expected to grow. The company supplies automotive interiors to companies such as GM, Ford and BMW, which together contributed 54% to the net sales last year, and also Daimler, Fiat, Hyundai, Volkswagen, Jaguar Land Rover, Peugeot and the Renault-Nissan Alliance. After rising 10.4% in Q1, Lear’s top line is expected grow again this quarter on the back of higher production levels in the U.S, China and Europe.
Lear’s results could slightly be hurt by the slowdown in vehicle demand in Latin America this quarter. However, despite declining overall volumes in the region, luxury vehicle demand has been on a rise. Higher premium auto demand should boost Lear’s average content per unit, as these vehicles require relatively higher seating and electrical content, as compared to traditional powertrain vehicles.
We estimate a $84.47 price for Lear Corporation, which is around 12% below the current market price.
Vehicle Production and Electric Vehicle Demand Grows in the U.S.
Around 19% of net sales for Lear were contributed by the U.S. in 2013. The company gained from the 6% rise in vehicle production in North America in the first quarter, and could continue to derive growth from the region this quarter. As the automotive sector continues to regain momentum in North America following the economic downturn, vehicle production volumes are expected to surpass the previous record of 17.3 million units in 2000 by the next couple of years. Auto demand in the U.S. is expected to rise due to lower interest rates, pickup in economic activity after suffering a negative 2.9% GDP growth in Q1, and replacement of ageing vehicles. The average age of a passenger car in the U.S. reached 11.4 years in 2013, while the average age stood at 8.4 years in Europe and below 5 years in China.  According to IHS Automotive, light-vehicle production is expected to rise by 3.8% to 16.8 million units this year in North America, and grow to 17.5 million units by 2016.   Higher production in the domestic market should also boost Lear’s automotive interior business in the country.
Lear supplies electrical interiors for the electrically-powered Chevy Volt and Cadillac ELR produced by GM, which constituted 22% of Lear’s net sales last year. With rise in demand for plug-in electric vehicles (PEV) and specifically these models, Lear’s sales are also expected to grow. Chevy Volt sold over 5,000 units in the U.S. in Q2, ranking as the third highest selling PEV in the country this year. Demand for electric vehicles is rapidly rising around the world mainly due to a relatively less harmful impact on the environment and lower running costs, as compared to gasoline-powered engines. In addition, governments around the world provide various incentives to boost electric vehicle sales. Moreover, PEVs also have lower battery prices, adding to their appeal. The PEV market is expected to sell over 2.7 million units globally by 2018, a massive rise from around 180,000 unit sales in 2013.  PEV sales in the U.S. constitute over 40% of the global PEV sales at present, growing by over 85% year-over-year to 97,507 units in 2013, and further by 42.2% in the second quarter this year. Growth in EV volumes bodes well for Lear, as these vehicles almost double the electrical content required per vehicle, thus boosting the company’s average content per unit.
Slowdown in Brazil Vehicle Production to Impact Lear’s Top Line
Production has taken a hit in the low-cost South American countries in 2014, particularly Brazil. This slowdown is expected to hamper sales this quarter for automakers such as GM and Ford, consequently lowering Lear’s sales. Brazil’s economy is slowing owing to higher interest rates put in place to control inflation. These measures have impacted consumer spending, which slightly slowed down this year, as compared to the last quarter of 2013.  Rising unemployment, higher inventory levels, and lower demand resulted in a 13.3% year-over-year decline in vehicle production in Brazil in the first five months of this year, with production falling 18% in May. Brazil’s automobile industry, the fourth largest in the world, has also suffered due to a fall in exports, primarily because of import restrictions in Argentina.
Brazil is the third largest market for GM behind China and the U.S., constituting roughly 7% of the company’s net retail volumes in 2013. Ford also sold around 6% of its overall wholesale volumes in Brazil last year, and together with GM, commanded 26.7% market share in the country’s vehicle industry at the beginning of 2014 (GM-17.3%, Ford-9.4%).   However, unit sales for both the automakers have declined in Brazil this year, owing to the slowdown in vehicle demand. GM witnessed a 2% fall in retail volumes in the country through March, while Ford’s South America volumes also fell 8% during this period. ((GM 10-q)) ((Ford 10-q)) Unfavorable currency translations and low vehicle demand could hamper GM and Ford and in turn Lear’s South America sales again this quarter.
However, despite the fall in overall vehicle demand in Brazil, luxury automakers saw large volumes rises in the country in Q2. Growth in premium car volumes is mainly because of low current penetration levels in the country, and lower impact of interest rate hikes and removal of tax breaks on the affluent customers, the target consumer base for luxury vehicle companies. Rise in volumes for premium automakers such as BMW, which constituted 10% of Lear’s net sales last year, Daimler, Jaguar Land Rover, and Volkswagen could not only boost Lear’s top line, but also the average content per vehicle this quarter.
Margins to Rise on the Back of Higher Revenues and Content per Vehicle
Lear’s seating division saw a decline in operating margins last year, with the figure falling to 4.8% from 6% in the previous two years. This was mainly due to manufacturing and launch inefficiencies in the Americas. However, adjusted segment operating margins for the seating segment stood at 5.5% in Q1, after adding back one-time restructuring expenses, boosted by the sales backlog from last year and higher car volumes. Seating margins this quarter are expected to remain in line with the company guidance of 5.5-6% for 2014, partly offset by currency headwinds, particularly in South America. On the other hand, operating margins for the EPMS segment, which stood at 12.3% in the last quarter, are also expected to remain strong due to the anticipated rise in divisional sales, increased electrical content per vehicle, and a competitive low-cost structure.Notes: