Lear Earnings Review: Europe Recovery Boosts Top Line Amid South America Slowdown

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LEA: Lear logo
LEA
Lear

Lear Corporation (NYSE:LEA) announced solid Q2 results on July 25 on the back of accelerated global vehicle production levels and benefits from restructuring activities. The company supplies automotive interiors to some of the leading companies such as GM, Ford, BMW, Daimler, Volkswagen, Fiat, Hyundai, Jaguar Land Rover, Peugeot and the Renault-Nissan Alliance. A rise in global vehicle production levels by 3% to 21.4 million units in the second quarter increased business for Lear’s auto seating parts and electrical supplies, resulting in an 11% increase in net revenues to $4.6 billion this quarter. [1] Growth in vehicle production levels in China and North America by 12% and 4% respectively, and recovery in European production numbers drove top-line growth for Lear. On the other hand, margins also expanded for the company as a result of improved efficiencies and benefits from restructuring activities, in addition to higher sales and favorable mix.

Lear’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. We estimate a $98.92 price for Lear Corporation, which is roughly in line with the current market price.

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See our full analysis for Lear Corporation

Rising Luxury Demand Fuels Growth in EPMS and Seating

Lear’s EPMS division constitutes more than half of the company’s valuation, by our estimates, forming one-fourth of the net sales this quarter. This is mainly as this division is more profitable, with more than double the operating margins as compared to the seating division. In addition, the average electrical content per vehicle is expected to rise at a fast pace due to the high demand for more electrically-controlled functions in a vehicle. Higher luxury vehicle and plug-in electrical vehicle volumes also boost the average content per unit, as these automobiles require almost 1.5-2 times the electrical content in traditional powertrain vehicles. With a surge in premium car sales, Lear’s EPMS business also witnessed a 10% growth in its top line to over $1.14 billion in Q2. On the other hand, sales for the seating business rose 12.2% to $3.44 billion during the period, also boosted by growing sales of premium vehicles, apart from the addition of new businesses.

Luxury vehicles also require higher seating content per unit, apart from electrical content. Lear is the seating provider for some of the compact models made by the German automakers BMW, Audi and Mercedes in Europe. As economic activity picked up in the region this quarter following the double-dip recession, vehicle demand also grew, especially for compact models. Entry-level luxury models are volume products for the German automakers, and have witnessed rising demand due to increasing disposable incomes, ageing vehicles, and as consumers trade-in their non-luxury large sedans. In Europe, sales for Mercedes rose 7.4% in the second quarter, bolstered by launch of the new version of the compact C-Class in March. BMW and Audi also saw 5.7% and 5.6% volume rises in the region through June. [2] Average content per vehicle for Lear in Europe and Africa rose by 13.5% this quarter. As Europe recovers further from the economic downturn, car sales are expected to rise in 2014 on a year-to-year basis. Lear’s sales from Europe and Africa rose 16% in Q2, contributing 40% to the net sales, and could continue to grow owing to the anticipated increase in vehicle production. The company expects a 3% rise in vehicle production in Europe this year, up 2% from the previous full-year outlook. This expected rise in production should also boost Lear’s sales going forward. The company now expects full-year net revenues to range between $17.6-$17.9 billion, up from the earlier guidance of $17.2-$17.7 billion.

South America Economic Downturn Continues to Impact Lear

Lear’s revenues from South America fell 13% this quarter, as vehicle production in Brazil was down 23%. 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. [3] Lower demand for vehicles prompted some of the leading automotive manufacturers to undertake measures such as shift reductions and layoffs, consequently decreasing production levels. In fact, employment in the automotive sector in the country through May was 2.8% below 2013 levels. [4] 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. Rising unemployment, higher inventory levels, and lower demand resulted in low vehicle production in Brazil in the first half of the year, and this scenario is expected to continue in the latter half. Vehicle production in the country is estimated to decline 8% year-over-year to 3.2 million units in 2014. [5] Lear operates four seating plants and one electrical facility in Brazil, and headwinds in the auto sector in the country could negatively impact the company’s net sales this year.

In addition to hampering sales, lower production in South America and operational inefficiencies in the region are also expected to affect profitability for Lear going forward. The company has opened 24 component plants in low-cost countries since 2010, and expects these new component facilities to constitute around 8.5% of its net sales ($1.5 billion) this year, and also spearhead growth going forward, particularly in profitability. However, with production taking a hit in the low-cost South American countries, margin-expansion for Lear could stall in the next six months. Adjusted seating margins stood at 5.7%, down slightly from last year, as Lear incurred higher costs due to program changeovers and inefficiencies in South America. On the other hand, EPMS margins remained strong at 12.5% on the back of benefits from the low-cost structure, restructuring initiatives and due to higher sales. Lear expects seating margins to remain between 5.5-6% this year, while EPMS margins to range between 11.5-12%.

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Notes:
  1. Lear 10-q []
  2. New passenger car registrations, europe.autonews.com []
  3. Consumer spending in Brazil []
  4. Brazil unemployment rate up, June 2014, latinnews.com []
  5. Lear press release []