Lear Corporation Priced Higher On Strong Growth Expectations

-10.27%
Downside
145
Market
130
Trefis
LEA: Lear logo
LEA
Lear

As automotive industries in developed markets show signs of growth on higher consumer demand, suppliers of automotive interiors should in turn benefit from inflow of additional business. Lear Corporation (NYSE:LEA) has come a long way since filing for bankruptcy in 2009, in the thick of the recession. Net sales for the automotive interiors supplier rose 67% between 2009-2013, and with key European markets returning to growth in 2014, net revenues could rise by another 8.5-10% this year. Solid growth expectations spurred investor confidence, boosting Lear’s stock by almost 50% in the 52-week period till September.

But automotive stocks have fallen in the last month, more than the decline in broader indices such as the S&P 500. Lear’s stock has plunged by nearly 15% in the last month, after reaching a high of $103.74 on September 8. The company’s competitor Delphi Automotive has also seen a similar decline. Share prices of GM and Ford, which together constituted 44% of Lear’s 2013 sales, have also declined by 7% and 16% respectively in the last month.

The declines in stock prices of Lear and Ford could also be due to the recent strike by around 760 workers in Lear’s Hammond plant in the U.S., halting production for one day in an attempt to get rid of the unfair two-tier wage system. As this plant produces seats and other crucial safety equipment for models such as the Ford Explorer and Taurus, manufactured at Ford’s Chicago assembly plant, disruption at Lear impacted production activities at Ford as well. In order to prevent further disruptions, Lear accepted demands of union workers, raising wage expenses for the automotive supplier. Despite the recent interruptions, Lear looks to be headed for strong growth in the bigger scheme of things. In addition to high vehicle demand in key markets, boosting volumes for Lear’s automaker clients and in turn for the company, interior content percentage in vehicles is also rising. Improving sales of premium vehicles and electrically-powered vehicles are fueling this rise in content per vehicle, and Lear has looked to take advantage of the high demand for these vehicles.

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Strong worldwide vehicle demand, increasing content per vehicle and expanding margins, as Lear looks to increase cost-effectiveness, are reasons why we value the company at $98.92 a share, which is roughly 14% above the current market price.

See our full analysis for Lear Corporation

Rising Electrical And Seating Content Per Vehicle To Boost Top line

Lear’s electrical content per vehicle has risen by almost 50% in the last couple of years to $787 in 2013. This is mainly as the requirement of electrical and electronic components in vehicles has increased. In fact, electrical vehicles use almost double the electrical content in traditional powertrain vehicles. Lear supplies electrical content for the Chevy Volt and Cadillac ELR, manufactured by GM, the company’s largest client. Cadillac ELR began selling in December in the U.S. and has sold almost 900 units since. [1] Electric vehicle sales in the U.S. have increased 25% year-over-year through September, and could continue to rise as consumers switch to economically and environmentally viable vehicles with improvement in battery charging infrastructure in the country. Due to rising electrical content per vehicle, Lear’s topline growth is expected to outpace the growth in global vehicle production levels, going forward. This means that apart from rising vehicle demand worldwide, which could see global vehicle production grow 4% this year, higher revenues per vehicle due to more content could drive additional growth for Lear.

In addition to electrically powered vehicles, luxury vehicles also require higher seating and electrical content. Gauging this trend, Lear is looking to acquire Eagle Ottawa, the world’s largest supplier of premium automotive leather, for around $850 million. The deal is expected to close by early next year and will further boost Lear’s premium seating business. Lear supplies seating and electrical interiors to premium automakers such as BMW, which constituted around 10% of the net sales in 2013, and also to companies such as Volkswagen’s Audi, Daimler’s Mercedes-Benz, Chrysler and Jaguar Land Rover. In fact, Lear is the exclusive seating provider for some of the compact models made by the German automakers BMW, Audi and Mercedes in Europe.

Although vehicle production is expected to be subdued in some emerging markets such as Brazil and India this year, rebounding production and sales volumes in Europe could more than offset this estimated fall in global vehicle volumes. Slowly recovering after the double-dip recession, overall vehicle production in the Europe and Africa division is expected to rise 3% this year to 20.4 million units, nearly one-fourth of the global volumes. In fact, Lear’s revenues from this division in the last quarter marked the highest year-over-year growth for any division, rising by 16% to $1.83 billion, representing 40% of the net sales. As Europe represents a bulk of Lear’s business, recovering auto sales in the region should bode well for the company in the coming future. The Eagle Ottawa acquisition will also boost Lear’s top line, as the former generates annual revenues of around $1 billion, with $170 million coming from Europe. [2]

However, Growth In Europe Could Be Slower Than Expected

While we currently expect auto sales to rise in Europe, following the recession, and consequently benefit Lear due to the company’s stronghold in the region, some signs prompt towards limited growth in the region in the near term. GDP growth in the euro area, which was positive in four previous quarters, stalled in Q2. [3] The euro zone economy continues to stagnate, with falling inflation rates and consumer price rises. The euro hit a two-year low against the U.S. dollar at the tail-end of last month, and further unfavorable currency translations in the region could drag down Lear’s revenues.

In addition, the Crimea crisis in Eastern Europe is expected to have an impact on automakers this year, and consequently on Lear. The Russian economy has been struggling lately amid geopolitical issues with Ukraine. The U.S. and the European Union issued sanctions against Russia for supporting separatist rebels in Ukraine, an accusation denied by Russia. Russia is the world’s sixth largest vehicle market, which suffered a 5.7% decline in annual sales to around 2.6 million units last year, following three consecutive years of growth. As the country’s passenger vehicle market continues to struggle due to the ongoing geopolitical tensions, negative consumer sentiment, high inflation and a weak ruble, foreign automakers estimate this market to decline by 14-18% this year. [4] Lear operates four manufacturing facilities in Russia, and due to the slowdown in the region, the company’s sales in the country and overall Europe could be lower than expected, going forward.

We currently estimate Lear’s seating and electrical content per unit to rise by 3% and 10% respectively through 2015. But if we lower our near-term estimate to around 1% and 4% respectively on possible sluggish growth in Europe, there could be a 4% downside to our current valuation for Lear.

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Notes:
  1. U.S. EV sales, insideevs.com []
  2. Lear press release []
  3. Euro area GDP growth rate []
  4. Citroen, Volkswagen, Nissan forecast Russia’s 2014 car market fall, itar-tass.com []