Lear Corporation Earnings Review: Top Line Expands On Strong Content Per Vehicle Growth
Lear Corporation (NYSE:LEA) reported a strong 8% sales growth in Q3, fueling an almost 5% jump in its stock after the announcement. [1] Sales for the supplier of automotive seating and electrical interiors have grown on a 3% rise in global vehicle production this quarter, buoyed by strong demand in China and the U.S., the two largest automotive markets in the world. But what pushed the top line to almost three times the global vehicle production levels in Q3 was the continual increase in content required per vehicle. Lear is now eyeing the acquisition of Eagle Ottawa, the world’s largest supplier of premium automotive leather, at the beginning of 2015, which should further boost the company’s seating content per unit. Growth in vehicle production was stalled by tough economic conditions in some of the key emerging countries such as Brazil, Russia and India, this quarter, and could further limit global vehicle production growth in Q4. But Lear’s strong sales growth reflects how despite only a small rise in vehicle manufacturing worldwide, the company could continue to extract higher revenues and profits through improving its market share and content per unit.
We estimate a $99.88 price for Lear Corporation, which is roughly 12% above the current market price.
See our full analysis for Lear Corporation
Despite A Weaker Economic Outlook, Europe Sales Remain Strong
Following the double-dip recession, automotive production in Europe is expected to return to positive growth this year. But economic recovery in the region has been weak, and volume growth could remain moderate in the near term. While vehicle demand in Western Europe hasn’t picked up by expected levels, and the impact of the Crimean crisis continues to cast a shadow over Eastern European economies, export volumes have been strong. In particular, export demand for luxury vehicles such as the Audi A4 and A6 and BMW 3-series has augmented European sales for Lear, despite weak demand within the region. Luxury vehicles require higher seating content and a relatively more complex electrical structure, which is why higher proportionate sales of these vehicles expanded Europe and Africa unit’s content per vehicle by 9.5% in Q3. This is why Europe and Africa sales, which together form around 40% of the net sales for Lear, rose by nearly 10% despite only a 1% increase in vehicle production in the two continents combined.
Going forward, luxury vehicle export sales should remain strong on anticipated high demand in markets such as China and the U.S. Luxury vehicle volumes in the U.S. rose 4% in the first nine months of the year, and with customers looking to trade-in their non-luxury sedans for entry level premium vehicles, export volumes for European manufacturers such as BMW, Audi, Mercedes-Benz and Jaguar Land Rover, which export to the U.S., could increase further. Large sedan sales declined in the U.S. through September by over 4% and by 35% last month itself. [2] On the other hand, each of the German trio of BMW, Audi and Mercedes has also witnessed double-digit percentage increases this year in sales in China, another key export market, outpacing their individual overall volume growth. Large demand for luxury vehicles bodes well for Lear, which receives business from premium automakers, with BMW contributing around 10% to the company’s top line last year. With export demand expected to remain strong in the near term, Lear’s sales in Europe could rise significantly again in Q4, even though domestic demand doesn’t improve substantially.
However, one of the main concerns over European sales for Lear in Q4 could be the weakening of the euro against the U.S. dollar. The company’s estimate for its full-year net sales growth of 9-10% is consistent with the growth achieved so far this year, but if the euro zone economy continues to stagnate, with falling inflation rates and consumer price rises, the euro could further fall against the dollar and drag down the net sales. According to Lear, every penny change in the euro on an annual basis affects the company’s top line by $48-$50 million, 0.3% of the net sales. [3] But barring the impact of unfavorable currency translations, higher sales of premium vehicles should increase the content per vehicle for Lear in Q4, boosting overall revenues.
Seating Margins Remain Within Expectations But Could Expand Going Forward
The seating division, which forms over half the valuation for Lear by our estimates, witnessed a sales growth of 10% mainly due to the addition of new business. With the acquisition of Eagle Ottawa by early next year, the seating division will add another $1 billion or so in annual revenues. But apart from the growth in revenues, margins for the seating division are also expected to increase. Due to a strong rise in revenues and the benefits of restructuring, this division’s adjusted operating margins stood at 5.6% through September, and the company expects full year margins to remain within 5.5-6%. As we expect luxury vehicle demand to remain strong through the end of the year, higher content per vehicle should boost net revenues for Lear and could trickle down to cause an increase in margins as well.
A meaningful expansion in seating margins could be achieved following the acquisition of Eagle Ottawa. Lear has already identified $20 million in cost savings from synergies, which it aims to achieve in around two years after the closing of the deal. In addition, Eagle Ottawa introduced a process to recycle the scrap hide into a traditional leather alternative for automakers, investing $3 million into its Rochester Hills plant to manufacture its recycled composition leather line, thereby adding environment-friendly and cost-effective methods of production to Lear’s operations. Eagle Ottawa presently operates at margins above the targeted near term operating margins for Lear’s seating division, which is why the latter’s profitability could further improve going forward. We expect adjusted seating margins to reach 6.4% in the next couple of years, up from 5.4% in 2013, and remain relatively constant after that. But if margins don’t increase beyond 6%, our price estimate for Lear would fall by 10%.
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- Lear 10-q [↩]
- Automotive sales in the U.S., wsj.com [↩]
- Lear earnings transcript [↩]