These Scenarios Could Significantly Impact Lear Corporation
Lear Corporation (NYSE:LEA) has come a long way since filing for bankruptcy in 2009, in the thick of the recession. The company’s net sales increased 82% from 2009 to 2014, reaching $17.7 billion last year, and the stock has almost grown 200% in the last five years. According to our estimates, the seating segment forms 54.5% of Lear’s valuation, with the rest constituted by the electrical power management systems (EPMS) division. Lear supplies interiors to some of the largest automakers in the world, and thus depends on the performance of its clients. Automakers, in turn, depend on the global automotive demand, which is influenced by macroeconomic factors such as declining oil prices. There could be a significant upside for Lear if oil prices do not increase by very much in the coming years. Another event that could impact Lear’s business is a possible split of the company into two separate businesses.
We estimate a $113 price for Lear Corporation, which is roughly in line with the current market price.
See our full analysis for Lear Corporation
Here are the two scenarios that could significantly impact Lear’s stock:
Oil prices declined by over 50% through last year, and hover around $58 per barrel for the Brent presently. Continual slowdown in crude prices has bolstered customer purchasing power, particularly in low fuel-tax markets such as the U.S. This, in turn, has boosted vehicle sales in the country, which witnessed its largest automotive demand since 2006 last year. Auto sales in the U.S. continue to grow this year as well, rising by 5.6% in the first three months. Rising automotive demand boosts sales of companies such as GM and Ford, which are the leading automakers in the U.S. and also the biggest clients of Lear. Low crude prices influence consumer behavior, prompting a shift to larger and luxury vehicles, which aren’t big on fuel economy. This should have a significant impact on Lear’s average revenue per unit, as premium and large vehicles typically require more seating and electrical content.
If the Organization of Petroleum Exporting Countries (OPEC) maintains its current stance and doesn’t decide to cut production, and/or demand for oil remains somewhat subdued due to weaker economic conditions in China — the world’s second largest oil consumer and the main driver of demand growth over the last few years — there might not be a significant rise in crude prices in the near term. The short-term impact of low oil prices is expected to increase sales of large and premium vehicles, which is a boon for Lear. Following the recession, cumulative global light-vehicle sales of over 760 million between 2014-2021 were expected, up 33% over the previous eight-year period. [1] According to IHS Automotive, another 5-7 million units could be added to this forecast due to low oil prices. To summarize, consistently low crude prices are expected to impact global vehicle volumes, as well as prompt segment shifts, which bodes well for Lear.
Accounting for the possible rise in volumes, global vehicle production could rise by a CAGR of 4% through 2021, to 112.6 million units, up from the current estimate of 3-3.5% annual growth through 2021. A rise in premium vehicle sales could also fuel growth in industry-wide average revenue per vehicle for seating and EPMS to $880 and $940, respectively, by the end of our forecast period, up from our current estimate of $843 and $908, respectively. In addition, low oil prices also reduce input costs for Lear, and coupled with the higher margins of premium products, the automotive supplier’s profitability could also slightly rise going forward. In this scenario, Lear’s price estimate would rise by 17% above our current estimate. Our forecasts can be seen, and further tampered with, on the Trefis website.
In February, Marcato Capital Management LP, which holds a 4.6% stake in Lear, called for splitting the company’s business into two separate companies — one focused on seating, and the other on EPMS. According to Marcato, splitting the company will allow the electrical segment to unlock its potential value, as it is growing faster than the seating segment, which might be weighing down the company’s market valuation. The EPMS division formed only 25% of the net sales for Lear last year, but has outperformed the seating segment each year since 2009 in terms of revenue growth, with the exception of last year, as the seating revenues were boosted by acquisitions. In addition, while the EBITDA margin for seating has declined or remained flat in the last few years, margins for the EPMS segment has grown by 8.7% percentage points since 2010 to 13.1%, according to our estimates. Marcato believes that Lear’s stock is undervalued and also called for an immediate share repurchase program of $1 billion.
Lear responded to Marcato by saying that it is open to the views of its shareholders and will review the suggestions. The company also increased its share repurchase authorization to $1 billion, up from $339 million at the end of 2014. If Lear splits up, a separate EPMS company might make more acquisitions, and augment its portfolio, boosting its market share and average electrical revenue per vehicle. If the market share for EPMS increases to 8% by the end of the decade, rather than our current estimate of 6.5% (flat through 2014-2021), and average revenue per vehicle rises to $1,000 by 2021, up from our current estimate of $908, there could be a 20% upside to our current price estimate for Lear Corporation. This scenario also assumes that margins for both the seating and EPMS divisions will increase due to a reduction in overhead corporate expenses, once the two divisions become separate companies.
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