Lear Pre-Earnings: Higher Content Per Vehicle To Boost Lear’s Top Line In Q1
One of the leading suppliers of automotive seating and electrical interiors in the world, Lear Corporation (NYSE:LEA), is scheduled to announce its Q1 results on April 24. Last year, net revenues for the company rose 9.2% year-on-year to $17.7 billion, more than the 3% rise in global vehicle production. Lear’s business depends on the performance of its clients, comprising leading automakers around the world, which, in turn, is impacted by trends in global vehicle demand. Lear has been able to outpace the percentage growth in vehicle production through a simultaneous increase in average revenue per vehicle, on the back of higher proportionate sales of large-segment and luxury vehicles, which typically require more seating and electrical content.
Lear expects to grow revenues by 4.5-7.5% this year, yet again outpacing the expected growth of around 2% in global automotive production. As vehicle production grew by a healthy rate in key markets such as North America and China this quarter, Lear is expected to report a strong set of financial results. This estimate is further boosted by continual low oil prices, which have prompted segment shifts to vehicles that require more content per vehicle, which is why Lear could continue to grow more than industry vehicle production levels. Solid growth expectations spurred investor confidence, boosting Lear’s stock by approximately 40% in the last 52 weeks, much more than the 13% growth for the overall S&P 500 Index.
We estimate a $113 price for Lear Corporation, which is slightly below the current market price.
See our full analysis for Lear Corporation
North America And China In Focus
Lear expected vehicle production in North America, which formed 38% of the company’s net sales in 2014, to grow 3% this year. Vehicle sales in the U.S. have risen 5.6% in the first quarter, which bodes well for Lear. Improving economic environment in the country, fueled by low oil prices, increasing customer purchasing power, and historically-low unemployment rates, have impacted automotive demand positively. Consistently low crude prices have not only impacted vehicle volumes, but also prompted segment shifts to larger vehicles. The SUV/crossover segment in the U.S. light-duty vehicle market grew 12.4% in Q1, and formed roughly 34% of the net volume sales in this market. [1] Higher disposable incomes and low energy costs have prompted customers to trade-up from their compact vehicles to large SUVs/crossovers, or from large sedans to luxury models, which aren’t big on fuel economy. This should have a significant impact on Lear’s average revenue per vehicle this quarter, as premium and large vehicles typically require more seating and electrical content, sometimes even doubling the content requirement, as compared to traditional powertrain vehicles.
On the other hand, the world’s largest automotive market, China, has undergone a slowdown of sorts, hurt by weaker economic activity and industry overcapacity. In the first three months, although automobile production in the country was up 5.3%, this growth rate was 3.9 percentage points lower than the previous year. [2] Nonetheless, the China automotive market is still growing, and should, in turn, drive growth for Lear, which derived 12% of its net sales from the country last year.
Lear’s largest clients–GM and Ford, which together formed 43% of the company’s top line in 2014, have witnessed growth in both the U.S. and China in Q1, which could have, in turn, boosted Lear’s quarterly performance. GM’s U.S. and China sales were up 5.3% and 9.4% respectively. [3] On the other hand, Ford topped one million unit sales in China for the first time last year, and continues to grow in the country on the back of a strong showing by its compact SUV Kuga. Production of utility vehicles increased by an impressive 36.7% to 4.32 million units in China last year, and could top 7 million units by 2018, according to IHS Automotive. This means that even though the overall vehicle production growth rate in China is slowing, segment shifts and higher proportionate sales of large vehicles could bolster content per vehicle for Lear, thereby boosting the top line.
Emerging Market Slowdown Could Hurt Sales
Increased volatility in some of the economies, such as Russia, Brazil, Argentina, and Venezuela, poses a threat to Lear’s sales. Lear, just like other companies in the auto sector, has looked to make the most of its operations in low-cost emerging countries, where vehicle demand is growing due to steadily increasing disposable incomes and low current penetration levels. In addition to benefiting from higher demand in developing markets, Lear has looked to leverage the low costs of manufacturing in these countries to boost profitability. More than 100 of Lear’s manufacturing engineering facilities, out of a cumulative 219 facilities, are located in low-cost countries. The company has 25 production facilities across China, Brazil, and Russia.
A slowdown in vehicle demand in emerging countries is detrimental to Lear’s clients and, in turn, to Lear’s business. Automotive companies tend to have a high degree of operating leverage, and are thus sensitive to fluctuations in sales growth. Assuming that operations in low-cost countries are more profitable for Lear, a declining proportion of sales from these markets will not only drag down revenues, but also negatively impact operating margins.
As the Russian economy continues to struggle amid geopolitical issues with Ukraine and collapsing oil prices, the ruble has lost approximately half its value against the U.S. dollar in the last 52 weeks. Negative consumer sentiment amid high prices and interest rates has also impacted the country’s automotive market, which was already in decline before the Crimean crisis. After declining nearly 5% in 2013, annual vehicle sales in Russia fell 15% last year, and continue to fall this year. [4] Low demand and negative currency translations in Russia have also prompted automakers such as GM, Ford, Volkswagen, and Jaguar Land Rover to halt or slow down vehicle production in the country from time to time last year and this year. Lower production for Lear’s clients in Russia will impact the company’s top line. On the other hand, high interest rates and inflation rates have choked Brazil’s growth in the last year or so. Lay-offs resulting in unemployment and lower consumer spending have hurt demand for vehicles in the country. This slowdown is expected to hamper sales for automakers such as GM and Ford, the two biggest clients of Lear, and leading automakers in Brazil. Lower vehicle demand will lead to lower production levels and could subsequently contract Lear’s business going forward.
What supports our estimate for higher seating content for Lear in the future, is the inclusion of Eagle Ottawa. As of January, Lear completed the acquisition of Eagle Ottawa for $850 million, which means that additional business should impact the company’s top line from this quarter onward. Eagle Ottawa generates around $1 billion in revenue, and is the leather supplier for over 50% of all cars in the U.S., including many for GM and Ford, which together constituted 44% of Lear’s 2013 sales. Inclusion of new business would not only boost Lear’s top line, but due to Eagle Ottawa’s expertise in premium leather, the company could also gain additional contracts from luxury automakers, going forward.
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