Lear’s Strong Growth Momentum Continues Into Q1
As expected, Lear Corporation (NYSE:LEA) reported solid Q1 results on April 24, yet again outpacing the growth in global vehicle production. Net sales grew 4% to $4.5 billion in the quarter, more than the 2% growth in vehicle production levels around the world. [1] As Lear’s business is spread across the globe, volatility in key emerging markets and negative currency translations dragged down the top line by 8 percentage points. Nevertheless, Lear had a strong start to the year, mainly on the back of rising vehicle demand in North America, and improving share in China, the world’s largest automotive market. The company is focusing on more mergers and acquisitions to move forward with a sound integrated model, and the acquisition of Eagle Ottawa, the world’s largest supplier of premium automotive leather, completed at the start of the year, is a testament to that. Eagle Ottawa aided in an impressive 16% rise in currency neutral seating sales in Q1, and is expected to benefit full year seating margins by 20 to 30 basis points, due to its higher price points and premium positioning.
Speaking of margins, profitability improved at both the seating and electrical divisions. Margins for the seating segment rose 80 basis points year-over-year to 6.3% in Q1, while margins for the electrical power management systems (EPMS) segment rose to a record 13.3%. Lear’s strong operating performance, coupled with additions of new profitable businesses, is driving a solid increase in return to shareholders, which is 180% for the last three years. In contrast, shareholder return for its peers averages at around 92% in the last three years. The company also increased its share repurchase authorization to $1 billion, up from $339 million at the end of 2014, and increased its quarterly cash dividend by 25%. Solid growth expectations has spurred investor confidence, boosting Lear’s stock by approximately 40% in the last 52 weeks. Continual growth in cash flows, expected to be around $575 million in 2015, could further bolster growth in return to shareholders.
We estimate a $113 price for Lear Corporation, which is slightly below the current market price. However, we are currently in the process of incorporating the recent quarterly results into our forecasts, and revising our price estimate.
See our full analysis for Lear Corporation
Growth In North America On Higher Vehicle Production
Vehicle sales in the U.S. rose 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. Vehicle production in North America rose 2% in Q1, and Lear’s sales in this region grew by an impressive 18% year-over-year, due to growing content per vehicle.
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. [2] 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. Lear’s average revenue per vehicle in North America increased this quarter, and could continue to post strong growth in the following quarters, as premium and large vehicles typically require more seating and electrical content, sometimes even doubling the content requirement, as compared to traditional powertrain vehicles.
Lear’s China Business Is Geared For Growth
The world’s largest automotive market, China, has undergone a slowdown of sorts, hurt by weaker economic activity and industry overcapacity. However, Lear has maintained strong relationships with foreign automakers in the country, as well as domestic automakers, to consistently derive growth from this market. In the first three months, automobile production in the country was up 8%, and is expected to grow by 7% for the full year. Although slower than previous years’ levels, the China automotive market is still growing, and should, in turn, drive growth for Lear going forward, which derived 12% of its net sales from the country last year.
In particular, what is expected to fuel growth for Lear in China is its strong relationship with domestic manufacturers such as FAW, BAIC, Dongfeng, and SAIC. Sales growth for Chinese-branded passenger vehicles outpaced growth in the country’s overall automotive market in Q1, reaching 2,292,200 units, up 20.8% year on year. The market share for domestic vehicles increased 4.2 percentage points compared to the previous year. Local brands are outpacing growth in foreign joint ventures, but this isn’t a problem for Lear, as a considerable 40% of its seating business in China is with major domestic automakers. [3] In addition, local companies are also looking at suppliers such as Lear to further develop their brand, which should contribute to Lear’s future growth.
In addition, there is also a lot of potential upside for Eagle Ottawa in China. Eagle Ottawa generates around $1 billion in revenue, with approximately 30% from Asia-Pacific. 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 in China, which is estimated to become the world’s largest luxury vehicle market in the next year or two, beating the U.S.
Lear’s automotive interiors business depends on its automaker clients. The company’s largest clients–GM and Ford, which together formed 43% of the company’s top line in 2014 — witnessed growth in both the U.S. and China in Q1, which, in turn, boosted Lear’s quarterly performance. GM’s U.S. and China sales were up 5.3% and 9.4% respectively. [4] 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.
The Q1 results for Lear, although marred by depreciation of key currencies such as the euro, Brazilian real, Mexican peso and Canadian dollar, reflect a strong core business, which continues to grow by more than the growth in global vehicle production.
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