Large Demand For SUVs Bodes Well For Lear’s Seating Business

-7.41%
Downside
140
Market
130
Trefis
LEA: Lear logo
LEA
Lear

Approximately 57% of Lear Corporation‘s (NYSE:LEA) valuation comes from its seating segment, as per our estimates. Sales growth for the automotive seating and electrical content supplier has consistently outpaced global vehicle production, rising by 9.2% in 2014, when vehicle production rose only 3%. In Q1 as well, when global vehicle production rose 2%, Lear’s top line expanded 4%. As a supplier of automotive interiors, the company’s business depends on the performance of its automaker clients, which, in turn, depends on the worldwide demand for vehicles. Why Lear has been able to grow by more than the industry production levels is bolstered by the increasing proportionate sales of larger and luxury vehicles, which require higher content per vehicle, and therefore increase Lear’s average revenue per unit.

One worrying trend for Lear could be the increased volatility in certain key emerging markets such as China, Russia, and Brazil. The rise in global vehicle production last year was bolstered by an increase in demand in mature markets, as the U.S. witnessed the largest automotive demand since 2006, and Europe returned to positive growth. However, vehicle ownership rates in developed markets is already relatively high, and once the automotive industries in these countries replenish sales lost during the recession and weak economic conditions, vehicle production growth could return to a more normalized figure of 2-3% in the near to mid-term in North America and Europe. However, even if global vehicle production growth remains at 2-3% going forward, what is expected to boost Lear’s sales is segment shifts to larger vehicles.

We estimate a $117 price for Lear Corporation, which is slightly above the current market price.

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See our full analysis for Lear Corporation

SUV and Luxury vehicle sales are growing at a faster rate than the overall market in most countries that are key to Lear’s growth. An upbeat economic environment in the U.S., historically-low unemployment rates, and low crude prices have influenced consumer behavior, prompting a shift to larger and luxury vehicles. Sales growth in the luxury SUV segment has outpaced every other segment in the U.S. this year, growing by 30.4% year-over-year through April. This segment still forms only 1.3% of the country’s light-duty vehicle market, which offers more potential to grow. Why this bodes well for Lear is that luxury SUVs significantly increase the amount of seating content required per unit. 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.

On the other hand, although China’s vehicle market has undergone a slowdown of sorts, luxury sales, and sales of SUVs are booming, which bodes well for automotive parts suppliers. 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. Economic conditions have become weaker in the country, over previously seen high GDP growth levels, due to industry overcapacity, and real estate and infrastructure sector slowdowns. However, the GDP growth for the country is expected to be 7% this year, which is still solid.

While car sales in China fell 2.7% through April, SUV sales were up a massive 48.7%. Customers are opting for SUVs, which combine the looks of a car and the functionality and power of a utility vehicle, over sedans. SUVs and Crossovers have more capacity, a higher vantage point for drivers, and also carry most of the features that make a passenger car attractive, such as connected car features, comfortable seating, and attractive styling. These vehicles are also considered safer due to their larger size and more power, and also preferred for their off-roading capabilities. SUVs form approximately 24% of China’s light-duty vehicle market, according to our estimates, lower than the 34% market composition for SUVs and Crossovers in the U.S. — suggesting there is room for growth in China. This bodes well for Lear, as higher proportionate sales of SUVs, which require higher seating content, will also increase the company’s average seating content per vehicle.

Why Lear is particularly well-placed in China is because of a strong relationship with domestic automakers too, apart from foreign automakers. In the first four months of this year, Chinese-branded passenger vehicles increased their market share to 43%, 4.2 percentage points more than 2014 levels. This was on the back of a 19.5% year-over-year rise in vehicle sales for local manufacturers. Lear boasts strong relationships with domestic manufacturers such as FAW, BAIC, Dongfeng, and SAIC. 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. [1] 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.

Lear’s average seating content per vehicle rose 5.6% last year to $727, and we currently estimate the figure to rise to $835 by the end of our forecast period, growing at a CAGR of 2.1%. However, if the large demand for SUVs and luxury vehicles boosts the average content per vehicle by more than expected, and Lear’s average seating content per vehicle rises at a CAGR of 5% till the end of our forecast period, there could be a 7% upside to our current price estimate for the company.

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Notes:
  1. Lear earnings transcript []