Despite Currency Headwinds, Lear’s Operational Performance Remains Solid In Q3
As expected, Lear Corporation‘s (NYSE:LEA) Q3 revenue growth outpaced growth in global automotive production levels, yet again. The supplier of automotive seating and electrical interiors to most of the top manufacturers in the world reported a 2% year-over-year rise in net sales to $4.3 billion, which included a solid 6% organic growth. While the negative impact of currency translations continues to wipe out most of the growth for American multinationals, Lear’s solid core performance has kept the overall top line growth positive, and more than global automotive production, which remained flat in the quarter. But what was the standout result for Lear yet again this quarter, was the improvement in its operating performance.
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Margins Continue To Improve This Year
Lear’s core operating earnings rose over 27% to $320 million, and adjusted margins for the company rose to 7.4% in this quarter, up from 5.9% a year ago. The company’s low-cost manufacturing footprint and increased operational efficiencies have helped in pushing up the margins. 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. 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.
But while having a diversified manufacturing footprint has helped Lear improve profitability, increased volatility in some of the crucial emerging markets in recent times has hurt the automotive industry, and also the company’s business. Revenues from South America are down 45.7% year-over-year through the first nine months, forming less than 3% of Lear’s top line. Inefficiencies in South America are also weighing on the company’s profitability. Lear generates close to four-fifths of its net sales from outside the U.S., and hence, with the dollar continually strengthening against foreign currencies such as the euro, Brazilian real, and the Russian ruble, organic growth is being obliterated. In this quarter as well, currency was a 9 percentage point headwind on the top line.
Adjusted seating margins are up to 6.9% year-to-date, up from 5.6% a year ago, helped by the rise in sales, but also by the addition of new businesses, businesses such as Eagle Ottawa. The acquisition of Eagle Ottawa, the world’s largest supplier of premium automotive leather, which generates around $1 billion in revenue, was completed at the start of the year. Eagle Ottawa is expected to benefit full year seating margins by 20 to 30 basis points, due to its higher price points and premium positioning. Inclusion of new business would not only boost Lear’s top line going forward, but due to Eagle Ottawa’s expertise in premium leather, the company could also gain additional contracts from luxury automakers.
The company had earlier in the year given a hint that future acquisitions could focus more on technology, seeing the requirement of content per vehicle is increasing at a fast pace due to more connected car features and driver-assisting software. And during the quarter, Lear acquired intellectual property and technology from Autonet Mobile, a developer of software and devices for automotive applications. Autonet Mobile’s technology directly connects on-board vehicle systems with cloud-based applications using proprietary data exchange capabilities via cellular networks. [1] This acquisition will boost Lear’s existing capabilities in wireless and help grow the electrical business. How this could boost margins is through higher average revenue per unit (more content per vehicle), which will, in turn, result in better price and product mix.
North America And Europe Perform Well, China Struggling
North America, and Europe and Africa, are the biggest markets for Lear, with combined sales of $10.8 billion through the first nine months of the year, forming approximately 80% of the top line. Amid concerns of softer global economic growth, the U.S. automotive market continues to record solid growth led by the sustained high demand for SUVs/Crossovers. The country’s light-duty vehicle market rose 5% year-over-year through September, but while car sales have declined by more than 2%, light-truck sales have risen 11.7%. ((Auto sales WSJ)) Not only in terms of high volume sales, what works in favor of Lear is that light trucks typically require more seating and electrical content per unit, which boosts the top line. Content per vehicle rose 12.6% year-over-year in North America in Q3.
On the other hand, vehicle demand in Europe has continued to rise in Q3, with the largest year-over-year increase in passenger vehicle registrations achieved in August (11.2%). Vehicle production was up 6% in Europe and Africa in Q3.
But while the developed markets of North America and Europe held strong during the quarter, China continues to struggle amid weaker economic conditions. Lear has a major presence in China with complete engineering capabilities and 44 manufacturing facilities. The company’s sales there are roughly $3.7 billion, including both consolidated and not consolidated, of which around $2.1 billion is consolidated. [2] Lower automotive demand has hurt automakers who previously depended on the growth potential of the Chinese market. As China comes to terms with normalization, automakers and auto part suppliers are bearing the brunt of lower production levels.
However, the advantage that Lear has in China is a well diversified business. The company has maintained strong relationships with foreign automakers in the country, as well as domestic automakers 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 30% of its seating business in China is with major domestic automakers.
Despite the negative currency impact, Lear has managed to consistently outpace growth in global automotive production levels. Also, Lear’s commitment to expanding its low-cost footprint, and increasing operational efficiencies, has shown how despite a small sales growth, the company’s net income growth remains solid, which means more cash for its shareholders.
See the links below for more information and analysis:
- Lear pre-earnings: North America and Europe to offset lower Asia and South America sales?
- Lear’s Q2 results review: profits grow despite currency pressures
- Large demand for SUVs bodes well for Lear’s seating business
- Lear’s strong growth momentum continues into Q1
- Trefis analysis: Lear Corporation Seating Revenues
- Trefis analysis: Lear Corporation EPMS Revenues
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