Strong Auto Demand Boosts Lear’s Profits; Company Raises Guidance
Strong global demand for automotive vehicles, along with improvements in operational efficiency, helped Lear Corporation (NYSE:LEA) deliver strong Q3 earnings. Total revenues for the quarter jumped 11% to $3.9 billion while the operating income rose 3% to $158 million. The company’s net income stood at $113 million, or $1.38 per share vs $1.25 per share in the previous year quarter. [1]
The management raised its guidance and now expects the full year revenues to touch $16.0 billion, up from the previous figure of $15.8 billion. Similarly, the operating income is now expected to be ~$835 million, up from the previous range of $750-800 million. [2]
We estimate a $72 price for Lear Corporation, which is about 5% lower than the current market price. We are in the process of revising our estimates in order to incorporate the latest earnings.
Lear Corporation is a tier 1 supplier of seating systems including seat structures, seat foam and seat covers and generates three-fourth of the revenues from them. The company also provides electrical distribution to both traditional and high power hybrid systems. Electrical and Power Management Systems (EPMS) include wire harness, terminals and connectors, junction boxes and wireless remote control devices.
Lear’s biggest customers are GM, Ford and BMW, all of which have significant operations in the world’s two largest automotive markets. During the first nine months of the year, the automotive markets in the U.S. and China are up 8% and 11% respectively. [3] The fact that Lear’s three biggest customers are all performing strongly is benefiting the company.
Strong Demand For Vehicles Lift Seating Segment Sales
Seating segment’s sales surged 9% to $2.9 billion, helped by higher vehicle sales in the U.S. and China. On the other hand, the reported segment margins declined 90 basis points to 4.9%. Adjusted seating margins now stand at 5.1% for the nine months of the year. For the full year, the company expects the segment’s margins of ~5.5%. [1]
The extra expenses associated with the changeover of key Lear platforms are hurting the seating margins at the moment. However, from the second quarter of 2014, the company expects these expenses to subside, as a result of which it expects the full year margins for the next year to rise by 50 basis points. The company also believes that the European automotive market has bottomed out and volume gains in 2014 could help improve the margins further. In the long term, Lear sees the seating margins rebounding to ~7%.
Profitability Continues To Improve For EPMS Segment
Although the EPMS segment accounts for only a fourth of the revenues, it contributes almost 50% to the company’s valuation due to its higher growth potential and heftier margins. The emergence of electric and hybrid-electric cars is generating more content per vehicle. Furthermore, Lear is gaining market share in the overall electrical distribution market, which is further driving the growth of the EPMS segment. During the third quarter, EPMS sales surged 17% to $1.0 billion.
For the quarter, the segment margins rose a massive 350 basis points to 10.9%, buoyed by higher volumes and improvements in operational efficiencies as a result of the ongoing restructuring. Since the EPMS business is more niche than the seating business, we expect the segment to possess higher margins in the long run. The company sees the long-term margin outlook in excess of 10%.
In the recent years, Lear has shifted its primary focus to provide complete electrical distribution systems. This production strategy enables it to better leverage its scale and minimize investment costs, which is one of the reasons why we expect the margins to expand in the coming years.
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