Lear Corporation: Sitting Pretty After Restructuring
Lear (LEA) is a leading supplier of automobile parts to manufacturers worldwide. Specifically, Lear focuses on two areas. The Seating division (79% of 2010 sales) designs and manufactures seat frames, recliner mechanisms, tracks, trim covers, headrests, filler material, and delivers completely assembled seats. Electrical Power Management Systems (EPMS) builds electrical distribution and wiring systems for vehicles, which include harnesses, terminals, junction boxes, and control modules. This division also makes a few "select" electronic compontents, such as keyless entry systems and both interior and exterior lighting (including headlights). EPMS also designs advanced electrical systems for hybrid and electric vehicles, including the Chevy Volt. Lear is internationally diversified, with 42% of sales in Europe, 34% in North America, 16% in Asia, and 8% in the rest of the world.
Lear, like many companies in the auto industry, is enjoying a rebirth. The industry unraveled in 2009, as vehicle shipments in North America plummeted to just 8.6 million units, from over 15 million just two years earlier - a staggering 43% decline. This hit hard on the domestic auto industry, which over the years was saddled with over-capacity, excessive debt, uncompetitive labor agreements, and shifting tastes towards Asian brands, notably Toyota (TM). General Motors (GM) and Chrysler both filed for bankruptcy protection, and Ford (F) barely escaped.
Similar issues confronted Lear. The tremendous troubles at GM and Ford (Lear's 2 largest customers) gutted sales. Lear itself suffered from labor issues, unprofitable business units, and a heavy debt burden, forcing it into Chapter 11 bankruptcy in July of 2009.
The company has emerged as a much more attractive entity. The debt load is down to a more managable $700 million, which is covered over two times by cash ($1.8 billion), and has no maturities until 2018. Interest coverage is more than comfortable at 17 times. The unprofitable interiors business was divested and the majority of labor in both Seating and EPMS was moved to low-cost locales overseas. Lear's robust health now is demonstrated by its commitment to return capital to shareholders, with the initiation of a small (1.2%) dividend, and a $400 million share repurchase program, in addition to a stock split earlier this year.
Going forward, Lear is well-positioned to thrive for the near future. North America auto sales rebounded to 12 million units last year, and is expected to show about 5% annual growth through 2016. Auto sales in emerging markets (a focus for this company) continue to be robust. China, for example, is growing auto sales volume almost 30% annually, and is now a bigger market than North America at over 14 million units. Lear expects the BRIC (Brazil, Russia, India, China) market to expand a robust 9% annually through 2016. With sales to nearly every major auto maker, and one of only 2 global suppliers of auto seating (Johnson Controls (JCI) is the other), Lear is well-positioned to benefit.
With sales growth comes higher margins, as this is a high fixed-cost business. For example, management is forecasting the EPMS business to grow operating margin from 4.7% last year to about 5.5% this year on ~25% sales growth, and expanding to nearly 8% by 2013. If they can hit those targets, Lear shareholders will benefit greatly.
Let's not forget the risks here, though. Europe is still in a credit crisis, and it is Lear's largest market at over 40% of sales. Recessionary fears have plagued the stock market all summer, and auto companies traditionally get killed in a recession. The company still has 52,000 unionized workers, which sets up the potential for work stoppages and collective bargaining renegotiation pains. And a new CEO just took over at the beginning of this month, replacing 40-year veteran Robert Rossiter. While Matthew Simoncini has held high positions at Lear (most recently CFO), executive turnover in difficult industries like this does create some risk.
Overall, I believe the restructuring and rebound in the auto industry makes this a better area to invest than in the past, and the proliferation of new electronic gadgets and hybrid/electric powertrains create a nice opportunity for this company. My fair value is about $55, representing a nice 30%+ upside to current trading prices. I'd like to see even a bit more cushion before considering the stock as a Top Buy pick, however.
Steve owns no position in any stocks discussed in this article.