Description

Lear is a Tier 1 auto supplier with approximately $20bn in annual revenues.  The business is split into two divisions with seating systems accounting for about ¾ of the revenues and E-Systems making up the remainder.  The company is the 2^nd largest seating supplier wit a mid-20’s global market share  and, in general, seating content per vehicle has risen as mix shift has gone to larger vehicles (SUV/CUVs light trucks).  E-systems produces components for vehicle electrical distribution systems that route power throughout the vehicles, which, similar to seating, also benefits from recent trends within the auto industry including electrification, rising luxury share and larger vehicles.   

The stock is down from over $200 last year to $110 today as declines in global auto production, most significantly in China, have impacted earnings results and forecasts.  The long-awaited cyclical roll in global auto SAAR seems to be well underway with only a few areas of resistance (US still over 16MM units) left to falter.  IHS revised down its 2019 industry production forecast from a year over year decline of 2% to down 3% with the biggest changes coming from China (which represents over 25% of the market by volume).

For Lear, however, things have been compounded by a reset in expectations in their higher margin E-systems business.  Part of the bull case over a year ago with mid-teens margins and the potential for higher growth from exposure to electrified vehicles, E-systems was the more exciting story while seating was seen as steady but always at risk of price deterioration.  To the Bulls surprise, however, E-systems has performed worse than seating, with margins falling from 14% in Q2 2018 to 8% in the most recent quarter and expected to fall further in Q3.  The Company blamed several issues for the decline, some temporary some longer term, but management finally admitted that a quick bounce back isn’t in the cards and that low double digit margins could be years away.

Given the current set-up, however, I’m not sure you need a return to double digit margins in E-systems for the stock to work.  The company is facing a cyclical downturn not a secular decline and the margin reset is now largely in the numbers.  With the stock at $110 and just over $1bn in net debt the company is trading at an EV/EBITDA of 4.4x (incl. minority interest and minor pension underfunding).  Current guidance puts free cash flow at 675-775 or a 10-12% yield at current levels.  The company has been buying back shares including $160MM in the most recent quarter and almost $700MM over the last twelve months reducing the share count by 6.5%. 

Street estimates now forecast flat operating margins next year on 3.7% revenue growth.  The company called out $75MM in annualized cost savings by 2021 as part of their $200MM 2019 restructuring spend with 80% in-place by 2020.  For reference $75MM at a low 20’s tax would be just under $1.00/share to earnings and 40bps to consolidated margins.   

Any indication that 2020 will show some stability to global auto numbers could get the stock trading closer to 10x earnings or over $150.  In the meantime the company's balance sheet isn't stressed and they have the ability to buyback shares while they wait for the auto cycle to turn.  

Catalyst

-Outlook for global autos stabilizing; Free cash flow