INVESTMENT THESIS
We are raising our rating on Lear Corp. (NYSE: LEA), a major supplier of automotive electrical systems and seating, to BUY from HOLD. We view Lear as a well-run company with a strong track record in its industry, and expect its products and services to be in high demand on the other side of the pandemic. On a technical basis, the shares had been in a long-term bearish pattern of lower highs and lower lows since June 2018. Since April, the shares have reversed their pattern to higher lows and higher lows.
RECENT DEVELOPMENTS
They have also consistently underperformed the Consumer Goods Sector ETF IYK. The beta on LEA is 1.61.
On October 30, Lear reported 3Q20 results. Excluding the impact of foreign exchange, sales were up 1%, reflecting new business, partially offset by lower production on Lear platforms. Adjusted EPS rose to $3.73 from $3.54 reflecting a lower effective tax rate. The 3Q20 operating margin rose to 7.0% from 6.7%.
For 2020, the company expects sales of $16.35 billion to $16.65 billion, capital spending of $425 million and free cash flow of $125-$175 million.
The company has a growth-by-acquisition strategy. On April 17, 2019, Lear completed the acquisition of Xevo Inc., a Seattle-based supplier of software solutions for cloud, automotive and mobile devices for $320 million. In 2Q20, Xevo was awarded the 2020 PACE award.
EARNINGS & GROWTH ANALYSIS
Lear has two segments, Seating (75% of sales) and E-Systems (15%). The Seating business consists of seat systems and parts, including seat foam, headrests, reclining mechanisms, seat frames and tracks, and seat covers. The company’s wireless communication modules process signals for cellular, GPS and wireless systems. Recent trends and outlooks are discussed below.
In 3Q, in the Seating segment, sales fell to $3.69 billion from $3.75 billion a year earlier; the segment adjusted margin was 7.8%, down from 8.2%. In the E-Systems, revenue rose to $1.21 billion from $1.1 billion and the adjusted margin was 7.7%, down from 7.8%.
At the expense line, in order to preserve margins and return to profitability, management has also reduced capital spending, cut salaries, and laid off some factory workers. However, in the third quarter, the company announced it will repay deferred salaries by the end of 2020.
FINANCIAL STRENGTH & DIVIDEND
Lear Corp. is Medium, the midpoint on our five-point scale. The company’s senior unsecured debt is rated Baa2/negative by Moody’s, and BBB-/negative by S&P.
The company ended 3Q20 with $1.25 billion in cash and equivalents, down from $1.49 billion at the end of 2019. During the quarter, Lear repaid $1.0 billion on its revolving credit facility and presently has no outstanding borrowings under the $1.75 billion facility. Long-term debt was $2.30 billion.
Lear had suspended its dividend due to the pandemic but reinstated it in November. It has declared a cash dividend of $0.25 per share payable December 29, 2020.
Lear has a buyback program, but has suspended buybacks due to the pandemic.
MANAGEMENT & RISKS
Ray Scott became the president and CEO of Lear on March 1, 2018. He was previously the president of Lear’s Seating business. Jason Cardew became the company’s senior vice president and chief financial officer on November 1, 2019, replacing Jeffrey H. Vanneste following his retirement.
Investors in the LEA shares face risks. COVID-19 has caused significant production disruptions. The company’s earnings could also be hurt by rising raw material costs. The automotive parts industry is cyclical, and vulnerable to economic downturns. As a global supplier, Lear also faces risks from unfavorable currency translation.
COMPANY DESCRIPTION
Based in Southfield, Michigan, Lear Corp. is one of the largest providers of automotive electrical systems and seating. The company has 164,000 employees.
VALUATION
The price/sales ratio of 0.6 is below the peer average and above the five-year average of 0.4. The price/book ratio of 2.3 is below the peer average and above the five-year average of 2.0. We believe that current valuations justify a BUY rating and are initiating a target price of $175, implying a potential return of over 10%.
On December 15, BUY-rated LEA closed at $160.25, up $4.18.
Source: Argus
