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Lear Company (LEA): Putting You in the Driver’s Seat

September 10, 2013 | About:

David Chulak

29 followers
History:

Lear Corporation was originally known as American Metal Products and has a history going back to 1917 as part of the automotive industry in the Detroit area. Lear Corporation manufacturers seat assemblies for automobiles and aircraft, along with other components. Lear is a mid-cap company with a market capitalization of $ 5.7 billion and is an international company that gives it presence in 36 different countries, including the fast growing emerging markets. With approximately 113,000 employees and 221 locations and total sales of just under $ 14.6 billion, Lear is divided into two main segments. The Seating segment consists of 76% of the business and the Electrical Power Management Systems segment providing 24% of the business.

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They are one of two independent global manufacturers of complete seating systems that provide systems and their components to nearly every part of the world. They provide high-quality systems for customers such as Audi, BMW, Cadillac, Mercedes, Porsche, Ferrari, Lamborghini, Jaguar and others. Their largest market is in North America (39%) and Europe (35%), with the remainder scattered throughout the world. Their largest customers, which provide more than 50% of their revenue, consists of General Motors, Ford and BMW.

In 2009, Lear filed for protection under Chapter 11 provisions due to extremely low profit margins, overproduction of product, excessive debt combined with the global slowdown of 2008 and 2009 which caused a large slowdown in the manufacturing of automobiles. The company has reorganized and restructured itself and converted some of its debt to new debt, equity warrants, etc. They have, since the filing come back with a vengeance, seemingly willing to prove to shareholders that they are serious about providing value. The Chapter 11 protection has left its financial position much improved and they are using their cash for share repurchases and concentrating on improving return on invested capital.

Guru Interest and Insiders

The largest fund holders of the stock belong to Oakmark Equity and Income Fund (OAKBX) with 5.49% of shares and Harris Associates Equity and Income Strategy with about the same as Oakmark. You will also find it included in some of the Vanguard funds, Blackrock, etc.

Lear Corporation currently finds itself in the portfolio of Ray Dalio, Steven Cohen, Pioneer Investments, Chuck Royce, Jim Simons, Mario Gabelli, Charles Brandes, Hotchkis & Wiley, David Dreman and Paul Tudor Jones.

Running the company past a Peter Lynch screen, the company rates a strong 93% rating from Lynch for its P/E of 5.5, Low P/S of 0.4, Inventory growth rate (year over year) of less than 5%, earnings growth rate, etc.

Some of the defensive Graham criteria come through with flying colors such as P/B x P/E being equal to less than Graham’s suggested 22.5 (P/B 2.14 x P/E 5.47 = 11.7). In addition, Lear’s long-term debt is less than the net current assets, another Graham requirement. Lear, having a P/CF ratio of less than 6.3, places it in the bottom 20% a metric that contrarians prefer to see.

Key Metrics

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Since the Chapter 11 filing or 2009, the return on invested capital (ROIC) has an average 23.80 per year with the last year and trailing 12 months exceeding 34. Depending on calculations for cost of capital, the average being approximately 10.5% to 11%, the company clearly appears to be creating considerable value for the shareholders. Note also the improvement for return on equity (ROE) and return on assets (ROA), while financial leverage is remaining low.

As far as the share repurchases, it is stated quite clearly from their Chairman Henry Wallace:

The Company is continuing to return cash to shareholders through our cash dividend and share repurchase programs. Since we initiated these programs in the first quarter of 2011, we have returned $608 million to shareholders and reduced our shares outstanding by about 10%. In January of this year, we increased our share repurchase authorization by $800 million, bringing the total available authorization to $1 billion. Our remaining authorization will allow the Company to further reduce its shares outstanding by about 20%.

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Looking at year-over-year and quarter-over-quarter, the share repurchases continue to make a dent in the total, well on their way to the goal stated by the company.

Lear’s sales are outpacing production creating a sales backlog of $ 1.8 billion. With their restructuring, none of their debt maturities are due until 2018, providing them with a cushion for a questionable recovery that might develop upon the industry.

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Improving margins since the bankruptcy and restructuring have continued to improve while the cost of goods sold have remained constant. Additionally, debt to equity is improving, along with a consistent growth of book value. The interest coverage ratio, the testing of the company’s ability to meet its interest payments, clearly indicates that the company is generating the amount of revenues necessary to pay their debts.

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The charts above give historical bands for price to earnings (P/E), price to book (P/B) and price to sales (P/S), the first two indicating that the ratios are on the historical low end, indicating that the stock is inexpensive or cheap, while the P/S ratio is barely above the mid range of the bands, still indicating value.

Competition:

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Above is a chart with key metrics indicating how Lear Corporation stacks up against its competitors, including, Wabco Holdings Inc., (WBC), BorgWarner Inc. (BWA), Astra International Tbk (PTAIY), Denso Corporation (DNZOY) and Autoliv Inc. (ALV).

Lear Corporation remains intent on remaining the low cost provider for their products. With the high ROIC, compared to the much lower cost of capital, the company continues to demonstrate strength, with a narrow moat at best. In addition, they have been intent on placing their part making and majority of employees in low cost countries, saving them a great deal of money. It could or should be noted that Johnson Controls Inc. (JCI) is a competitor of Lear Corporation, but was left from the chart due to the company’s metrics and overvaluation on most fronts.

Management

The management team consists of several members with good experience.

Management is lead by Matthew J. Simoncini, who holds the job of president, CEO and Director. While normally, it’s preferable to divide those jobs among others, Simoncini seems focused and up to the task. His background at Lear Corporation includes Senior Vice President and Chief Financial Officer (CFO).

Early in 2006, he was responsible for worldwide operational finance, including accounting and financial reports, along with vice president of finance for Europe. His career started as a certified public accountant with Touche Ross.

Terry Larkin is executive vice president, business development and general counsel. As a lawyer, Larkin handles all regulatory issues. He has both a bachelor’s degree in finance also received his law degree with honors.

Jeffrey H. Vanneste is senior vice president and chief financial officer. Some of his vast experience includes vice president of finance for Ford and GM Divisions. He had joined Lear as early as 1991.

Management, based upon the chart below has done an incredible job for the shareholders in creating value.

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Valuation:


Next year’s earnings are projected to be around $7.50 at this early stage with a forward P/E of 11 to 13. Using earnings of $7.50 with a P/E of 12 would give us a fair value of approximately $90. The current price is around $71.00 for a cursory glance at the value, but there is much more that meets the eye.

The DCF numbers I ran indicate a much better number at $110 with a 35% margin.

GuruFocus DCF number is still more extremely favorable:

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My five-year discounted earnings analysis, using $7.50 for next year earnings with a forward P/E of 11, 10% earnings growth and a 15% hurdle indicates that I’ve passed the point of entry for the 15% return, but still leaves me with a valuation of approximately $137. The earnings yield presently stands at 18%, so it’s close either way. My discounted book value analysis gives me a value of $170.00.

Enterprise value to EBIT indicated a ratio 5.4, the latest quarter 7.66, still indicating the stock is cheap. Using the 7.66 number, this would indicate the stock is about 25% undervalued.

Ultimately, I can conclude that the company can safely be valued somewhere around the $130 range, meaning that my safety of margin could not be met unless a reasonable pullback occurred as the market has been predicting now for some time.

Bulls and Bears:

The bulls think that Lear Corporation has made some good choices recently and runs a much tighter ship giving them a competitive advantage.

The numbers prove that the course of action taken since their bankruptcy filing is providing value.

A big Lear customer, GM’s Cadillac brand name is expecting to expand greatly, doubling its sales and adding new vehicles to their lineup.

Emerging markets and China are great future areas of growth.

The growth of hybrids, including the electric cars is a perfect match for Lear’s technology and a good place for future growth.

The company is now better positioned for a weaker economy or recession.

The bears worry that if the economy tanks and auto sales tank, Lear will once again get in trouble with their reduced margins.

Increased competition makes it hard to maintain margins and they have little control over prices or their ability to raise them when auto sales deteriorate.

Conclusion:

When I think of Lear Corporation and their bankruptcy filing and restructuring, I cannot help but think of Joel Greenblatt’s book, "You Can Be a Stock Market Genius." Greenblatt talks extensively about companies that go through the distressing times of both bankruptcy and restructuring and shows how investors can take advantage during these times. I discovered that while Lear Corporation still shows on a Greenblatt Magic Formula screen, Greenblatt discovered it quite some time back and obviously walked away with some handsome profits, GuruFocus indicating an average return of 63%.

Lear is a much better company and still is relatively inexpensive, though I would want to see a pullback prior to entrance into the stock.

With share repurchasing at such a large percentage of the stocks being removed from circulation, increasing margins and return on capital, return on assets, etc., there is not much to dislike about the company except perhaps the risk of the economy. With that said, that risk remains for all stocks.

Disclosure: I currently have no position in Lear Corporation. This is not a recommendation to purchase or sell the stock.

About the author:

David Chulak
David Chulak is a private investor that uses a value approach to investing in the styles of Graham & Dodd and Warren Buffet. Looks for that margin of safety in an effort to preserve capital and attempts to guard against short term market fluctuations by having clear rules laid down in advance for selling an equity. Likes to visit the company's where his investments are in order to understand the business better.

Rating: 3.2/5 (5 votes)

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