Lear Corporation (LEA) is the leading tier-1 global supplier of seating and electrical distribution systems, with manufacturing operations in 36 countries with 221 locations throughout the world. Investors would be wise to further investigate Lear Corp. because consumer demand in the auto industry is rising and the company has taken significant measures to sustain its competitive advantage of being a low-cost provider in the auto component industry. Lear recently invested $300 million to increase its low-cost production capabilities, which should further strengthen their competitive advantage as a low-cost supplier.
Lear Corp. serves all the world's major automakers and has maintained its excellent brand name by providing the highest level value to its customers. Lear's largest customers include BMW, Ford (F), and General Motors (GM), Fiat (FIATY.PK), and Volkswagen (VLKAF.PK). Two of Lear's largest customers and two of the biggest automotive and light truck manufacturers in the world, General Motors and Ford, combined for 41% of Lear's total net sales in 2012. BMW was responsible for 11% of net sales. Given Ford and GM's recent joint efforts to develop more fuel-efficient transmissions, plus a recent increase in total truck sales, equals rising sales for Lear in the months ahead. By leveraging their synergies, Ford and GM will not only create more fuel efficient transmissions, but should also see increases in sales as consumer preferences are pointing to more fuel efficient vehicles.
Share Repurchasing Program
Lear has remained committed to rewarding its shareholders since its inception. Case in point: it recently began repurchasing its shares while maintaining its cash dividend. The Southfield, MI, based auto part supplier has rewarded its shareholders with $608M in dividends and bought back approximately 10% of its shares. What's more, the company plans to continue buying back shares while further decreasing its total shares outstanding by about 20%. On February 7, 2013, Lear's board of directors declared the company had increased its dividend to $0.17 per quarter-a 21% increase over the year prior.
Lear's management has delivered on its promises of maximizing long-term shareholder value by taking significant action steps. The company has become focused on shedding unprofitable business operations and specializing, enhancing, and expanding its two primary businesses: seating and electrical power management systems (EPMS). Lear has divested its unprofitable automotive interior business to further bolster its core businesses. I believe management's astute decision to specialize in its seating and EPMS divisions will increase its economies of scale, allowing the company to diversify its customer base and further expand its global operations. What's more, Lear's decision to divest has improved the company's cost structure and has resulted in higher year-over-year margins for the last three years. Given Lear's excellence in producing its two primary components coupled with its position as a low-cost provider and management's decision to specialize should result in steadily rising profit margins.
Considering the oligopolistic nature of the automotive components market (one competitor in its seating segment, three in its EPMS segment), Lear's position as a low-cost provider should position the company to be a price leader. Because Lear can produce their auto components at lower costs than their competitors, they can cut the prices they charge to their customers and increase sales volume-resulting in greater revenues. Lear's competitors will be forced to lower their prices in order to compete. Put simply, the competition either figures out how to become more efficient or they risk losing market share and potentially going out of business. In addition, Lear has leveraged its massive economies of scale to reduce its marginal cost. What does this all mean for shareholders? Long-term reduced costs coupled with greater revenues will lead to larger future margins for Lear. Moreover, Lear has focused on creating a more efficient supply chain, reducing inventory levels and further reducing costs.
Sales and Production Breakdown
In the last two years, global production in the auto industry improved 3% in 2011 and 7% in 2012. Production in North America increased 10% in 2011 from the prior year and another 17% in 2012. Roughly 39% of Lear's sales were generated in North America while 35% were generated in Europe. Rounding out the list was Asia, responsible for 17% of sales, and 9% in the rest of the world. I believe Lear's geographic diversification will hedge the auto manufacturer against risks like demand fluctuation, weakening currencies, and economic recessions. Moreover, Lear is aggressively expanding operations in Asia-where net sales have increased 127.27% over the last five years.
Financials and Valuation
Lear's efforts to reduce costs and repurchase its shares played a significant role in the operating results for Lear in 2012. Net income improved 132% to $1.283 billion. Furthermore, return on equity, assets, and investments were 43.31%, 16.93%, and 28.84%, respectively. Assuming a very conservative 4% free cash flow growth rate, 11.58% weighted average cost of capital, 2% terminal growth rate, and a 9.58% capitalization rate, I believe the fair value of Lear Corp's share price to be $130. Given the May 9th closing price of $59.91, investors could purchase shares in the auto component manufacturing company for a 54% discount! Moreover, Lear Corporation's valuation ratios are enough to make any value investor salivate. Price to earnings, sales, book, and cash flow were 4.48, 0.36, 1.58, and 3.51, respectively. Compare that to the industry averages of 16.7 times price to earnings for the auto industry. In addition, both value and growth investors alike will be delighted by the fact that Lear's current price earnings to growth ratio is currently 0.4-which trounces the auto industry and market averages of 1 and 1.6, respectively.
Lear has remained committed to maximizing long-term shareholder value and has been relentlessly focused on being a low-cost provider. Lear should have no problem further diversifying its customer base both domestically and abroad. Management's decision to divest in its unprofitable businesses will give management more capital to distribute to investors and reinvest in expansion efforts. Lear's continued emphasis on improving its core competencies coupled with the strengthening of its balance sheet should equal greater cash returns to shareholders in 2013. Investors looking for a consistent, high-quality Company committed to expanding its low-cost production advantages would be wise to explore Lear's operations further.