A Closer Look At Lear: Many Reasons To Be Long And Short

| About: Lear Corporation (LEA)

Over the last year, shares of Lear Corp. (NYSE:LEA) have fallen around 13%, despite a relatively flat performance in 2012. Lear is a supplier to the global automotive industry. The company supplies its products to automotive manufacturers and is divided into two segments -- seating and electronic power management systems (EPMS). The seating segment produces a significant amount of cash and is in a mature market, whereas the EPMS segment is in a growth market. At current levels, the company has a market capitalization of roughly $3.9 billion.

The company's financials have been inconsistent over the last five years, as Lear is highly levered to the outlook for the global automotive business. Not surprisingly, the company's revenues plunged in 2009 amid the financial crisis, and this risk is something that investors take into account when valuing the stock.

In 2008, Lear had revenues of $13.57 billion. In 2009, sales plunged to $9.739 billion as the turmoil in the automotive industry took a steep toll on the company's financials. In fiscal 2011, revenues had grown to $14.156 billion as a cyclical recovery in the global economy helped the company rebound.

The gyrations in Lear's sales based on cyclical factors, however, make this stock difficult to own when sentiment and growth are poor. Alternatively, Lear is a great way to play a rebound in economic sentiment. The stock's recent rally demonstrates how perceptions of the health of the global economy are among the leading factors that drive price action in this name.

Not only have revenues been volatile in recent years at Lear, but the company's bottom line has also been all over the place. Not surprisingly, Lear posted big losses in 2008 and 2009, but has since turned into a profit. The wild gyrations in net income based on the health of the economy underscore some of the risk embedded in this stock. On balance, Lear lost around $131 million in the time frame between fiscal 2008 and fiscal 2011.

For fiscal 2012, analysts are projecting that Lear will be solidly profitable, posting EPS of $5.25. Next year, earnings per share are expected to grow to $5.40. Any unforeseen gyrations in the global economy, however, could cause these numbers to appear optimistic. For the current fiscal year, Lear is expected to post revenues of $14.38 billion. For fiscal 2013, revenues are anticipated to rise by 7% to $15.38 billion.

Overall, Lear appears to continue to be a company that is on the mend from the financial crisis. Despite the fact that analysts are only projecting modest growth over the next couple of years, this stock is likely undervalued if you use a very strong economic recovery as a backdrop for evaluating the investment. Shares trade at a very low forward P/E of 7.32 and also yield around 1.50% at current levels. In a robust forward-looking economic environment, this stock could post substantial gains given its current valuation.

The way that investors are pricing the shares, however, reflects the fact that Lear's operations could be significantly impacted in the case of another downturn. There appears to be a fair bit of pessimism priced into the stock. In light of Lear's high cyclical exposure, the stock may not be a good investment for extremely risk-averse investors. In any event, a grinding recovery, at worst, will likely be necessary to see an uptick in the share price over the next year. If economic conditions were to improve substantially, the stock could easily show large gains.

The near-term technical outlook for the stock is promising. An earnings report released on Aug. 2, along with a rally in global markets, has caused Lear to rise sharply. The company's most recent quarterly earnings report showed that it earned $1.45 per share in the fiscal second quarter compared to analysts' estimates of $1.28. Revenues were $3.67 billion, which also came in ahead of analysts' estimates of $3.65 billion.

The stock has been reacting to the strong second-quarter numbers over the last few days. Lear is now trading above both its 20-day and 50-day moving averages and has an RSI reading of around 64. This suggests that momentum is heading in the right direction and that over the next month or so, Lear could overtake its 200-day moving average, which is around 5% above current prices.

The most recent rally has convincingly broken the near-term downtrend in the stock and aggressive investors could feel comfortable owning it here. Investors with a longer time horizon that also use some form of technical analysis to determine entry and exit points might want to see the stock retake the 200-day moving average and demonstrate that this recent trend change is here to stay.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.