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Alexander Valtsev

Lear Corp.: An Interesting Company At The Start Of 2016

Lear Corporation (LEA) is engaged in providing automotive seat systems and individual seat component parts. The Company has two segments: seating and electrical (Source: Google Finance). It has manufacturing, engineering and administrative capabilities in 34 countries with 219 locations and has incurred a net income of $772M on revenues in excess of $18B (free cash flow for the period totaled about $730M, just for a reference). In terms of share dynamics, the stock performed very well over the last 52 weeks:

(Source: Google Finance)

In fact, Lear Corp. managed to beat not only the broader index but also all of its peers. Besides, most of its free cash flows have gone into shareholder compensation (dividends and buybacks), according to my calculations:

(Source: Capital IQ. Calculations by author)

Two things are evident in the above picture:

- The company had to borrow funds to finance massive buybacks (totaled $2.4B over the five-year period), increasing its total debt to a level of 20% of total assets (up from 10% in 2010);

- The company's bank account cannot afford an expansion of the payout ratio. This means that the current yield of 0.8% can only grow in tandem with earnings.

Nevertheless, Lear Corp.'s management thinks the company is undervalued relative to its peers:

(Source: October Presentation)

Note: the share price has barely changed since the valuation date.

This could look convincing investors dug into the comparative analysis:

(Source: Capital IQ)

Apart from the EBITDA growth, the last twelve months have been uneventful for the company in terms of profitability. Compared to peers, Lear Corporation has below-average results on all lines. Add the outstanding last year’s share performance to the equation, and the thesis about the company’s relative undervaluation becomes hard to defend.

No doubt that the company has shown good growth rates in the past five years (CAGR of over 8%) but the growth has slowed down, as evident in the FY 2015 forecast:

(Source: October Presentation)

Over the last twelve months, the company’s revenues have increased only marginally – by a meager 1%. Currency headwinds have made it difficult to maintain high single-digit growth in the top line. This is no surprise given the company’s revenue structure:

(Source: October Presentation)

Almost 60% of total sales come from overseas, while the company’s key currency is Euro, which went down by 17% over the last year, according to the presentation.

Despite that, Lear Corporation plans to come up with $650M in free cash flows in FY 2015 which gives room for a marginal increase in dividends and buybacks:

(Source: October Presentation)

Let us sum up the findings:

- The company positions itself as undervalued. Our analysis has shown that the “undervaluation” is likely justified given the relatively low margins;

- Historical growth rates are high but the last twelve months’ data show that the growth in the top line has slowed down substantially;

- Currency swings do have in impact on the company’s statements. This is a serious concern going forward given the current situation on the Forex market. I expect margins to be under pressure in 2016.

I feel uncomfortable with the idea that Lear Corporation is undervalued. I also do not like the fact that its growth has slowed down. Although I feel positive about the company’s future, I am waiting on the sidelines to buy into its shares when they start offering a margin of safety.

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