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Elevator Pitch
My investment rating for Lear Corporation’s (NYSE:LEA) shares is a Hold.
In my prior article for Lear Corporation written on August 5, 2022, I discussed about how “recession concerns” had hurt LEA’s stock price performance. I will be focusing on Lear Corporation’s recently announced partnership with General Motors Company (GM), and its third-quarter results which will be announced next month.
My analysis leads me to the conclusion that LEA still warrants a Hold rating. In the short term, I am worried about the possibility of below-expectations Q3 2022 earnings for the company, which could exert further downward pressure on its stock price. In the intermediate-to-long term, I am positive on the growth prospects of the E-Systems segment, as there are encouraging signs observed as part of the company’s recent contract win with GM. Considering my mixed view of Lear Corporation, a Hold rating is fair in my opinion.
Partnership Between LEA And GM
Last month, Lear Corporation issued a media release announcing a new contract win from General Motors. On September 14, 2022, LEA also participated in Morgan Stanley’s (MS) 10th Annual Laguna Conference and shared its thoughts on the company’s partnership with GM. This is arguably the most significant corporate development for Lear Corporation in recent months.
A September 14, 2022 Seeking Alpha News article mentioned that Lear Corporation will “supply key electrification technologies for the automaker’s (GM’s) Ultium global electric vehicle platform” as part of this recently announced deal. LEA also revealed at the MS Laguna Conference that the company is also a supplier to General Motors for its vehicle models like “Hummer pickup, the Hummer SUV (Sports Utility Vehicle) and EV Silverado.”
This General Motors announcement is much more significant than what it seems on paper, although Lear Corporation didn’t provide any quantitative information about this new GM contract win.
The company specifically highlighted in its September press release that the partnership with General Motors “includes the largest award to date for our Connection Systems business.” At the company’s most recent Q2 2022 earnings briefing in early-August, LEA outlined its goal of expanding the top line for its Connection Systems business from an expected $500 million for full-year fiscal 2022 to $750 million in FY 2024. Lear Corporation also mentioned at Morgan Stanley’s September 2022 Laguna Conference that it sees its Connection Systems business delivering a revenue of $1 billion in fiscal 2025.
In other words, Lear Corporation’s management expects the company’s revenue contribution from the Connection Systems business to double between 2022 and 2025. The recent GM announcement certainly helped to validate the growth potential of LEA’s Connection Systems business.
More significantly, the growth of the Connection Systems business is a critical factor that determines if LEA is able to deliver faster-than-expected growth in the medium-to-long term.
In its Q2 2022 earnings presentation slides, Lear Corporation guided that “Connection Systems” will support its “E-Systems (segment) growth and margin expansion.” Separately, LEA noted at the Laguna Conference hosted by Morgan Stanley that its “electrification” and “E-Systems (which) makes up 25% about revenue growth” will play a big role in helping the company to achieve “growth above market in the future.”
In a nutshell, I have a favorable view of LEA’s intermediate-to-long term growth outlook. Lear Corporation’s recent GM announcement and its revenue growth guidance for the Connection System business suggest that the growth prospects for its E-Systems segment and the company as a whole are excellent.
Potential Third-Quarter Earnings Miss Represents A Significant Downside Risk
Lear Corporation announced earlier on September 16, 2022 that the company will host its Q3 2022 earnings briefing on November 1, 2022.
LEA’s shares have fallen by -31.1% in 2022 year-to-date, and the stock’s consensus forward next twelve months’ normalized P/E multiple has compressed from 15.7 times at the start of this year to 11.1 times as of October 17, 2022 as per S&P Capital IQ’s valuation data. I am concerned that if Lear Corporation’s actual third-quarter financial results fail to meet analysts’ expectations, there could be another round of valuation derating and share price decline for LEA.
It is noteworthy that Lear Corporation acknowledged at MS’ Laguna Conference on September 14, 2022 that Q3 2022 (up to mid-September) was “challenging” as expected due to sustained “disruptions in North America, Europe and China.” More importantly, LEA noted that its quarter-to-date performance was “a little bit better than” than its guidance, but it cautioned that “there’s a couple of weeks left in” Q3 2022 which leaves “time for more production to be cut.”
Separately, Lear Corporation declined to provide guidance for the company’s Q3 2022 operating profit margins. The company explained at its earlier second-quarter earnings call that “the lumpiness of some of the commercial negotiations (regarding cost recoveries) between the third and the fourth quarter” means that there is uncertainty with regards to LEA’s Q3 2022 profitability.
Also, the changes to LEA’s third-quarter consensus forecasts in the past month are not particularly significant, especially in view of the company’s management comments at Morgan Stanley’s Laguna Conference. In my opinion, this increases the chances of negative surprises. In the last one month, the sell-side’s consensus Q3 2022 top line and normalized EPS estimates for Lear Corporation were lowered by -0.5% and -3.9%, respectively.
Closing Thoughts
I still assign a Hold rating to Lear Corporation’s stock. While LEA’s long-term growth outlook is good, there is a risk of an earnings miss in the short term. As such, I maintain my Neutral view and Hold rating for Lear Corporation.
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