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Morningstar | Lear Reports Record 2Q Results but Disappoints Slightly; Maintaining $112 FVE

Narrow-moat Lear, vendor of seats and electrical architectures to the global automotive industry, reported record earnings per share before special items of $4.95, $0.04 short of the sell-side consensus EPS of $4.99 but 13% higher than the $4.27 EPS reported in the same period last year. Record revenue of $5.6 billion, represented a 9% increase compared with the second quarter of 2017, but would have been 5% higher excluding the impact of currency.

Management maintained 2018 guidance including a revenue forecast range of $21.8 billion-$22.0 billion and adjusted operating income in a range of $1.79 billion-$1.81 billion. Our model already reflects higher revenue and adjusted operating earnings for 2018 at $22.2 billion and $1.89 billion, respectively. Even so, the sell-side values the stock as though economic cycles no longer exist. Currently trading at an eye-popping 60% premium over our $112 fair value estimate, we view the 1-star rated stock as being overvalued relative to our expectations for revenue growth, future cash flows, and returns on invested capital.

Our investment thesis on Lear remains intact. Lear's above-industry growth rates are supported by a growing global premium-vehicle segment and increasing penetration of automotive electrical and electronic content. A culture of continuous innovation at Lear enables regular and consistent product and process development, commercializing technology that generates solid margins and returns on invested capital. Automakers' growing use of common architectures benefits Lear because of its global footprint.

However, the market has become enamored of several stocks in the auto supplier group that possess technologies that enable participation in the growth of automotive electronics and electrical systems, including Lear. These stocks have been trading as though revenue growth and margin expansion continue in perpetuity. For our DCF model's fair value estimate to reach the sell-side's $203 consensus price target, one would have to believe that Lear could generate a normalized, sustainable, midcycle EBITDA margin of 13.0%. Compare this with the 2017 EBITDA margin of 10.7% (a 10-year high), our midcycle assumption of 8.5%, and the 10-year historical median of 7.5% and one can begin to see how the consensus price target may be valuing Lear stock as though economic cycles are extinct.