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Morningstar | Lear Reports Record Results for the Full-Year 2018; Maintaining $112 Fair Value Estimate

Narrow-moat rated Lear, supplier of seating, electrical, and electronic systems to the global auto industry, reported record full-year earnings per share before special items (EPS) of $18.22, $0.12 higher than the sell-side consensus and $1.22 better than the prior year. Record revenue of $21.1 billion, represented a 3% increase compared with 2017. Adjusted EBIT also rose 3% to $1.759 billion for a flat year-over-year margin comparison to 8.3%.

Given the uncertainties of global trade conflict and Brexit as well as increased spending to support launch activity this year, management's 2019 guidance contains wider-than-usual ranges. Lear expects revenue between $20.9 billion-$21.7 billion, core operating earnings in a range of $1,600 million-$1,700 million, and free cash flow in a range of $850 million to $950 million compared with $1.1 billion in 2018. Barring a no-deal Brexit, we are slightly more optimistic about European light vehicle demand relative to management guidance, resulting in our consolidated 2019 revenue estimate of $21.9 billion. At an 8% adjusted EBIT margin, in line with management expectations, we estimate $1.76 million adjusted EBIT, flat with the 2018 result.

Unfortunately, the investment community is very well aware of Lear's impressive growth potential and margin expansion. Consequently, the market has bid the shares up to a 41% premium over our $112 fair value estimate. At 2-stars, we view the stock as being overvalued relative to our expectations for economic profits and future cash flows.

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 with several stocks in the auto supplier group that possess technologies that will participate in the growth in automotive electronics and electrical systems, including Lear. These stocks have been trading as though economic cycles no longer exist. For our DCF model fair value estimate to reach the sell-side’s $170 consensus price target, one would have to believe that Lear could generate a normalized, sustainable, mid-cycle EBITDA margin of 11.4%. Compare this with the 2018 EBITDA margin of 10.7% (10-year peak), our midcycle assumption of 8.6%, plus the 10-year historical median of 7.5%, and then one can begin to see how the sell-side consensus price target has valued Lear stock as though economic cycles no longer exist.