Description

Executive Summary

The post-reorganization stock of Lear Corporation provides over 30% upside in a relatively short amount of time, with time-certain catalysts to help an investor realize the return.  Lear will exit chapter 11 as the most well-capitalized automotive supplier in the industry trading at a significant discount to other suppliers.  When the stock begins to trade on the NYSE regular way (expected by the end of this week or early next week--it is currently trading on a when-issued basis as 'LEA-W'), and equity analysts pick up coverage, I believe the discount to the peers will disappear, and the uniquely strong / cash-rich balance sheet of Lear should help the company trade in-line/at a slight premium to other automotive suppliers, despite the taint of having filed for chapter 11.

 Company Description/Chapter 11:

Lear supplies automotive seat systems and electronic products and supplies to the global automotive industry.  The seating segment (80% of sales, 95% of EBITDA) includes seat systems and the components. The electrical and electronic segment includes wire harnesses, junction boxes, terminals and connectors, various electronic control modules, as well as audio sound systems and in-vehicle television and video entertainment systems.  In 2008, 36% of sales were to North American, 49% to Europe, and 15% to ROW.

In 2008, sales were comprised of the following vehicle categories: 65% cars (including 28% mid- size, 22% compact, 13% luxury/sport and 2% full- size), and 35% light truck  (including 21% sport utility/crossover and 14% pickup and other light truck).  General Motors, Ford, BMW, and Chrysler accounted for 23%, 19%, 12%and 3% of sales in 2008.

The competitive dynamics are generally favorable in the Seating industry (95% of 2009 EBITDA) relative to most other automotive supplier segments.  Lear and Johnson Controls (JCI) have close to 80% of the North American market and close to 60% of both the European and Chinese market between the two of them.  In addition, Lear is an asset-light supplier (CapEx runs at 1-2% of sales-much lower than the rest of the space) and is a negative working capital business (averages negative 5% to negative 6% of sales; 2009 will be around negative 4%), so I would characterize Lear as being in an above-average competitive position versus the 'comp group'.

As a result of the massive slowdown in automotive production, the Company filed chapter 11 in early July with an agreement in place with the majority of the pre-petition secured lenders and unsecured creditors.  The Company did not impair pension/post-retirement obligations or trade payables, and emerged after a quick 4 month case.  The chapter 11 replaced approximately $4.3BN in debt/other unsecured claims (including the DIP facility) with a new $400MM exit facility and $550MM in new second-lien notes.  In addition, pre-petition creditors/management received 35.4MM shares of new common stock, 10.9MM shares of new preferred stock, and 8.2MM shares of new penny warrants pursuant to the plan of reorganization.  I will spare people the details of how they work, but the net result is that there will be approximately 54.5MM shares of fully diluted new common stock.  It will become clearer in 30 days when the preferred stock and warrants ought to be converted to common stock.

Upon exit, I assume that Lear will have net cash in excess of $500MM (even after deducting for a 4th quarter working capital swing), and should be meaningfully cash flow positive in 2010 and beyond. 

Current Stock Price: ~$60

Shares Outstanding: 54.5MM

Equity Market Cap: $3.3BN

Net Cash (Excl Working Capital): $521MM

TEV: $2.7BN

The Company has filed projections in their disclosure statement.  Here is a summary of those projections (all EBITDA numbers exclude restructuring; numbers in MMs).

2007 Net Sales: $15,995
2007 EBITDA: $1,061

2008 Net Sales: $13,571
2008 EBITDA: $718

2009 Net Sales: $9,154
2009 EBITDA: $118

2010 Net Sales: $11,384
2010 EBITDA: $441

2011 Net Sales: $12,567
2011 EBITDA: $703

2012 Net Sales: $13,345
2012 EBITDA: $795

There are several reasons I believe that these numbers are excessively conservative.  In addition to management of bankrupt companies typically putting out low projections (their equity compensation is often based on the reorganization value and they are ultimately evaluated based on performance relative to those projections), the Company has already updated guidance for 2009 EBITDA to be approximately $350MM.  I believe this is a fair starting point, although I fully believe the 4th quarter to be better than they are projecting.  Based on their new guidance, their EBITDA will exceed the disclosure statement projections by 200% for 2009.

My EBITDA projections ($MM):

2009: $355
2010: $625
2011: $800

Based on my projections, Lear is trading at 3.4X 2011 EBITDA and 5X 2011 EBIT versus 4-6X 2011 EBITDA and 6-10X 2011 EBIT for other suppliers.

I believe with equity analyst coverage out of the bulge brackets and significant liquidity when the Company begins trading regular way on the NYSE, the stock will trade to a more reasonable 4.5X-5X 2011 EBITDA, which would equate to low $76-$83 on the stock (versus ~$60 today).

Even on 2009 numbers, Lear trades at 7.7X EBITDA, which is a pretty decent trough multiple considering that the industry ran at production levels that were 45% lower than the average over the past 15 years.  If you annualized their last quarter run-rate (3Q 2009), Lear trades at approximately 3.9X EBITDA.  Both of these numbers are significantly below other automotive suppliers.

Auto Industry/C4C/Procution Estimates

I will just give a brief summary of why I think that production will be up next year and what I am assuming in my numbers.  Production is clearly a macro call and very open to debate/differing opinions.

For 2010, I am expecting an 11MM production year in North America and a slightly down production year in Europe. These numbers are slightly below where I believe the consensus to be.

For 2011, I am expecting a 12.3MM production year in North America and Europe to be up 6%.

In addition, Lear has $1.4BN of incremental business (15% of sales) in backlog that it is expecting to flow through over the next three years.  I am discounting this new business at a very high rate (i.e., not giving them much credit on the top line).

For 2009, North American production will come in around 8.5MM units and SAAR will come in around 10.5MM units.  Typically, production lags SAAR by 500K to 1.3MM units.  However, in 2009 there was a huge (and needed) inventory drawdown over the fist 9 months of the year, which led to production being much lower than actual demand.  The inventory at December 2008 was 3.2MM vehicles versus 1.7MM vehicles at September 2009.  DSOs went from 121 days in January 2009 to 56 days at the end of September 2009.  This led to 2009 production levels being 2MM less than SAAR versus the more typical 1MM range.

Thus, I think it stands to reason that even is SAAR stays flat at 10.5MM units, NA production will rise by something around 1MM light vehicles (12%) and be in line with the 3Q run rate.

On Cash for Clunkers, my best estimate is that the demand likely pulled some people forward a few months, but on a yearly basis, it should not have as much of an effect.  When looking at monthly SAAR, July (11.2MM) and August (14.2MM) were very strong and September (9.2MM) was accordingly extremely weak.  October (10.4MM) was probably a better estimate for post-clunkers SAAR (and November/December will be as well), and was the highest non-clunkers month of 2009.  However, for all of 2010, I don't think the comparisons will be too much affected.  The other thing to keep in mind is that CFC was a much bigger boost to the Japanese/smaller car auto makers.  This will not affect Lear quite as much as the content per vehicle is smaller for smaller cars and they have much smaller positions with the Asian OEMs.

Finally, 3rd quarter production will come in around 2.3-2.4MM units.  If you annualize that number, you will get to 9.6MM units on the high end.  As mentioned earlier, even if we stay at 10.5MM SAAR, a reasonable estimate of production would be 9.5MM units, approximately equal with the 3rd quarter run rate, a quarter in which Lear did $175MM in EBITDA, or a run rate of $700MM-this is 13% above my estimate for all of 2010.

 DISCLAIMER:
Nothing contained in this analysis shall be deemed to constitute investment advice or a recommendation to purchase, sell or otherwise transact in any security.  This analysis contains information from sources the author believes to be reliable, but the author cannot guarantee the accuracy of any such information.  The author undertakes no obligation to update or revise this analysis, whether as a result of new information, future events or otherwise.  The author owns share of the company, and may buy additional shares or sell shares at any time.  

Catalyst

• Stock starts trading on an exchange (likely within 1 week)
• Equity research coverage (likely shortly thereafter)