Lear: A Second Half Story

10/25/2016 7:00 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

This year is shaping up to be a tale of two halves for this firm, a supplier of automotive seats (77% of sales) and electrical components (23%), notes Richard Moroney, editor of Dow Theory Forecasts.

In the first six months of 2016, Lear (LEA) shed 17% of its value on concerns about slowing auto sales and the U.K.’s decision to leave the European Union.

But the stock was priced for a disaster that failed to materialize. Since the end of June, Lear shares have surged 22%. Several factors have made Lear a second-half stock story.

In July, Lear trimmed its 2016 guidance for revenue but raised its outlook for operating earnings (up 11% to 15%) and free cash flow (up 8%). The new guidance echoes Lear’s track record of delivering consistent growth in a sluggish global environment.

Sales have risen in 16 consecutive quarters, while both operating cash flow and free cash flow have climbed by double-digits in each of the past five quarters. Operating profit margins have expanded in 10 straight quarters.

Encouragingly, U.S. demand for bigger models continues to rise, amid low fuel prices. Large vehicles, crammed with more seats and electrical features than passenger cars, tend to be more profitable for suppliers.

Even if auto sales are leveling off, management expects higher demand for premium features, such as climate-control seats and audio-equipped headrests.

Lear has seen little fallout from Brexit. So far, demand remains stable in the U.K., which accounts for 8% of Lear’s sales. About 70% of its U.K. revenue is denominated in euros, limiting currency risk.

Lear says the shift toward 48-volt systems from the traditional 12-volt could create a significant opportunity to add more electrical content in vehicles.

Automakers are beginning to test 48-volt electrical systems to better satisfy the power demands of autonomous vehicles and meet future emissions standards.

Lear expects to outgrow the auto-parts market by five percentage points over the long term. Earning a Quadrix Value score of 96, Lear still looks like a bargain.

At 10 times trailing earnings, the stock trades 10% below its five-year average and 26% below the median for S&P 1500 auto-parts suppliers. That discount looks especially enticing given Lear’s superior operating momentum.

Lear grew earnings per share 38% in the 12 months ended June, versus its industry median of 18%. And Lear’s profits are projected to rise 22% in 2016, twice the industry norm.

If Lear meets the 2016 profit consensus of $13.27 and its trailing P/E ratio climbs to 11, the shares would rally 17% to $146 by early 2017. Lear is a Focus List Buy.

Subscribe to Dow Theory Forecasts here…

By Richard Moroney, Editor of Dow Theory Forecasts

Related Articles on STOCKS