Lear Corporation (LEA) Earnings Call Transcript & Summary

Hi, everybody. Welcome back to our next session at the Wolfe Auto and Autotech Conference. I'm very pleased for this session to be talking to the management of Lear. As all of you know, Lear has 2 principal divisions, 64% of sales roughly, say 75% of sales comes from the company's Seating division, and then 26% comes from E-Systems. That E-Systems business includes components that basically make up the data and electrical network within the car. Of course, wire harnesses and terminals and connectors, electronics, software, that's all in there. And what's interesting right now is with the continued growth in vehicle electrification, which has been clearly a big theme of this conference increasing data connectivity, another big theme. Mary Barra, Jim Farley talked to us about that yesterday. Think about that and then think about Lear's positioning in the kinds of technologies that it has, the high-voltage terminals and connectors, DC/DC converters, chargers, battery management systems, a lot of technology for connectivity gateway modules. So we continue to think that Lear is a very interesting play amongst suppliers with regard to these themes that we're hearing about and certainly getting the sense that they're gaining momentum. And management has recently been highlighting that they are seeing more and more opportunities there. So with that as an introduction, we're very pleased to welcome Lear's President and CEO, Ray Scott; and Senior Vice President and CFO, Jason Cardew. So Ray, I'm going to pass it along to you maybe to just start us off with a little bit on the general state of the business.

Yes. Yes. Thanks, Rod, and thanks for having us. You hit on a couple of key points, Rod. It's obviously an incredible time in this industry. And I think a pivotal time and thinking about the future and where you can go and the prospects. And I couldn't be more excited about our prospects in our future at Lear. We do look forward to a sustained volume recovery. You think about the volume recovery from 2009 to '17 after the Great Recession, it increased the production environment, industry production volumes increased 60%, plus 60%. And when you look at our midpoint of our guidance right now, Rod, from '17, industry volumes are down 15%. And so I do look forward to a step back in volume. I think obviously, it's really a story between the first half, second half. We are dealing with different challenges as an industry between the carryover effects of COVID, obviously, the microchip situation and shortage, commodities, those type of things. But we have a very strong industry. I think that we're going to see those things dissipate over the next 2 quarters, but be in a much better position, not only for the second half, but moving forward. And I think Lear is very well positioned. There's a lot going on. Seating is a great business for us. You think about the business cycle we just went through and how well Seating performed in respect to the margins. I believe that team has done an excellent job in really driving sustainable margins and profitability. And done a nice job growing that business. I think there's a number of key factors there. One, our operational excellence. We've been investing in that business for a long time. It doesn't take a significant amount of restructuring or we've been looking at it from a -- really the transformational change to Industry 4.0. And we've put different components in place, digitization, the analytics, what we're looking at in respect to operational performance and improvements with cobots and robots and automation. And the additive features just with some of the technologies. So they're in a good position. We're going to continue to invest in that area of operational excellence because I do believe it's at the core of our company. And I think on the other side, product innovation. We've been investing for years in into Seating and ConfigurE+. And now we're proud to announce we have 2 production contracts in both those different areas. And I think those are significant ways of differentiating our products. We are the most vertically integrated seat company in the world. And I do believe in a world that there will be modular components that incorporate innovation and technology. And having that distinct advantage of being vertically integrated capabilities puts us in a unique position. And then the excitement around E-Systems. I mean, we couldn't have been positioned better. I know the team has done a remarkable job, and we'll talk a little bit around the margin profile. But from a product category standpoint, electrification has just I think, accelerated beyond anyone's expectations, and we're so well positioned. You think about China was the first one to kind of lead in electrification and move quickly to Europe, and now we're seeing a rapid change within North America, and it's really well positioned around our product offering, and we'll talk a little bit more about that. But just generally, we're very well positioned, excited about the future. Despite some of the short-term headwinds, and I think, well, without question, we put that in our guidance, so we kind of saw those coming. So we're very comfortable with our full year guidance at this point. And really looking forward to a good year. And I think, consecutively stronger years in production environment as we move forward.

I'd like to just dive into a couple of questions, maybe first on the E-Systems division because we've been getting quite a bit of questions about the margins, but look, let's talk about the growth. The business is going to do $5 billion revenue this year. You had 10 points of growth over market last year. You're expecting 10 points of growth over market this year again. And you've talked about that business achieving 6 points or more potentially over time. And I can see where that's coming from. You've got that high-voltage electrification business growing from $270 million to $1.4 billion by 2026. That alone looks like it's 300 basis points of growth for the division. Maybe you could talk a little bit to us about where are the big opportunities coming that are driving overall that 6 points of growth. What are the products and -- that are driving your growth over market target over the next couple years?

Yes. Let me take a step back a little bit, too. And we talked a little bit about the need to vertically integrate with engineered components in wiring. And I'll tell you that our own internal expectations, we've exceeded those. I can't tell you how much increased quoting activity we've seen. And not just for the low voltage, but for the high voltage. But when you think about the low voltage, we've always talked about engineered components and the majority of that being in a catalog, which is somewhat restricted or exclusive. Our customers are opening that catalog and offering us a tremendous amount of insight and ability to quote those programs, which is a significant change. I think we've seen issues relative to some of our peers that they've had trouble with some of their launches and programs that we've even had competitors come to us and ask for opportunities to quote connectors business. And so I think that is moving along extremely well. And I think it's even exceeded our expectations as far as targets. And Jason will elaborate a little bit more on where we want to go with that business. And I think the other part of this is just the continued pipeline of quoting activity, but I think back, it wasn't that long ago, we were talking about $500 million in electrification. And now we're talking about $2 billion. And even though we've given a target of $1.4 billion, we're looking at this. And if it changes, obviously, we'll make adjustments, but we're very positive on our -- the success rate we've had with quoting. We are very selective on who we're quoting, the type of platforms we're quoting. We want to really participate where we have a deep domain expertise than we do. We've been supplying electrification and high-power components for well over 13 years, goes back to the original Volt. So we have a deep domain expertise. So we want to stay true to that and create value for our customers in very selective areas because there are a lot of different areas that you can look at, build-to-print, which are fine if they get us a good return, but we're very focused on what we consider to be our core competencies and that's the area we're really building. And I think just generally, the opportunities that we've seen with the continued relationships, you think about it, Rod, we were somewhat customer-centric. And we had 2 or 3 major customers that made up these systems. Man, the expansion and the diversification, and again, you have to have the technical competencies to go and quote the specifications and then they review your plants, your facilities and they walk into our plants and they say, "Wow, you guys have the operational excellence. You have the ability to deliver and execute." And we do it in a way that it creates value. And that has changed. Now we have Geely, Volvo, Volkswagen, BMW, Silanis, I mean, it's amazing how we changed the diversification of customer base. And I think that's a credit to our skills, our competencies and our ability to execute in a timely manner. And so yes, I couldn't be more excited. We have outstanding reviews. We've made sure we're being very focused on the investments where we want to invest, and we're going to continue to grow that business. And I think, Jason, you want to add a little bit around the margin.

Yes. Just starting on the growth side, how we see this unfolding, Rod. In our guidance for this year, as you mentioned, roughly $5 billion sales, at the midpoint of $5.3 billion of revenue. That business today is comprised of it's 76% power distribution. So that's wire and commercial sales and connection systems and 24% in electronics and software. We've established targets in vertical integration on our wire business and connection systems. And our goal is to double the size of that business. That business today is about $450 million in sales. It's about 11% of our power distribution revenue overall. And we see that business doubling over the next 5 years. So that's one catalyst for growth. On the electronics side, we've talked about between electronics and software, growing that business from roughly 25% of sales to 35% of sales, we have a pretty clear line of sight, getting that business to 30% of sales as I look out to 2025. So those are kind of 2 big growth drivers. We're also picking up share on the low voltage side. And that's sort of the third piece of the growth driver for that business overall. And so we see our revenue in these systems getting to $7.5 billion in 2025. That's a 5-year revenue CAGR of a little bit more than 11%. If you look at IHS' projections, they have the industry growing at about 5% from 2020 through 2025. So that's more than 6 percentage points of growth over market. And I think there's some conservatism in that IHS volume outlook. If you look at what they're projecting for 2025, we only get back to 93.5 million units. That's flat with the 2017 peak. So I think as the industry continues to recover -- come out of COVID and the global economy picks up steam, there's some upside to that volume projection, but that's what underpins our assumptions on the revenue side.

Great. And maybe it's just worth pointing out what Ray was referring to when you were talking about that the catalogs are opening up, electrical engineers at major automakers have a catalog of parts that could be terminals and connectors, electronic components that they've used historically and their 12-volt architectures. And to mitigate warranty issues or other reasons, they're generally going to use what's in the catalog, but now when we're going to high voltage, many of those products don't really apply anymore. So it's an opportunity for companies like Lear to come in and take market share because all the incumbency is being shaken up. I wanted to ask you just -- maybe, Jason, you can maybe elaborate on this question a little bit more. So look, the lower volumes and higher engineering investments, they are clearly the headwinds for the E-Systems business. But you're talking about the base business showing signs of improvement. You just talked about a significant increase in the terminals and connectors, doubling the electronics going from 25% to 35%. Those should all be tailwinds. Can you just give us some way to sort of think about the pluses and minuses? And give us an update on when we might expect that original 10% margin target coming through for that division.

Yes. Yes. So Rod, as you point out, the 2 biggest kind of near-term headwinds are the lower production volumes and now the investment in engineering that we're making in the business. But the engineering investment was anticipated. That isn't new. So when we originally talked about going from sort of mid-7s to 10%, which we've talked about at the end of 2019, the key drivers of that, first and foremost, was improving the margin on some of the new customers we added to the portfolio. So we've expanded our business in China. We added business with FAW, SAIC, and those came in at a little bit lower than the segment margins. We've already seen improvements there, 100 basis points roughly in those -- with those customers, and that's led to about a 30 basis point improvement in the operating margins in E-Systems, again, from the second half of '19 to what's embedded in our outlook for this year. The second factor was vertical integration. And so the growth that we've already achieved in connection systems, which Ray referred to, that's improved operating margins by 15 basis points in E-Systems. So those 2 actions alone, we've seen about 50 basis points of improvement so far, just in what we've been able to achieve in this very difficult environment. Again, we see operating margins this year, sort of at 7.25%. That's what's embedded in our guidance. And as you look out to next year, you get beyond COVID, you get back to a little bit more normal environment for volume, we see operating margins in the 8% and a little bit above that in 2022. And then as you move forward from '22 to subsequent years, the key drivers are going to be that additional vertical integration, and we see that adding 75 basis points to operating margins over a 3- or 4-year time period. We see the shift to more electronics in the portfolio, adding about 25 basis points to operating margins over that same time period, so roughly 100 basis points. So as we look out to 2023, we see the improvements in the margins on our core business, and we see the additional actions that I just outlined, we see a path to 9% in 2023. If you look out to 2024, and you start to see engineering costs sort of normalize in that business as the electronics portfolio is more fully developed, and we see a path back to 10%. So it's going to take a year or so longer than what we outlined, I think, at the end of 2019, primarily because of the steep reduction in volumes, but we do see a clear path back to that 10% over that time period. And I'll point out that we're not fully achieving our -- the targeted 35% electronics, 65% wire and connection systems at that stage. If we get to that point, which is probably more in the 2026 and beyond time frame, we do see a path to operating margins above 10%.

Okay. That is perfect. That is very clear, Jason. Thanks so much for clarifying something that I know it's come up quite a bit, but it looks like the trajectory is clearly there. Can you just talk a little bit more about the content in electrification. So just so that we can understand what the opportunity for growth is better. The content in an EV versus and ICE, and maybe just a step beyond that, we have this universe of companies as analysts that we can look at that have different components, whether it's terminals or connectors or power electronics and things like that. What is separating Lear from the competition? And maybe talk a little bit about who you compete with in some of these areas.

Okay. I'll take the front, and you could talk a little bit about CPV and areas of growth. And Rod, that's a good question, an important question, too, because we want to make sure we're very clear where we're participating and why we're so confident that we're going to continue to grow that business. It really is -- our focus is around 3 product families. And power electronics is a key driver in where we have tremendous expertise. And it's integrated power modules, onboard chargers, DC/DC converters or power conversion and battery disconnect units would make up power electronics. The second part of that family is the battery management systems. And then that's really the battery monitoring, the sensors and software that goes along with it, very, very key attributes to really driving that battery management system and differentiate yourself. And then obviously, the high-voltage wiring and connection systems. And if you break those down, where we differentiate ourselves, and we've been very successful. You touched on it a little bit, Rod, that the world's changed and where 80% of the catalog was complete in low voltage wiring and connection systems. And even though that's opening up to us, it's much different in high power. And so maybe 20% of the catalog is somewhat subscribed. And we're obviously winning business in that. And so 80% of that's open. I'd give you an example. We have an incredible power to scale ratio. I believe we're one of the best power to scale ratio, which means we can put more power through a connector with smaller size. That's a very, very important ingredient as you continue to reduce weight. Obviously, time and efficiency is a big part of the overall battery and the usage within the system. And we won with Volkswagen, which is an important win, the plugboard, the battery plugboard, which is a very, very sophisticated connector, very unique. And so we see that as a continuation of the catalog. Obviously, we're waiting for the derivatives to come out, but we believe we put ourselves in a great position to be recommended for future applications and business. And so that's a dramatic change. And where we really do a nice job is in the grounding and the power scale ratio. And we've been able to be successful and win business. And we're competing against [indiscernible]. It's all the usual names that were included in low voltage, and we're winning business there. I think the other key ingredient, and I'll talk a little bit about competitors is, we have been in this for a long time. The power electronics and the battery management systems. The ability to write software. And what we're focused on, Rod, is important. The -- if you talk about a TAM and say it's $20 billion, there's a lot of different things in that. And one part of it could be a build-to-print, you could have a third-party design, you could have your own design. We're really focused on the components that and I talk about this deep domain expertise where we can create value, where we deliver the software, we deliver the hardware, we have the efficient system that helps with efficiency of the battery, the battery mining system and the software that really utilizes that hardware in an efficient manner. And so we've done a nice job growing that business, but we are very focused on value-added content and not just build-to-print type applications. And I do believe that when you break that down, within power electronics, there's [ Contes ], the Boschs, we got Panasonics, LGs, Delta, Cosel. But when you get a battery management system, it really gets exclusive. There's some players, I'd say, Panasonic is probably one of the big players that we compete against. And then you have some build-to-print applications that other companies are looking to just build design from a particular customer, which we'll do if it gets us a fair return, but we're much more focused on the expertise that we bring. Because we do believe, Rod, that those key ingredients are going to continue to be integrated. And we're looking at like talking about the next generation. And I do believe that there's platforms and each customer is treating these components differently. And there are quick changes, quick changeover. So we want to look at programs that we believe will be on the next iteration or derivatives of platforms. The battery disconnect for General Motors is a perfect example. We're going to be -- we designed that, engineered that, and we'll supply it on the Hummer. And we're hopeful we put ourselves in a good position that, that product will then go on to other families or products within General Motors. And so we're really focused on where we can drive scale. We do have a scalable product. We're very focused on where we create value with our expertise, and we do have incredible expertise for the software and the hardware to deliver that and the continuation of integration. We do believe that there'll be further integration of these modules that I'm talking about, and that's what we're working on is the next generation of efficiencies and power modules that will help our customers. And so we are very well positioned. And I think when you boil that all down, from a competitive standpoint, we're the only supplier in the world that does everything I just mentioned. You have competitors that are in parts of those things, but we are the only one, LG, like I said is -- Panasonic is in battery management system, but they don't deliver the power distribution, wiring and connectors. We have a combination of all those things. And so I do think it uniquely helps us when we look at a full architecture. Even though we may not get sourced the complete architecture, understanding each one of those components helps really drive efficiency at the component level. And that's where I think we benefit. And we are very particular about our customer, the platform and thinking more generational about where that product is going to go because we're putting investment in that with a very specific need. I don't know, Jason if you want to talk a little bit about the CPV.

Just -- yes, on the CPV part of the question, Rod, and we've talked about this before. So roughly $2,000 of additional content compared to a low voltage vehicle system today for us. And $1,500 of that $2,000 is on the electronics side, which would include both the power electronics and the battery management system that Ray referred to and then $500 roughly on the high-voltage wire and connection systems. And we'll point out on high-voltage wire and connection systems, it's a little bit different than on the low voltage side, you have a little bit more vertical integration opportunity with the -- on the high-voltage side, it's about 50% of the content and the wire is the engineered components connection systems, whereas on a voltage system, it's more like 1/3, about 30% of the content of the low voltage alternatives.

Did you say that you are doing the battery connect system? So that's like a contactor? Is that the same kind of product?

It's a switch. It's the switch that literally shuts the power off to the vehicle. So...

But it's like a sophisticated switch because you've got like a 400-volt system, right? So these things, if I I'm thinking about the right product, that could be like $100 product kind of thing? Is that...

Yes. Much higher than that number.