Lear Corporation (LEA) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to our fireside chat with Lear. My name is James Picariello. I cover the auto space at KeyBanc. Very pleased to have Lear's CEO, Ray Scott; and CFO, Jason Cardew, with us today. Thank you guys for the time. Really appreciate it. I want to jump right in. But before we kick things off, just everyone out there. Please feel free to submit any questions you have through the Q&A browser at the bottom of your screen, and we'll get to as many of those as we can. So yes, to start, Ray, would you like to maybe provide any general industry or overview comments based on what you're seeing thus far?

Yes. Thanks, James. Good morning, everyone. It's an honor to be here. Real quick. Obviously, there's some short-term pressure. I think everyone knows. I won't belabor the microchip situation and how it's impacting the overall industry. And it will be more of a short-term issue. I do think some of the chip concerns will be primarily impacting the second quarter. However, I do think in the third and fourth quarter, we'll still be managing, but the quarters will be significantly better. With that said, we're very bullish on the industry as a whole. We do believe that the volume trajectory of growth will increase. And Lear is very well positioned in both business segments. In Seating, we've done a remarkable job. I couldn't be more proud of the team and the sustainability. It's a very challenging 12 months, and the robustness of our seat business continues to prove that it's a great business. And that comes with a lot of capital investment, well over 10 years of investing in that business and really focusing on vertical integration and positioning ourselves very well. The growth trajectory, we believe, we're very confident will continue to grow 4 percentage points over market. And E-Systems, equally as exciting. With the electrification story, how we're positioned in power electronics. We're very uniquely positioned with power distribution and power electronics. So well positioned for growth in that area. And we're seeing nice growth within our connectors business. And so the story that we've talked about as far as growing that business, really driving the margin profile to double-digit, a 10% profile is in place. We do have, like I said, some short-term headwinds, particularly around E-Systems in the second quarter. But very, very bullish on the long-term perspective around electrification and engineered components. So that's really the story where we're at, and we look forward to answering some of the questions.

Yes. Yes. A lot to dig into. I guess, first off, I mean, you mentioned the chip shortage. There are plenty of OEM downtime announcements to point to but we did just get GM's very positive announcement yesterday morning. So I mean, the second quarter is slated to be the most challenged. We're 2 months in. How are things trending from Lear's standpoint?

Yes. Certainly, the second quarter has been a challenge, never been as challenging as we expected, maybe a little bit more so even. And first of all, I want to just compliment the operating team. It's really well seen in E-Systems. They've done a remarkable job of navigating through this challenging time. And as Ray said, the demand setup is fantastic, I think, for industry volumes once we get through this. But the second quarter when we guided to that, when we issued our guidance on the first quarter earnings call, we talked about sequential revenue being down about 9% at the midpoint from the first quarter, second quarter with a range of down 7% to down 11%. As we sit here today and there's still 4 weeks to go, but we have a pretty good line of sight through the end of the quarter, I think we're going to be down about 10% sequentially. So sort of in between the midpoint and the low end of the range. If you do the math on that, revenue would be down about $550 million. But the story is very different in both segments. In Seating, we have, just given the mix of customers there, we're seeing Seating revenue down about 8% sequentially and E-Systems down 16% to 17%. And I think everyone is aware that Ford is our largest customer in E-Systems, and they've been pretty transparent about their production cuts in the second quarter. So that's had a meaningful impact on E-Systems in particular. And if you think about the operating earnings side of the outlook, if you look at our decrementals historically, 15% to 20% in Seating and 25% to 30% in E-Systems, you can get pretty close to where we see the quarter shaking out. Looking beyond the second quarter into Q3. As Ray mentioned, it's certainly going to be better than the second quarter. It's still going to be challenging. The fourth quarter is going to be better than the third quarter. Our visibility into the second half of the year is improving. And we still feel very confident in the full year outlook that we provided on the first quarter earnings call.

Okay. Great. That's super helpful. A lot of great detail there. I guess focusing on seating and maybe just the top line. The growth over market this year is well above what you're targeting over the midterm. So we certainly have the favorable dynamic of content, just favorable program mix, right? The content mix is strong. What else is there -- what else is kind of driving that outgrowth within Seating? And I've gotten the question, we all have the question, does this favorable content mix this year pose a major headwind, some form of a headwind next year as the full slate of models are back in production? How should we be thinking about that?

Yes. I think that the -- what drove the first quarter growth over market in Seating was really the strength that GM full-size trucks and SUVs in our luxury platforms in North America, Europe and in Asia. And I think we have 45% of the luxury market. It's an important part of our seat business. And I see that remaining strong into next year. I don't see that as a headwind, maybe -- or a tailwind. But I do see the GM full-size truck and SUV production continuing to be a tailwind. GM's talked about adding a facility in Oshawa to produce additional trucks. So I think we're going to see higher volume year-over-year, and that will be a growth over market tailwind in our Seating business, at least through 2022. And so I think we're a couple of points above our 4 points of growth over market target in that business this year. I think we're at or above the target next year and then maybe moderating a bit after that back in line with our historical 4 points of growth above market.

Got it. And then on E-Systems, right, basically the inverse, right? I mean -- and you already alluded to many of these points. But growth over market is going to trend below what you would be targeting over the midterm. Clearly, the chip shortage is in play. And so my question there is, is Lear -- is Lear E-Systems having trouble procuring the chips that you need? Or is it just your more so your OEM customer exposure and their own chip exposure?

Yes. It's -- the vast majority of that's a result of our customer production disruptions. Our electronics business is a relatively small part of the business overall. And we talked about it on the first quarter earnings call. We made it through the first quarter and through that point in time without any disruptions to our customers. I think everyone is faced with constraints. It's a very real issue for all suppliers in that space. But the driver of the lower production volumes and the lower growth over market is a result of our customer production downtime, particularly again with Ford. Ford is a really important customer of ours, and we love our business with Ford. But we are a little bit overexposed there. It's 27% of our revenue last year. This year, it was 35%. If you go back 5 years and if we look out 5 years, we think it's more like 20%. So we continue to improve the customer diversification in that segment. And in addition to that, we -- within the forward book of business that we have in E-Systems, we've been overexposed to the C2 platform. It's a great high-volume platform, but we have a growing business on the F-150. We had some new business that launched the battery cable of the F-150 last year. We have the Mustang Mach-E low-voltage wire business and so our mix of business is improving within the Ford portfolio as well. And I think that's a great setup going into next year. And I think we'll see some additional growth above market. In E-Systems next year, just as you see the reversal of those platforms that have been hit particularly hard this year, and you look at inventory levels on a lot of those vehicle lines, it's a nice setup for a big volume recovery next year.

Yes. No. I mean that's all -- those are all good green indicators. How about if we kind of dig into the margin side of things. I mean, obviously, you just gave great second quarter color. You feel good about your full year guidance. But if we dig into maybe the segments, as of last quarter's conference call, both segments should -- it seems as though should get to a solid normalized run rate by the fourth quarter, right? So as we think about next year and beyond, what is the right trajectory to be -- to have in mind for Seating and E-Systems? Where do we kind of -- where should we land for the full year this year? And should we really be using that fourth quarter as a good trajectory from there?

Yes. I think the fourth quarter exit rate will be a good indicator of what we can do with both business segments next year. We're anticipating the fourth quarter volumes to be similar to the first quarter of this year in terms of the level of disruption that's still taking place. And in that environment, given the current commodity environment, we think we can run seating between 7.5% and 8% in the fourth quarter. And E-Systems a little wider range, 7% to 8%, just depends more on the timing of the commercial recovery and some of the commodity inflation. But I think that's the right run rate for both businesses as we look at next year. And we're expecting 2022 volumes to be higher certainly than this year. I think IHS is projecting an 8% increase next year. We may be a little less bullish than that. But certainly, 5% is a reasonable target. And if we see a 5% increase in industry volumes in '22 versus this year, then I think both businesses can be at or around that 8% operating margin range.

Yes. I won't -- I'm not going to try to pin you down to your 2022 industry production outlook. But given how depleted the inventory levels are in North America, right, we got the SAAR trending in that 17 million to 18 million range, which was really inconceivable 9 months ago. I mean, why would industry production only be up 5% next year if you have strong demand on top of the need to get inventory levels back up? I mean that's specific to North America, but I think that's also probably playing out in Europe. So yes, maybe we could just -- if you don't mind, digging into the regional kind of thoughts there.

Yes. So I think North America has certainly been hit hardest by the production disruptions and the chip shortage. So I can see North America doing considerably better than that. I think that if you look at China and Europe, there's maybe less room for volume growth year-over-year, and that sort of balances out the 5% that I referred to. And it's early and lots of things can change between now and the end of the year. But I do see a very robust growth opportunity in North America heading into next year. As you mentioned, the SAAR is 18.5 2 months ago and 17 again in month of May, is a fantastic setup. I think inventory levels are down to 1.5 million units. I don't know that they've ever been that low. So the combination of demand and low inventory levels is a great setup heading into next year.

Yes, for sure. Okay. Higher level per seating. I mean by objective measures, right, Lear has the best run seating business globally. Others compare their performance to yours as kind of the industry benchmark. So can you discuss the maybe the trajectory of Lear's market share over the last several years? Where you want to take it 5 and 10 years from now to start?

Yes. Yes. Thanks, James. And we have historically done a really nice job of growing that business. If you just think over the last 5 years, we've grown our market share from approximately 18% to 23% today. And we look at that business, and we've been investing in that business for a long time. And I think even historically, if you go back even further, we've been able to outgrow the market by 4 percentage points. And so we're very confident, not just historically what we've been able to do, but I think we're even in a better position as we look forward. Over the last 2 years, we've won approximately net conquest wins of $1 billion. And this year, we are quoting between $300 million and $700 million of potential conquest wins. I think it will be more reflective of what we saw 2 years ago, around $300 million. But nonetheless, good opportunities for us to grow our business. I think in addition to how we look at JIT, we've always looked at our business, and I think it's been in an indicator of how we run the business on return on investment. And that really drives what is the outcome, which is margin. And so each one of our different businesses look a little bit differently. JIT, we can really generate a nice return on investment at a 5 to 6 percentage points as far as margin. Other parts of our business, if we're more vertically integrated within the award of a JIT business can be higher. And obviously, where we're focused, and we've talked about it quite a bit, is on priceable features. We think driving innovation and technology that's embedded into a modular concept within the seat creates a significant value for our customers. And in some respects, is agnostic to JIT, meaning, that we can continue to grow our business on the component side and still remain focused and competitive on the JIT side of the business. And so we have aspirational goals to hit 20% market share. But I think it's going to be a combination of vertical integration, the JIT business and new technologies and innovation. And something that we're really excited about when I talk about technology and innovation, and we've been spending a tremendous amount of effort over the last 5 years on intuitive seating, smart seats, thermal comfort seats, I think ConfigurE+ is a great example of what we're talking about. It's a design and engineered value proposition for our customer that allows the seat to be powered on rails. It's -- we own the patents, so it's very unique to Lear Corporation, but gives our customers an incredible flexibility. You can move consoles fore-and-aft. You can add power and signal 2 different components within the vehicle, including seats. You have ultimate flexibility of being able to pull the seats out and reversing the seats for a number of different storage purposes and also flexibility of cargo and space within -- in the vehicle. And right now, we're launching with Volkswagen. It's going into production. And over the next several years, we'll be launching with Ford Motor Company, and it will represent about $100 million of business. But the significance of that type of technology innovation is drawing significant interest from all kinds of customers. It's almost -- once it goes into production, and it's offered as an option or feature, other OEs are looking and saying, "I have to really have that feature within my vehicle," because it is so unique. And that concept isn't limited to just passenger vehicles. What we're doing is we're looking at last-mile delivery. It sets up perfect for cargo, like I mentioned, racking systems, other utilities within the vehicle. So when I talk about -- yes, we're doing a really nice job, we're going to continue to invest in capital, in investment within our people to drive operational excellence within our plans for the seat business. But there's a number of different very innovative ways that we can continue to grow our business with intuitive seating, thermal comfort, ConfigurE+. And so yes, I couldn't -- listen, we're very confident in our growth perspectives within seat. I think we've done a nice job historically. I think the robustness of margins that we've been able to prove that it is something that we can maintain during very challenging times has been evident over the last 12 months. And we're going to continue to work at our efficiencies within our plants, but more importantly, how we differentiate our seat business model longer term to grow the business.

A lot of great color there. One follow-up. Is there any common thread to the type of conquest awards you've been able to win? Meaning, do those -- do you win a new customer relationship through the JIT only piece first? And then you have to kind of earn your right into a complete seat vertical integration type of relationship? Or not necessarily because it kind of just run the gamut?

Yes. It depends on the customer, and it could be very independent. I will say this. I think that why we have so much confidence in the continuation of growth is when you have capabilities and you have the vertical integration and technology and innovation, we're in the studios very early. We're looking at solutions, like I just mentioned with ConfigurE+. We're into the studios with the claims, and we're talking about different applications, which then leads to other conversations with other components or even the ability to quote the JIT business. So I think it depends on the customer. I'll give you an example like in China. We've done a really nice job of growing with Western customers. And now the domestics are really picking up because of our technology with ConfigurE+. They find it as a really interesting value proposition for them. And that puts us in a nice position to quote the JIT business that would be a part of that type of RFQ or request for quote. And so it depends on the customer. It does depend on the region. But having the broad breadth of capabilities, including our leading position within operational excellence and what we do for our customers on the JIT side, down to having very unique innovation and technology, gives us, I believe, a unique advantage to grow depending on where the customers are looking.

That's super helpful. You mentioned China. A major competitor of yours, as we all know, just announced a significant realignment in China. What doors potentially open up for Lear from this? The majority of -- is the majority of your Seating business in China through your JVs? Or is it mainly consolidated? And is there an opportunity to further consolidate those businesses? Or is part of the M&A strategy maybe to go up to the China market? Curious your thoughts on...