Lear Corporation (LEA) Earnings Call Transcript & Summary

All right. Good morning, everybody, and thank you so much for joining us for this session with Lear as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the senior U.S. autos and technology analyst at Deutsche Bank. Lear is a global leader in the supply of automotive seating and electrical architecture and a fast-growing player in electronics and vehicle electrification and connectivity. At its E-Systems Day earlier this year, the company outlined a plan to reach $7.5 billion or more in revenue at 10% operating margin by 2025 as it continues to rely on the segment for long-term growth. And so I'm very pleased to be joined today by Carl Esposito, who's SVP and President of E-Systems; and Jason Cardew, who is the CFO of Lear, to discuss latest trends as well as long-term dynamics. So gentlemen, thank you so much for being with us.

Thank you.

Thank you, Emmanuel.

So let's dive right into question, if that's okay. I wanted to start with a few short-term -- near-term questions around the environment you're seeing. Compared to your expectations at the beginning of the quarter, how has the semiconductor shortage progressed as far as impact on industry production and your revenue? I think you were looking for Q2 impact from disruption twice as large as in Q1?

Yes. The second quarter has proven to be every bit as challenging as we had anticipated, and we issued guidance in May. We talked about sequential revenue being down about 9% from the first quarter to the second quarter. We participated in another investor event 2 weeks ago and we talked about conditions being a bit more challenging than that in the second quarter, down about 10%. And that's pretty close to what we're seeing right now, although we're continuing to see additional customer announcements for downtime with limited notice. So the second quarter is very challenging. Both of our operating teams have done a remarkable job of navigating this. We really started the process back in the fourth quarter, anticipating the difficulties we were going to have, not just on the semiconductor issue, but on other components as well. And so the teams have done, I think, a remarkable job of navigating this, and we've done it. We've been able to navigate this better than most. But nonetheless, the second quarter is quite challenging. As we look into the third quarter, I think that given how June has gone, which is not much better than May, we would expect the third quarter to start out quite challenging as well. I think, overall, the third quarter will be better than the second quarter, but the third quarter will still be challenged. We talked about the impact specifically of the chip shortage being twice what the impact was in the first quarter. The first quarter revenue impact was about $400 million. We're now seeing the second quarter impact at about $1 billion, so more than double what we saw in terms of disruptions and production impact in the second quarter. All that being said, if you look at our full year guidance, we guided to an industry that was going to be up about 9% year-over-year. I think IHS is around 12%, I think they're still a bit high. We feel very confident in our outlook for the year. The second half will be better than the first half, the fourth quarter will be better than the third quarter. And so we still feel good about the guidance that we issued back in May.

That's very helpful. And then I guess, any sense on when the industry can get back to what may be normalized level of production? I guess it seems like the institution is still pretty fluid. Any visibility on chip supply and when things will look more normal?

Yes. I think you're right. The situation is very fluid. Again, in the third quarter, it's going to remain challenging. In the fourth quarter, I think, recovers a bit, and we're expecting it to be more in line with the first quarter. So still continued disruptions throughout the remainder of the year. And as we look out into next year, I think conditions improve, but the industry's ability to grow and meet the full demand is probably still not there at the beginning of next year. And as '22 progresses, I see that gradually improving. And I think it's important to point out that the end consumer demand remains extremely strong, particularly in our key markets in the U.S. and in China, maybe a little less so in Europe. And I think that's a great setup for industry volumes into '22 and '23 as well.

In terms of the chip suppliers, we're working very closely with all of the leading chip suppliers that we use as well as with our OEM customers to make sure that there's clear communication, the forecast of the anticipated demand going forward for both the balance of this year as well as into 2022, to make sure that we've got the right demand signals across the supply chain. And really we're working very closely with all of them on those parts.

That's great to hear. And if I may squeeze a quick follow-up on this. You're sort of your point around potential tight supply into next year. So actually, as part of IHS latest update, I think from yesterday or 2 days ago, it looks like they sort of increase, I guess the growth in LVP for 2022. We're not probably looking -- they're not probably looking at high single digit. Do you think the chip supply you're seeing would be able to accommodate this kind of growth? I realize it's a recovery versus a low point. But nevertheless, obviously, a pretty decent amount of growth from where we are now.

Well, we're working with all those chip suppliers to understand what those real demands are as well as any overdemand or oversupply requests in terms of building back some of the inventory buffers that all of us had across the industry. So we're working through those with all the chip suppliers right now and reconciling those demand forecasts across all the customers.

Yes. That being said, it's probably a bit early to provide guidance for next year, but I think IHS has the industry up 8% next year. And as we're starting to build our plans for next year, we're anticipating something a little bit beneath that, more in the 5% range or so in terms of industry volume increases.

Great. And just maybe one final one around near-term conditions. How are you tracking with some of your important U.S. launches this year? Should we expect any delays with these at all?

No. The launch cadence has held up pretty well. We have $1 billion backlog this year, and that remains on track despite the near-term component shortages. I think customers are prioritizing the new vehicle launches, particularly around electric vehicles. And so, for example, in the U.S., the Bronco Sport, it's an important launch for both seating and E-Systems, and that's on track. The Bronco is now ramping up, which we have proceeding on. Hyundai Tucson is ramping up, which is an important seating program. And the Ford Mach-E is another important program where we have the low-voltage wiring in E-Systems, and all of those remain on track.

Great to hear. So let's maybe shift to E-Systems, I guess taking advantage of Carl's participation. So as we continue to reposition the E-Systems for this long-term growth, what are the primary drivers to reach the outline target of $7.5 billion in revenue, and also importantly to get back to this 10% operating margin?

Yes. So I think it's important to note that $7.5 billion target doesn't include any inorganic growth. And so any benefits from M&A that we do would really be incremental to those targets. The $7.5 billion target of 2025 implies an annual growth rate of about 11%, which puts our growth over market at 6%. And we see half of that coming from the electrification side of the business. And we see that electrification part of our portfolio really growing to be about $1 billion in 2025. The other 3% or half of that growth is driven by continued expansion and growth in low-voltage wiring, connection systems and our other electronics and connectivity products. We're looking at increasing the vertical integration of our wiring and connection systems, really being able to double that connection system revenue business over the 5-year period. And we like to see that more vertical integration, obviously, across both our wiring products and our electronics products being able to supply more of our own connectors and connection systems as well as some of the engineered components that we manufacture ourselves. We're working on shifting the electronics and software business to be about 30% of our segment sales by 2025 and growing to 35% longer term. It's currently about 24%. So we see a shift towards those electronics, the electrification programs and products. And in addition to the high-voltage and electrification products, we also look to pick up additional share in low-voltage wiring, our low-voltage connection systems, both on ICE vehicles as well as hybrid and battery electric vehicles. We see that strong performance in that core wiring and electrical distribution business, including some conquest wins because of the operational excellence that we've been able to demonstrate with our customers, particularly through some of these challenging times. On the margin side, I think we work through some near-term industry headwinds as well as some of the engineering investment. We see a path back to 8% margins next year, 9% in 2023, driven through increased vertical integration and that portfolio shift to more electronics and more optimization there. And by 2024, as those engineering costs begin to mitigate and normalize, the electronics portfolio becomes more developed, we see us getting that 10% margin target.

That's very clear. Just honing in specifically on the electronics revenue, what's the expected margin profile there? Is it additive? Or the needed investment upfront are sort of pushing it in the other direction at least initially?

Right. So the way we look at the business is based on return on invested capital and earning a return in excess of our cost of capital. So the return target is our main focus and the operating margin sort of an output of that. That being said, the electronics business tends to be a little bit more capital-intensive, a little bit more engineering-intensive. The main factors that are going to determine where we fall in the margin range in our electronics business is -- are those 2 things. It's the level of capital intensity and how complex the design and engineering work is that's required upfront on the product. So we see a fairly wide range in electronics. It tends to fall in terms of operating margin sort of in between wire and connection systems, connection systems being the most profitable, highest-margin part of the portfolio, wire being a little bit lower. Typically, our more highly engineered electronics products are going to be in the 15% to 20% plant operating margin range and 10% to 15% at the segment level. Some of the build-to-print programs that require less engineering may be more in the 10% to 15% range at the plant and 10% or a little bit lower than that at the segment level. That's a much smaller share of the portfolio. So most of it is going to skew more to that 10% to 15% all-in or 15% to 20% at the plant level.

Part of our engineering investments have really been in core reusable assets, so thinking about core building blocks of the power electronics, core building blocks of our software and our software architectures. And we're able to then replicate those core building blocks across multiple customers and multiple programs. And as we see some more stability in the, I'd say the rapid technology evolution of electric vehicles and the increase in power density, increase in charging capacity, for example, we see that start to stabilize into more mature designs. We're able to then reuse and reapply those engineering investments multiple times.

Okay. Can you remind us the size of the electrification opportunity for Lear? What's in the backlog? What's being ordered? And what do you expect revenue to look like down the line?

Sure. Yes. So in 2020, our electrification business was $270 million in sales. We've guided to $385 million this year. So it's growing by 43% year-over-year. If you look at our E-Systems backlog, overall, it's $900 million over the next 3 years. $450 million of that or half of that is in the electrification products. We've established a target, as Carl mentioned, of $1 billion in revenue in 2025 based on what's been booked. We're at $725 million of awarded business as we sit here today. About 60% of that $1 billion target is in power electronics, 40% of that is in wire and connection systems. And that's really a function of the content per vehicle opportunity in each of those distinct spaces. So in wire and connection systems, we've talked about $200 to $400 of incremental content. As the electrical architecture evolves, we're seeing that skew more to the low end of that range, but that's the sort of the average CPV on the wire and connection system side. And on the power electronics side, there's a very wide range, but then the products that we make, it could be up to $1,650 of content per vehicle. So the kind of disproportionate share of that business in electronics versus wire and connection systems is more a function of the addressable market in those 2 categories. In terms of our quote pipeline and growth prospects there, it's very similar to what we saw last year. We would expect around $1 billion of business to be quoted this year. We're continuing to win at our historical win rate, in the 25% to 35% range. And what we are seeing though is an increase in the -- just the sheer number of quotes and the number of customers that we're quoting business with. We've seen about 1/3 increase in that as we compare that to what we experienced in 2020. So there's definitely an acceleration in the opportunity that we're seeing in this area generally.

Okay. Can you go over some of your major reasons or upcoming BEV launches, what content you have? And then specific to high-power wiring and connectors, have you been successful at winning business on battery electric vehicle?

Absolutely. We've been successful in winning that. Maybe I'll talk about those 3 areas, high-voltage wiring, the high-voltage connection systems that go along with that wiring and the electronics and then the power electronics themselves. Our largest customers on the high-voltage wiring side are Renault, Nissan, Stellantis and JLR. We also have business with Ford, GM and Volvo. And we have customers both domestic as well as European that I can't name, unfortunately, because of some confidentiality requirements by those customers. But we certainly do have some of the new electric vehicle entrants and customers in that regard as well. We produce that, on the connection system side, high-voltage connection systems for Ford, GM, Stellantis, Volkswagen as well as some of those unnamed customers. And for example, on the connection system side, we were selected by Volkswagen to provide the main battery connector for their battery pack. We see that battery connector being replicated and reused as they proliferate that battery pack across multiple vehicles. And we really like looking for those kinds of very large platform opportunities, where that engineering investment in that product has the opportunity to get replicated across a lot of different nameplates. On the power electronics side, large customers include General Motors, JLR, BMW, Volvo, Geely, Renault Nissan. Other customers like Ford, Stellantis, Mazda, Mercedes, Volkswagen. So really a large swath of customers there as well. We're really happy and excited about the battery disconnect unit that's being launched this year on the GMC Hummer EV. Again, a great example of our power electronics engineering capability, being able to take a very challenging engineering problem and solve that for our customer in a compressed development schedule. In fact, being nominated for a PACE Award this year for that battery disconnect unit. I'm really excited to see the innovation that we're bringing to the table from the power electronics and driving new capabilities and even new types of vehicles that -- into the marketplace. So that battery disconnect unit, again, another opportunity we think from a platform perspective to have the opportunity to be proliferated in different instantiations as those vehicles and those types of vehicles expand over time.

Yes. That's great color. And then just honing on the high-voltage wiring and architecture specifically, are there any -- can you name some platforms where you're supplying some of this high-voltage architecture on the EV side?

Well, in terms of some of the names of the models themselves, we see some of the -- obviously, the JLR and the Volvo vehicles, electric vehicles. Some of those others we can't name, unfortunately, but either in production or will be in production this year or early next year.

And just one point to follow up, Emmanuel, if you just -- if you look at our book of business in high-voltage wire and connection systems and the backlog that we've been awarded there, as that business grows to $400 million, the market share in high-voltage wire and connection systems is similar to or slightly higher than our low-voltage wire market share, which has historically been around 7% to 8%. We see in high-voltage wire and connection systems, it could be as much as an 11% as we look out to 2025. So we're doing a better job in the marketplace, just generally speaking, on high-voltage wire than in our core business, the low-voltage wire. That being said, also and Carl, just to point this out, in electric vehicles, the low-voltage wire content is significant. And so platforms like Mach-E where we have the low-voltage wire in an electric vehicle, we're typically seeing a higher CPV in the electric vehicles despite the fact that you're eliminating the engine harness and there's other components that go away, they tend to be feature-laden vehicles, more sensors and more complexity, and that's driving a higher CPV on the initial low-voltage systems that are launching on electric vehicles as well.

We see that additional content in those electric vehicles requiring more specialized wiring, more specialized connectors and connection systems. In fact, recently, we announced a development agreement with IMS Connection Systems (sic) [ IMS Connector Systems ] out of Germany to help work collaboratively on higher-speed Ethernet in the vehicle, Ethernet connections, and work collaboratively to bring their technology and our technology together for both the connection systems side and the wiring systems side. So I think a lot of innovation on the high-voltage side of the connectors and the wiring, but also an equal focus on the low-voltage side of things.

And I appreciate the comments on the market share because, obviously, one of your larger competitor who happens to be presenting next, sort of like speaks about incredibly high win rates on the high-voltage wiring. And so it's sometimes a little bit difficult to sort of like make sense of everything. So the 11% by 2025, is that what you're -- you think you can achieve? That's what's in the plan, I guess, to each to talk out.

Yes. That's what's in our plan, and we're on track to achieve that.

Okay. Let's maybe switch gears to Seating. First quarter growth over the market was very strong, and you raised the growth of the market for the year at the time from 2 to 3 points, like 6 to 7 points above market. What are the drivers of it? And do you view them as sustainable?

Yes. So starting in the first quarter, we really benefited from our portfolio with GM on the full-size pickup trucks and SUVs as the volumes have been very strong in that platform. In addition to that, our global luxury platforms did quite well. They explored it very well in the first quarter. SUVs in North America, in general, did quite well. And so those are the key drivers in the first quarter. As I look out to the balance of the year, again, it's going to be GM full-sized trucks and SUVs. It's been a great platform, it's the most important platform we have in our Seating business, and we see that doing quite well for the remainder of the year and into next year. Think about GM's announcement, they're planning to add capacity in Oshawa. That's additional volume on the T1 platform. That will be supportive of faster growth over market than what we've historically enjoyed in Seating. Also our luxury market share, we have 45% of that market, and so luxury has held up better than the rest of the market in general. And so that's been a catalyst for the increased growth we're seeing this year. And I don't see that abating as we look out into next year. I think that our strong portfolio in luxury is going to continue to benefit us. Longer term, I still think 4 points of growth over market is the right target for us, really driven by market share gains and CPV growth. And then continuing to embed proprietary technology and innovative products in Seating and particularly on the luxury side of the market, which is most receptive to those new technologies.

Okay. I guess as a quick follow-up to this, I think that, obviously, your largest competitor on the Seating side, obviously, had spent quite a few of the last few years, essentially probably more about improving profitability than sort of really about growth. At least the messaging from Adient seems to be a little bit more about we're going to grow sort of that going forward. Are you seeing any different dynamics in the marketplace from -- coming from them or just on the competitive landscape?

Just generally speaking, the Seating business has always been quite competitive. I think one thing that's differentiated us is our consistent commitment to that space and our investment in technology and innovation, our leadership position in vertical integration. We are the most vertically integrated supplier in that space. And that gives us an advantage in the marketplace as we're pursuing not just JIT programs but also component awards. So the competitive dynamics really haven't changed. I think that they remain supportive of the margin targets we've established in that space. And we see a continued path to growing that business and taking market share. We grew that from 18%, 19% to 23% market share over the last 5 or 6 years. And we announced $1 billion in Conquest awards in 2019 and 2020. And we're continuing to see strong growth in Seating. So we like our ability to compete there certainly. And maybe just talking generally about Seating. I think one thing that's differentiated us again is this consistent investment in that space in the sustained -- sustainable profile of that business. You go back to 2007, that was a business that first earned 7% operating margins then and it has consistently generated strong return on invested capital in the teens. For the last 15 years, there's nobody else that's been able to do that in the space. And it's not by accident, it's by -- it's a result of the strong team that we have in place. It's a result of good decisions that we made with the portfolio over the course of that 15-year time period, good acquisitions that have further extended our advantage in that space. We continue to build that competitive moat out around that Seating business. And we don't think that there's anyone positioned over the next 5 years to compete with us. That's not to say that it's not a challenging market, but we think the investments we've made in technology and innovation allow us to do 2 things. It allows us to offer a value proposition to our customers that can't be replicated, and it allows us to continue earning a high return in that space that's warranted because of the unique technology and innovation proposition that we offer there. If you think about some of the new introductions to the portfolio over the last couple of years, we had the awards with ConfigurE+, a PACE award-winning technology. It's a $100 million business, it's just getting started. We see that business growing to $500 million over the next 5 or 6 years or so, maybe even more as we look at markets beyond traditional automotive markets. Think about our INTU suite of products. That's really evolved into a particular focus on INTU Thermal Comfort. And we think, particularly with electric vehicles, that offers a really unique opportunity for our customers to reduce the battery draw that's consumed by HVAC, traditional HVAC systems today. And so over time, we see that as a really great growth opportunity for us. Again, that's a PACE-nominated technology. We've worked with Gentherm in their ClimateSense product, but ultimately, it's our full integration of that system with the other products that we make or the seat that truly differentiates it. And I think that will be difficult for competitors to replicate. And for all those reasons, we're extremely confident in our ability to continue to run that business sort of in that 7.5% to 8.5% operating margin range, which gives us enough room to continue investing in the business while earning a great return and growing the business at 4 points above the market. I think it's just really a fantastic combination of events that are coming together as a result of our commitment to that business over a long time period.

So that was going to be my follow-up question, the Seating margin -- the Seating returns, obviously, very strong. But the reported margin seems to me remain consistently around that 8%, even in time periods when we see very strong revenue growth, very strong growth over market, positive mix. Is there room at some point for more visible operating leverage?

Yes. I think if the volume environment remains strong and the mix of products remain favorable to us that you're going to tend to skew a little bit more to the higher end of that range, I think there's sort of a natural baffle on the operating margins in that space. It remains a competitive marketplace. And if you think about just-in-time seating, for example, at 5% or 6% operating margins, you can earn a mid teens return. And so we don't want to shy away from growth opportunities in order to drive operating margins above that range. We think the right balance is to remain in that range, and that gives us some nice growth prospects, allows us to continue taking share. We earn a nice return while at the same time remaining competitive from a pricing standpoint in a very competitive marketplace.

Okay. And one quick very follow-up just on the back of maybe Adient's presentation yesterday. So they're sort of talking about EV seats market share. And again, I don't assume that there's necessarily completely different dynamics in there. But they sort of seem to imply that on the EV side, at least so far, they have larger share than overall reported. So maybe -- I think they were mentioning 50% EV market share on the complete seats. Do you see different dynamics on the electric vehicle side for seats as sort of like on the combustion engine ones? Are there any different technologies that apply to this?

I think generally speaking, the technology is quite similar between ICE vehicle and electric vehicle. The one unique opportunity that I do see, again, is this INTU Thermal Comfort product which will allow you to heat/cool the occupant through that microclimate as opposed to only using the traditional HVAC. I think that's an appealing technology that has value to our customers in the EV space. And I think over time, we would expect our market share in electric vehicles to be very similar to what we enjoy in the ICE marketplace today.

Okay. Since we have a few minutes left, just wanted to come back to a few topics. Maybe just one on the short term again. What's your most recent outlook on commodity costs through the remainder of the year and particularly as it relates to steel and foam? Should we expect this to be an additional headwind into 2022?

Yes. I think that the commodity market has remained stubbornly high or commodity prices have remained stubbornly high. Certainly, steel, I think, at this stage in the year, we would have anticipated some moderation in North America and Europe steel prices, and we haven't seen that. We've locked in most of that by -- at this stage and factored that into the guidance that we issued in May. Copper, we're starting to see come down a little bit after reaching all-time highs in the high $4 range, $4.75 to $4.80 a pound. It's come down to, I think, yesterday was $4.30. So we're seeing some moderation there, and that will be helpful as we look out to next year if that holds or if it comes down further. But I think steel is going to remain a challenge for us as we look out to next year. I think it will be a bit better than what we've experienced here thus far this year. I think steel prices will moderate some, but I think they will be higher than they were in 2020 certainly and higher than they were pre-pandemic in 2019. So I think it remains a factor that's on our radar screen. Other commodities, we're seeing a bit of a moderation. I think fuel prices over time will come down. So those chemicals that are derived from oil will moderate, and I wouldn't expect that to be an issue. But copper and steel are the main factors that we're managing as we look out to next year.

Okay. Great. And then, Carl, maybe one follow-up for you. So in the power electronics side, Lear has been very specific around where you want to play and where you feel like you have a room to succeed. But some of your competitors in power electronics have complete electric powertrain competency. And so how relevant is that? And how competitive is this market?

Yes. So we can look at the electric vehicle architecture in the power electronics kind of in 2 ways. One is kind of what is feeding the battery, if you will? What are the power electronics that are conditioning the electricity, managing the power into and out of the battery and managing the battery itself. And we're very strong in those power electronics feeding the battery, things like onboard chargers, DC/DC converters, DC fast charge, battery management systems and battery disconnect units. And we focus on particularly on those products, and we also see an integration of those products. As the power electronics get more efficient, we see unique packaging opportunities working with our customers to package an onboard charger with DC/DC fast charge or with power management or batter disconnect or battery management. So those products are integrating together in unique ways, and we're very flexible in working with our customers to drive that type of integration to make their vehicle architectures very unique. And then also having a broad system knowledge, obviously, from the low-voltage and high-voltage wiring and connection systems. Downstream or within the battery itself, we do things like those main battery connectors. We also have battery interconnects and some other components that go inside the battery pack. And if you look downstream of the battery, the inverters and the battery and the motors themselves, we don't play in that space. And we don't see those inverters or motors really kind of impacting or affecting the upstream of the battery power electronics. So that's not an area that we play, and we don't see that having any issue or challenge with our power electronics feeding the battery.

That's very clear, and great way to conclude this conversation. So Carl and Jason, thank you so much for your time, for participating in the conference and for your insights this morning. Very much look forward to continue following and monitoring your progression and success. Thank you, everybody, also for joining us. And the next session is in exactly 10 minutes. Thank you so much.

Thank you, Emmanuel.

Thank you very much.

Thank you.