Lear Corporation (LEA) Earnings Call Transcript & Summary

Well, thanks, everybody, for joining us today. I'm John Murphy from Bank of America. We're very happy to host Lear for a fireside chat with Jason Cardew, Lear's CFO. Uncertainty has gotten even higher in the last week here from a macro standpoint, from an economic standpoint and potentially even from an auto standpoint, but there's definitely one certainty that we rely on or a couple of certainty we rely on is that all cars in the future are going to have to have seats, are going to have increasing electronic content. And we do anticipate, and I think this is ultimately almost a fact is that auto volumes were covered very significantly from the current lows in the industry. So we believe that positions Lear incredibly well as a leading global supplier of automotive seats which is about 75% of the business and electronics which is about 25% of the business. So I think they're very well positioned for the near term and ultimately, for the long term. You combine this with about a $22 billion top line this year. That's our estimate, roughly consistent with the outlook, consistent strong execution, improving margins, strong free cash flow, and we believe that Lear will take that and generate meaningful shareholder value over time. So today, we're very happy to have Jason. Thanks for joining us. We're going to kick off with a near-term question first.

So Jason, we have about 2 weeks left in the quarter. There's been a lot of volatility, some changes in schedules at the last minute over the course of the quarter so far. So can you just please give us an update on where things are progressing here in the first quarter and how we should think about our results early in the year?

Yes. Thanks, John. I appreciate the opportunity to speak with you today. I'd say that the first quarter is sort of continuing on that slow improvements cadence that we saw last year in terms of the production environment. It's not uniform, it's not all customers, but generally, we're seeing an improvement in the production environment here through the first part of the first quarter. And although we didn't provide guidance on our fourth quarter earnings call by quarter, we do see a first quarter that's shaping up better than what we had anticipated when we issued our full year guidance. So we're expecting revenue in the first quarter to be $5.6 billion to $5.7 billion, which is $400 million to $500 million higher than prior year. We see operating income in the $240 million to $250 million range, which is $55 million to $65 million higher than last year. So decent conversion on the higher revenue. And we do see revenue up sequentially from the fourth quarter. So production environment for us and our mix of customers is holding up pretty well. General Motors, you've heard about the recent down weeks that they announced on the pickup truck plant in Fort Wayne and Silao. Despite that, the GM full-size truck and SUV programs is still up about 2% year-over-year and in line with what we had anticipated. So the down weeks, while disappointing, are certainly not unexpected. Jaguar, Land Rover, another important customer for both segments has got off to a very strong start. Range Rover, Range Rover Sport and the Defender have tremendous pent-up demand and now, they're able to start filling that. So we're seeing significant production increases on debt, those three platforms collectively, which is benefiting Europe and both of our businesses. And then maybe one exception with Ford. The Ford Escape went through a mid-cycle change at the beginning of the year. It's an important platform in E-Systems, and it's down about 60% year-over-year. We had expected it to be sort of flattish just down slightly during that ramp up. And so that's a fairly meaningful impact on these systems. But on balance, I'd say things are a little bit better than what we had anticipated. I don't want to get too optimistic, 2.5 months into the year. But as I sit here today, if these volume conditions hold up, I would expect to be sort of midpoint to the high end of the range for the full year. Let's wait and see what happens with the -- as you mentioned, some of the recent macroeconomic issues and how that impacts demand. But as we sit here today, we think it's a little bit better than we expected. Seating, in particular, I think, is off to a stronger start, again, with the production mix being a little bit better than what we had anticipated. So we had built in this sort of 2 points of negative mix. It may be a little bit less than that now as we sit here right now, given the resiliency of the GM volumes and the strength of the Jaguar Land Rover volumes. And we also see more consistency, I think, in the operating margins in seating throughout this year. Last year, we had a pretty big step up from the first half and second half. I think you're going to see a little more consistency sort of that mid-6s, high 6s throughout the year starting in the first quarter. Q2 and Q3 may be weighed down a little bit by launch and engineering costs, but on balance, it should be a little bit more consistent quarter-to-quarter than last year. E-Systems, I think, will be similar to last year. It's going to start off a little bit lower and work its way up through the year. As a result of the Ford Escape volumes being one catalyst, but also in that business, just one important nuance is sort of differentiates E-Systems and Seating. In Seating, the vast majority of bill material is directed. And so the component cost increases is sort of a 3-party discussion with our customers, and it's easier to pass that through or it happens in a more timely fashion, whereas in E-Systems less of the bill of material is directed. So it's a kind of longer and more protracted negotiations and discussions with customers. And so that will play out over time this year. And also, there's some component supplier challenges unique to the wire business that some of our suppliers are dealing with some issues that have impacted our productivity here the first part of the year. That being said, I see E-Systems margins at or above where they were last year. Revenue is up over last year and seating margins up compared to the first quarter prior year, but even more so.

That's actually incredibly helpful and encouraging. Maybe a second question, if we think about the backlog, you talked about some of the backlog being pushed from '23 into '24 for some program timing changes at one of your customers. And that's maybe '24, really big year. I think it's about $1.5 billion, I think, is the backlog you've talked about. Maybe you could talk about sort of that change as well as the potential to grow the '25 backlog as well. I mean, it sounds like that is also going to be very strong, it might be another record year, and there's some opportunity to push that ever higher.

Yes. So as you mentioned, there was some movement between '23 and '24 given the cadence of some of our customer launches that really impacted the backlog by year and sets up '24 to be a record backlog of $1.5 billion. The backlog in both segments is strong and growing. It's, I think, the second highest backlog we've had in E-Systems at $1.05 billion. Seating is sort of in line with its historical average at $1.8 billion. As I look out to 2025, the third year in our backlog usually increases pretty dramatically from the time we release the backlog for the next year and this year is no different. The pipeline of opportunities in both segments is very strong. We've got about a $5 billion pipeline of quotes in the seating side and a little less than that on the E-Systems side, but a strong pipeline of opportunities in both segments. And we've already started to win business year post the fourth quarter earnings call. We had the most significant award on the E-Systems side. GM on that Intercell Connect Board has increased the volume that they're allocating to us, and this is about three in the battery electric truck platform. So we had expected that to be about $150 million program for us. Now it's more like $250 million of revenue at its peak, and we see the 2025 rather than on that platform, increasing from $50 million to $100 million. So it does a couple of things. One, it contributes to our electrification growth target that we've established for $25 million, but also drives margins as well. Connection systems is the highest subset -- subsegment margin within the systems portfolio. And so now we have a clear path to the 2025 revenue target and connection systems of $750 million with that additional award. And then in Seating, we have 3 customers we're working with on Conquest opportunities right now. So sort of continuing the market share gains we've enjoyed over the last number of years. We see 3 opportunities. They're not all going to hit this year, but I would certainly expect one of those to hit maybe as soon as the first quarter, and we can talk about that on the first quarter earnings call. We're seeing tremendous growth opportunities in both segments. We don't talk as much about our nonconsolidated revenue, but we do have a $380 million backlog in nonconsolidated sales, and that's on top of growing $600 million in nonconsolidated revenue in '22 versus '21, that's where some of that Seating, Conquest business shows up, particularly with BMW. We have a joint venture in China that's not consolidated, and that drove -- they increase in revenue there. And we also saw equity earnings increased $17 million last year. So we're converting on that at higher revenue. That's also where you're seeing growth opportunities for us with BYD and some of the other Chinese domestics. So we're servicing that customer through a nonconsolidated joint venture. As we look out 3 years, 4 years, we see that we're going to have roughly 1/3 of the Seat business for BYD. So it's a meaningful market share with a fast-growing customer.

That's also incredibly helpful. And if I think about Seating, and this might -- you might be kind of transitioning to this, taking your chip market share from about 19% to almost about 25% today. Talking about gaining more market share in 28%, 29%, maybe more we'll see over time. I mean, how do you drive that? What are the key drivers? Is it stuff like what's going on with BYD? Or are there other Conquest businesses or programs that you're winning? I mean what's the key driver there?

Yes. I think kind of take a step back and look at what we did from, say, 2010 to 2020 with the portfolio. We were very focused on organic and inorganic investments over that time period, focused on product first, with -- I think we were early in identifying the industry shift from a complete seat sourcing model to more of a directed model where component capabilities became increasingly important and so that really drove a lot of the M&A activity during that time period. We acquired [ Renison ] on foam side; Guilford, fabric; Eagle Ottawa, leather. And I think that combination of product capabilities allowed us to grow JIT market share, made us a more competitive complete seat supplier, but also created a path to higher margins, higher returns as we found these kind of pockets of above-market margin opportunity within the seat that really drove the business during that time period. The thermal comfort acquisition of Kongsberg and the pending acquisition of IGB is a continuation of that. And we see that driving growth -- the components that are comprised of thermal comfort, but also driving jet growth in the future, I think that's a key point that will take us from 25% to 28% and beyond in the complete seat side. And so in addition to the product acquisitions, I think as we look out over the next 10 years, it's going to be more process-driven. The last 10 years, labor arbitrage was a path to increase profitability and competitiveness. The next 10 years, I think, is more process automation, Industry 4.0 is a catalyst for becoming more competitive. And so we acquired Thagora last year, InTouch. These are relatively small acquisitions that have an outsized benefit on margins in our competitive position in seatings.

So I mean skeptic would hear that and say, okay, you're growing market share. Does that put your margins at risk? An optimist would say, hey, listen, we're gaining more scale. We're getting into these semi-niche parts of the seat that might have actually much higher margins. So you might say that your margin -- the real higher market potential is actually going up over time. I mean how do you think about the gaining share and maintaining or maybe even growing margins over time?

Yes. I think history is the best indication what we can accomplish in the future in our Seat business. If you look at the trend line for our operating margins in Seating over the last 20 years, each peak has been higher than the prior peak, each trough has been at or above the prior trough. There's a steadily sloping upward trajectory to operating margins and we see that continuing as you look out the next 5 years. And the biggest catalyst for that is going to be this combination of thermal comfort capabilities and automation achieved through Industry 4.0 investments. So we do see higher structural margins in size, one bar heat-cool systems than seating overall. So I think that is a catalyst for margin expansion. And the investments that we're making in automation we're seeing is margin accretive as well.

So if you think about the thermal side, I mean, you kind of mentioned the Eagle Ottawa, I remember I think it was summer of 2014, that didn't get a lot of press, but it was a very important small acquisition. As we look at Kongsberg and IGB and this growth on the thermal side, I mean how receptive are your customers to that integration? And what is that integration of thermal in a single company really means for the opportunity set?

Yes. So it's an attractive market by itself. It's a $2.5 billion to $3 billion subset of the seat business that has margins that are above the segment overall. So it's an attractive component on a stand-alone basis, and it's growing faster than the industry. If you look at IHS projections, their projections, two points of growth above market over the next 5 years. I think that's light. I think it's affected by some constraints that we're trying to address through our design and development work with our customers. The first constraint is around packaging. And we've been working on this for 7 or 8 years here. And so taking the comfort components from the B surface, the back of the [ season ], bringing them closer to the [ Action ] in the A surface does two things. One, it improves the performance of the system itself, but it also allows you to package these features in the second row. And so you have heat and lumbar are fairly pervasive in seeing globally, about 40% of vehicles have one or the other. But vents or cool systems and the [ SAS ] systems are much less prevalent. So we see a real opportunity for those features to penetrate further, and that will drive growth above market. The other constraint is around the performance of the system itself and the cost. And the work we've done to improve the -- reduce the complexity, reduce the cost, reduce mass and improve the time to sensation. That combination of activities has really got our customers excited. Now we have 17 development projects. We're working on in 43 different [ tire lines ] with 8 OEMs. So across the board, we're seeing interest from our customers. And so it's forcing them -- not forcing them, but it's encouraging them to change their sourcing model. And so this isn't a change in the sourcing model that applies to all seat makers. It applies to us because we have the capabilities in-house. And so because we're able to offer them a value proposition, lower cost, better performance, better integration of the system, they're giving us sourcing control of those components, which gives us a chance to both increase the revenue and profitability of that subsegment but also to drive JIT market share as well.

So you think about sustainability. I mean you think about from a product sourcing standpoint but also an efficiency what you bring to the HVAC or the change in the HVAC system, which is the HVAC system gets downsized and potentially some of the stuff gets transferred in the seat. I mean how much of an opportunity is that? I mean how are they thinking about this holistically in the vehicle?

I think we're in the very early stages of that opportunity. I do believe that over time, that will be a significant catalyst for growth and heat, cool in particular. I think on the sustainability front, we have other products that are gaining a lot of traction as well. We have this ReNewKnit suede-like material that we've sold to a European OEM that's going to be used on a number of power lines. It's a fully recyclable end-of-life product that's -- there's other customers that are interested in that as well. And then FlexAir, a new kind of foam alternative that's 100% recyclable at the end of life as well. We have two development projects right now, one with the European OEM, one with the U.S.-based OEM that could go into production on a niche basis. So small applications as soon as next year. And we're really excited about that. That could be a significant opportunity for us on the sustainability side, but also helps us grow the business over time as well.

One last question on the seating side. During the last earnings call, you talked about winning a JIT program that will be in launch in 2023. And that's very unusual that you basically have an announcement to 12 months or less launch so that's [ bizarre on your own ], somebody can actually move that quickly. Can you just talk about how that happened? And you also just had alluded to like three other programs that are in process that may have something similar to that. I mean how big an opportunity is this near term, right? I mean [indiscernible] more time. It's actually...

Yes. So that was an unprecedented decision by a customer. And obviously, they were not satisfied with their incumbent supplier from a quality or operating perspective. The supplier wasn't able to ramp up mid-time of the customer needed. And so they came to us because of our reputation for both quality and execution. And it wasn't a normal quote process. It was -- they were comfortable sourcing it to us because of the capabilities that we've demonstrated from an operational excellence standpoint. And we're not yet in a position where we talk about the customer or the competitor that we took the business from. We'll save that for a little later in the year. But I will tell you that it's two different programs. There's an SUV program that we're launching towards the tail end of this year and then there's an electric pickup that will be launched next year. So the first vehicle is an ICE. Second vehicle is an electric vehicle. So It's a nice combination of content programs for us. So we're really excited about that opportunity. Now what does that mean in terms of similar opportunities, the complex words that I refer to would be a more traditional kind of end-of-life or mid-cycle resourcing as opposed to a running change. But it does open the door once we execute this launch to similar opportunities down the road. So we're very excited about it.

So maybe switching gears to E-Systems. Electrification is a big opportunity for the industry, a big opportunity for you on the E-Systems side. Obviously, you have some Intercell Connection Board wins. I think that -- I think there's some stuff with GM and maybe some other folks that you could talk about on the car electronic side, battery -- BDU, battery disconnect units, [indiscernible]. You've generated, I think, between $500 million and $600 million and $565 million in revenue last year on the pure electrification side. I mean what do you expect in '23 and how big an opportunity should we think about this being over time? Because I think people kind of think about you in the EV breath, but like they probably should think about you a lot more whether you got the potential.

Yes, electrification is significant catalyst for growth in these systems. It's the primary driver of our six points of growth over market near term and I think longer term as well. So of our $1.05 billion backlog in E-Systems, 55% of that over the next 3 years is electrification or $575 million. As you mentioned, our revenue in electrification was $565 million last year. We see that growing by about 1/3 this year to $750 million and growing to $1.3 billion in 2025. We established that target and communicated that on our E-Systems product date around a year ago. And now we see a path to exceeding that $1.3 billion in 2025. So we expect that kind of mid-30% growth rates continue through '25 and likely beyond that. As I've mentioned earlier in our conversation, we did have -- we do see the momentum on awards continuing in that space. So we have the additional volume on the GM Intercell Connect Board that was awarded since the earnings call. We have another premium European OEM that we were awarded business with as well on the Intercell technology. So we're seeing significant interest in the market in electrification products that we're offering and see that as a growth driver for us for the next 5 to 10 years.

So some of this comes by sort of a focus on the right products. I mean, obviously, on the right products, right? You guys are good. You are good at that, but there has been somewhat of a [ winding ] to some degree and a focus on the right products. Can you talk about how that process has worked over time? And how we should think about the product portfolio for Lear in the E-Systems over time development?

Yes. We've really spent the last 3 years doing a deep study of our electronics portfolio. This has been a particular area of focus for Ray and I and the broader management team. And we came to the realization after that work that we were trying to do, maybe we participate in too many product categories through the size of that electronics business that we have. It's a $1.2 billion business roughly and we were in 15 different product categories. And so it became a constraint to expanding margins and returns there. And so what we did, took a step back and say what are the product categories that were best at, what gives us the best path to returns growth and margin accretion over time. And so we look at -- there are three factors that we studied. One, where do our engineering and manufacturing strengths best aligned with the customer needs? What are products that they want us to engineer or manufacture? They're not going to do it in-house. They want a supplier to do it. What products do we have a truly differentiated capability? Is it either manufacturing driven because you're vertically -- you have the ability to vertically integrate or engineering driven because of the products in the portfolio? And then where do we see the best kind of intersection of revenue growth and margin opportunity and return opportunity? And the conclusion of that work was there are two products that we're particularly excited about that we think meet those three criteria most directly, the battery disconnect units and zonal controllers and both have tremendous growth potential. I'll spend a minute on the battery disconnect unit product in particular because that has the most significant near-term growth potential for us. So we're one of three suppliers that has a multi-customer portfolio today. We have BMW, Stellantis, Volvo and of course, General Motors business within battery disconnect unit. So we have a strong market position, and we see a path to 15% to 20% market share being a top 3 player in that business. So we think we can bring -- we can establish a business with scale in that space and built on this foundation of those four customers, but the GM BDU in particular because of the unique capabilities of that product, it is the most complex battery disconnect unit product and has already been a catalyst for interest in new customers that have come to us looking to solve similar technology issues that they're having with their platform. So I think that, that platform in and of itself is a fantastic foundation for us to have a top three market position in the most advanced battery disconnect units as we look out over time. And so by streamlining the product portfolio and focusing on those two products, we can really bring scale to that business. We can improve near-term profitability. We've reduced our administration and engineering investment in electronics as a result of that window in the product portfolio. We've redirected our best engineering resources into those two product categories. And we're going to continue to run the business that we've been awarded in those products that we're exiting and enjoy the profitability and cash flow that will throw off over the next 3 or 4 years and that will help fund our investments in the battery disconnect unit as well.

One more E-Systems question in -- just enough time. Zonal controllers and getting to sort of the next-generation architectures that are viewed as simpler but more zonal controllers and fewer compute centers. Some people view that as a risk for Lear. They kind of look at sort of the old guard and the sort of spaghetti, [ big, giant ] wiring harnesses and not getting into sort of the future tech. How much of a risk or an opportunity is this create for you over time?

Yes. So first of all, I acknowledge that the evolution to the zonal control architecture is inevitable, but it's going to happen over a long period of time. And each OEM is approaching it a little bit differently. And on balance, we don't see a reduction in wire content over the next 5 or 6 years. We see that continuing to grow at sort of 2% to 3% despite that trend. So I think it's a result of the customers trying to integrate more content and features, advanced safety, for example, it's necessitating a shift in this architecture. And what's happening is you're seeing low voltage were being displaced by high-speed data lines, more expensive wiring and connection systems. And we have great capabilities there internally and through our joint venture with Hu Lane. So we're embracing that shift, and we see it as an opportunity over time.

Okay. And lastly, in the last few minutes, you got a real high-cash issue. You generate a lot of cash, good times and in bad. Can you give us an update on your sort of cap allocation strategies? I mean it sounds like some of these bolt-on small acquisitions are huge opportunities, so it's a buyback given. So can you just kind of remind us we how you think about cap allocation that may shift over time with technology.

Yes. We have an investment-grade balance sheet, and we want to protect that. And so our focus really right now is on free cash flow generation, returning excess cash to shareholders, much like we did last year. We've returned all of the excess cash in the form of dividend share repurchases to our shareholders. We do see an improvement in the free cash flow conversion rates. Last year, I think we were around 73%. This year, 76%. We see a path getting to 80%. And the more free cash flow we generate, the more opportunities we see to increase share buybacks. And I think that's a meaningful part of the value creation opportunity over the next 3 years or so, and I can see taking out 5% to 10% of the share count given our projections on -- and free cash flow generation. So it's a meaningful catalyst for earnings per share growth over time, and it's a particular focus for us. On the M&A side, really the only things we're looking at are kind of more of those Industry 4.0 process-driven acquisitions like Thagora and InTouch, smaller tuck-in deals like that as opposed to something more significant. We really like the portfolio that's here today overall.

Well, Jason, we are at just 10:30. So thank you so much for joining us today. I appreciate everybody on the line for joining us. And if you have any follow-ups, you certainly can reach us or the great IR staff at Lear. So thank you so much for joining us. We appreciate it.

Yes. Thank you, John. Appreciate it.