Lear Corporation (LEA) Earnings Call Transcript & Summary

Okay. We're live as we continue Day 2 of the Barclays Industrial Select Conference, the autos track here. I'm Dan Levy. I lead Autos & Mobility -- U.S. Autos & Mobility coverage at Barclays. And very pleased to have with us Lear, a leader in seating and electrical architecture products. Pleased to have with us Jason Cardew, the company's CFO; and Erik Elie, VP in Thermal Comfort Systems, really a critical part of the seating strategy going forward. So we're going to kick off with a series of audience response questions -- you guys don't get put this -- yes, you guys have quicker, see -- so we're going to kick it off, maybe we can start with question on, you're just going to quickly go through these questions and ask for response [indiscernible].

[indiscernible] opportunity to [indiscernible]. Question 2, please, general bias. I think there's probably some opportunity here. General bias is mixed, okay. Hopefully, I think the broader supplier space needs a bit of an uplift. So question 3, through-cycle EPS growth. And I think this is very fitting actually because this is a key part of your growth strategy. This is versus the roughly auto supply peer side. Okay. So mix there, all this is, yes, I think some opportunity to show that there's more growth here, which there is. Question 4, excess cash, which is very topical, and we're going to touch on that a little later, holistic response later in conversation. I think we know this is probably going to viewed late now, kind of number three, share repurchases. That's what -- people want you do it with your cash. Question 5, multiple, the rate multiple. Okay, which I think is going to be in line with the part suppliers, again, some opportunity. And then if we can just question 6, the most significant investment issue here. My opinion is that I think probably no [indiscernible]. Okay. Growth in margin. Just makes sense. So let me just start broadly. Generally, you're hitting the autos conference circuit. This is a little different, okay? So people may not -- this is an industry -- broader industrial conference. It may not be as familiar with Lear. So help us understand what part of the Lear narrative do you really think is underappreciated? What may not be maybe as well understood by the broader industrial investor set, beyond the typical -- I think most of the auto industry know the value proposition, the opportunity. But for the broader industrial set, help frame the opportunity?

Thanks, Dan. And thanks for the opportunity to participate today. I think for those that are familiar with Lear Corporation, we're one of the largest global Tier 1 suppliers to the automotive industry and revenue is expected to be $24 billion this year, a little bit higher than that. The two businesses, Seating and E-Systems, our Seat business is 75% of revenue, E-Systems is the other 25%. And I think what may be underappreciated about the kind of Lear story in general is just the significant competitive advantage we've built within the seat business and the consistent track record of growth and margin performance and financial return performance, free cash flow generation performance of our seat business. The seating business over the last 4 years has grown 4 points faster than the market. Pretty consistent margin performance despite numerous headwinds from COVID and chip shortage, inflation, et cetera. And throughout the last 10 or 15 years, we're really the only global seat maker that has consistently invested in that business. Those investments are organic and inorganic. They're product and process, most recently. [indiscernible] thermal comfort capabilities, which Erik will talk more about in a few minutes. We're all the way back to 2013, '14, '15, the acquisitions of Gilford in fabric and [indiscernible] really built the most vertically integrated highest-quality, best-performing seat maker in the industry. And I think that's undisputed, right -- I think that's underappreciated. I think that the growth potential of E-Systems and the recent track record of growth in that business is underappreciated. We've grown that business at 6 points above market over the last 4 years. We have begun to repair the margin profile of that business with a 6 consecutive quarters of margin expansion in E-Systems over the last -- over the last 6 quarters, 1.5 years, and we expect that to continue this year. And both businesses are relatively low capital intensity. Our CapEx as a percentage of sales is less than 3% last year and again this year. And so we generated significant free cash flow and, as one of your questions there on capital deployment, I suggest looking for the buyback stock at that last year. And we do appreciate the need to return excess cash to shareholders, and we've done that consistently over the last 10 and the 12 years since we started the share repurchase program. I think that's -- those are the key points that are underappreciated in the Lear.

Let's talk a little bit about some of the sort of underlying industry dynamics because I think what we're seeing in the industry, both from a cyclical and secular perspective is some shift, right? From a cyclical perspective, with maybe a pivot from [indiscernible] constraints in industries that will be different there. And then on the secular side, we're facing whatever you want to call it, an EV winter, maybe we -- there was a little too much euphoria in the last couple of years about mega trends, broadly AV, some of the software-defined vehicle features. And clearly, we're seeing some challenges on uptake on a variety of things. So from both cyclical and secular perspective, how did all of this impact your [indiscernible] change the way that you run the business?

Yes. I think if you look at what we did last year in response to that, that kind of push out of the EV transition, lower volumes, maybe slower ramp-up of certain programs, we responded very quickly to that, both in terms of our relationship and collaboration with our customers to delay investment, so that we didn't have idle capacity put in place as well as steps that we could take in firmly to ensure that we were not getting too far ahead of that adoption on EV. So we really cut our capital spending at the end of last year, just looking at what we guided to in the third quarter earnings call to where we ended up the year, we reduced our capital spending by $50 million. So we're very aggressive in terms of how we responded to that, and that will really benefit us this year in terms of not having the excess capacity weighing on the business. From a technical standpoint, I think that we are positioned to grow margins despite a relatively low volume increase expected globally this year. Our guidance assumes on a super sales-related basis at the industry volumes would be flat. Despite that, we're growing 4%, and we're converting on that growth at margins that are above the segment average in both businesses. So that's going to be the near-term driver of margin expansion. In addition to that, we've had significant improvements in the performance of our E-Systems business over the last, again, over the last 6 quarters. And so that -- we see that as a driver of growth in operating margins for this year. So we can continue to grow the top line through our backlog, and we can grow margins through a combination of [indiscernible] and performance in the business. That's why it was impacted by lower electric vehicle volumes, now a little bit this year. There actually the backlog is roughly the same as what it was prior to the change in volumes with electric vehicles. And if you look at a non-consolidated backlog, it grew significantly from the prior year. So on an overall basis, our business is growing faster despite that, right?

Why don't we ask some questions about the Seating business? And I think, generally, people know you have, people are generally familiar with the JIT business, but I think what's interesting here is you made a couple of key acquisitions in IGB [indiscernible] that really take your level of vertical integration to a level that we've seen beyond your competitors. So help us understand, how does this approach on vertical integration, which is beyond what you've been doing in the past where you had [indiscernible] and some of the fabric and thermal capabilities really going into thermal comfort, from the massage heating capabilities. How does this really change the way that you approach the business and help us contrast where you are now competitively versus others?

Sure. Thanks, Dan. The thermal comfort business is a great business. Things like you mentioned, the products that we -- the temperature heating and cooling, adjust comfort, lumbar adjustments, massage, all that business is growing at 4% above the market. So customers love these products. They can price for them, the vehicle, put on the sticker or an option packages. So it's a great growing business. Like you mentioned being vertically integrated [indiscernible], we've been working with these products and designing with them for 10 years now. We've been working on this. We identified Kongsberg Automotive and IGB as very -- yes, has great technology to vertically integrate these capabilities, and we purchased them over the past couple of years. That gives us a top 3 market share position for all of the thermal comfort components. And with our plans and integrating them into the Lear portfolio, we'll have a #1 or 2 position within 5 years in all components. So it's a good business that we're excited about. But what really changes it for Lear and gives us our unique competitive advantage is that when it comes to comfort, the entire seat system is used to deliver the experience to the occupant of the vehicle. You can heat or provide massage, but without understanding how the cushioning system was and also the surface material and the trim cover, all those products interface together to deliver the experience that you want. So what we've been working on and why we targeted Konsberg and IGB is our strategy is to deliver full-seat thermal comfort modules to our customers. And when I say that, it means we combine the surface materials, the trim cover, the cushioning materials, along with the components to deliver one piece to the JIT assembly plant. Now this thermal comfort module, which is one piece, it combines parts, so it eliminates parts because we can now replicate functionality in common parts. We can leverage our expertise in cushioning and surface material to enhance performance and we can significantly reduce mass. So we end up with a 1-piece solution that goes to an assembly plant that has significantly reduced costs. We're able to eliminate parts which reduces cost. Also the typical value-add and a higher cost JIT assembly plant, you have to deploy to put all the components together. Because we built a module, typically, that's done in a lower-cost region. So that higher cost assembly labor has been pushed to a lower cost area. The complexity of the supply chain is greatly reduced. And most importantly, we see great performance. Because we can leverage our seat complete expertise, we see massage intensities that go up 150%. We see almost doubling the time to sensation to heat or cool the seat. We see greater airflow in the vent. So overall, we can deliver to our customers now a full seat with much better performance, much better cost, mass savings, complexity reduction. And we are the only company in the space that has the technical and vertical integration capabilities to use the module as it can meet -- in the context of a complete seat...

Just a quick, maybe you could just remind us because I think you outlined some at your Seating Product Day last June, what are the cost benefits that you outlined? And I suppose the point here is that underlying increased customer uptake is you get some of the saves and you pass into that to customers. That's a probably value proposition?

Yes, that's essentially the models. The savings come in the form of a reduction in the component costs themselves, but also in the JIT labor time and JIT labor cost shifting that labor to a lower-cost location. And we share the savings with the customers to incentivize them in our system and retain the balance of the benefit. And that benefit is reflected in our projected improvement in profitability in that segment. That was $600 million on a pro forma basis last year, roughly breakeven, a little bit less than that. We're projecting $100 million of operating income and $1 billion of revenue in 2027. Those are the numbers we've released at Seating Product Day last year, and we're on track to meet or exceed that as we sit here today. Even looking at this year, we expect to see the first $25 million of that improvement in earnings take place this year, that's the driver of the Seating performance overall.

I think the act may have just some of the follow-up, but it sounds like the integration is going well and maybe you could just give us a sense of the customer response on this strategy?

The integration is going very well. We have -- we've released in our Seating Product Day that we have a 3-phase product road map. Phase 1 is our business integration, and that's right, we've integrated Kongsberg and IGB into the Lear system. We're realizing the scale there in the logistics network and also the purchasing of the supply base. We've been able to leverage the Lear commercial network with our customers and Konsberg and IGB component products, and we're seeing award rates for new business that are 25% above pre-acquisition award rates for the company. So we've had a lot of success in growing the business, leveraging the Lear footprint, which is fantastic. It's also given us a chance with these products to talk about other innovations as well as part of the Comfort portfolio. Two, I'd like to mention is FlexAir, which is our polyethylene alternative to molded polyurethane cushioning material. So this is -- this product replaced molded urethane. It's environmentally a 50% improvement in carbon dioxide emissions. And that's been rolled into the Thermal Comfort Systems portfolio. We just went into production on the Hyundai Santa Fe earlier this year with that product. And there are 28 other projects in development around the around FlexAir, which is a real nice part of our initial launch of these products. We've also launched a new facility for our thermal comfort systems in North Africa, so leveraging Lear's operating model there, which is helping our margin in this first phase. The second phase of our product road map is a component modularity, and this is where we are combining 2 or more parts of the complete seat that I described earlier. This is really where you can start to eliminate parts, eliminate complexities, start to leverage the performance enhancements that we want. We've got 12 different OEMs have given Lear sourcing language as part of a JIT board. And what this allows us to is, as we're working in the JIT development with the sourcing language, we can in-source or source ourselves all of the thermal comfort components and then bring module -- thermal comfort modularity to the OEMs and help them realize their cost targets and their performance benefits. So customers are very engaged and like the value proposition there. We're launching our first Phase 2 module very late next year with a luxury European OEM. And this module combines pneumatic massage, heating and ventilation systems all into one piece. So we're excited to keep track on to, it's great. And then finally, Phase 3 is our full-seat modularity, which I went into earlier. And this combines all of the thermal comfort components along with a trim cover. And in some cases, the cushioning system that could shift in one piece. We have 10 ongoing projects on different vehicles right now, and we're planning to be in production with that product in 2026, which is on track with our timeline [indiscernible].

Let's translate some of this into maybe some of the targets that you laid out. And I think the most interesting one here is some of the market share targets. So I think you laid out at the Seating Product Day, 25% you're currently in JIT, targeting 29%. Total market in seating components, you're targeting 32% by 2027 share gains. Maybe give us a sense -- and I think you just alluded that you're seeing some higher win rates. How this strategy is playing out in terms of the bidding and how this ultimately will get reflected in the backlog, because I think the share gains are really a critical part of this growth of the market strategy that you have at Lear?

Right. Yes. The growth of our market, if you see, historically is driven by 2 factors: it's content growth, CPV growth, which has typically been around 1%, 1.5% a year -- additional features going into the seats or mix within the market in the luxury or full-size SUVs that have more content. And then market share gains is the bigger component of our growth of market. And -- so we've announced over $2 billion of conquest wins with the programs we've taken from competitors. Many of those have launched already, but we're still ramping up the most recent conquest award, Grand Wagoneer and Wagoneer launched last year in September. So that's ramping up in the BMW 5 Series and i5 in Europe and Asia, both launching -- that's launching this year as well. So those are the kind of near-term market share gains or drivers of market share gains that we're seeing in seating. And going forward, is the thermal comfort in modularity is a key driver, enabler of market share that we've established as well. Our key component [indiscernible] taken together with 32% [indiscernible] of the full seat market. And so we -- at some point, we're going to reach sort of a saturation point on JIT market share. So we want to also focus on growing our component businesses. Erik referred to FlexAir, this is just 1 example. The foam market today is -- the polyurethane foam is a $4.5 billion market. We have less than 10% of that today. Looking at the industry shift, the polyethylene that we're driving, you see [indiscernible] grab a significant portion of that seat cushioning market. That's the enabler of the overall 32% of the seat components [indiscernible] modularity, so selling modules to our competitors that are sourced by our customers. So it's to nastic JIT strategy that allows us to find more components [indiscernible] customers that are making -- I won't talk about specific customers, but this gives us access to those customers as well because of our vertical integration capabilities, we can sell anything from seat covers to complete seat modules, which opens up a whole new growth market for us longer term.

Maybe if we could just talk a bit about the -- some of the margin dynamics. And part of your recent guidance, you talked about there's some FX and inflation headwinds? But what is your ability to offset some of these headwinds on the margin front as far as some of your initiatives, be it automation, restructuring or pricing vertical -- any -- what are the levers you have?

Yes. I mean the basic business equation that we have each year, you're trying to offset your customer contractual price reductions and wage inflation. And the net of that what we refer to as that performance in both of our businesses that are generating a modest positive net performance this year. And really, the -- what's obscuring the progress we've made in efficiencies and the gains we're making through our investments in automation and [indiscernible] systems is the level of wage inflation. And I would argue that this is sort of the peak year. We had a lot of inflation. And we've had, I think, global inflation generally has peaked or peaked last year, and the last piece of that is that rolling into wages. We're seeing that at globally. I would argue that at 7% to 8% is what we're seeing this year with twice the historical norm, that is the peak. And next year, we'll see that start to work its way down. It's not maybe going to go back down to 3% or 4% or down historically. But I think it's going ahead in that direction. And so you'll start to see a full effect of all these investments we've made in automation that show themselves in margin improvement once you -- we have a more reasonable level of waging inflation offset. We're in negotiation with our customers to pass-through portions of that as well. And our guidance suggests that we will either pass it through or off through our performance this year.

Okay, okay. Very topical. I think [indiscernible] these days. There is some news on this front lately. You increased your authorization to $1.5 billion, $600 million increase. Plan extended through the end of 2026. So maybe you could just refresh us on capital allocation. In the past, I think there's been a balance and a blend, some of buybacks, but obviously from bolt-on M&A. How are you thinking about capital allocations these days? And is there an incremental focus on [indiscernible]?

I think we demonstrated that last year that we're shifting our emphasis to share repurchases and returning cash to shareholders through that mechanism. If you look at our historical approach to capital deployment, we focused first on investing in the business organically, tuck-in acquisitions inorganically to round out our capabilities. We're very happy with the portfolio that we have in both segments right now after completing the acquisitions of Konsberg and IGB, we think that largely give us the scale that we need to be the leader -- continue to be the leader in seating. We do see an opportunity to do some modest tuck-in acquisitions on the automation and equipment side, like we did over the last 3 or 4 years with ASI, Thagora, and Intouch. And we're starting to see the benefits of those investments impacting our business right now. So those are $15 million to $25 million acquisitions, not significant, not going to move the needle. So the predominant focus is going to be on returning the cash -- shareholders through share repurchase. We bought more than $300 million, back about 4% of our market cap last year. Given our outlook for free cash flow this year, we would expect to do something similar to that or maybe a little bit more. And we had a great discussion on this topic last week in our Board meeting. The Board authorized that the increase. And so we're absolutely in locks with the Board in terms of their view on capital deployment as well. And that -- there is a signaling effect or kind of that announcement that we made at the beginning part of this week that we are fully committed to returning excess cash to shareholders through share repurchase...

Can you just remind us on the minimum cash balance target leverage? And the framework generally if maybe there's some bolt-on M&A, but generally, most of the free cash should be going toward?

Yes, I think that's fair. Our gross leverage target is 1.5x EBITDA, we're right there now. On a short-term basis, we could notch that up a little bit, and we're going to grow into more capacity as earnings continue to grow as well. And we have, at the end of the year, I think, with $1.2 billion of cash on hand, and that's an area that we're comfortable with sort of $1 billion to $1.2 billion cash on hand is sufficient to run the business.

Wrap with a question -- a couple of questions on E-Systems. And I think the margin trajectory is the key point here. Maybe you can give us a sense, obviously, slower EV penetration is impacting some of the pace of margin expansion. Maybe you can give us a sense that in the face of the lower EV uptake, what are the levers you have in driving E-Systems margins higher and to offset the inflation, offset maybe some of the weaker EV uptake?

Despite the lower EV volumes, we still have a very strong backlog in E-Systems. We have $1 billion of new business for rolling down over the next 3 years. Each of the last 3 years, we've won $1 billion of new business. And so that that's going to be the single biggest catalyst over time, I think, of margin expansion in E-Systems. That coupled with what we're doing on the performance side, efficiency improvements passing through inflationary increases to customers, a combination of the automation that referred to earlier in seating, also apply in E-Systems. Fantastic opportunities there. And we really took a step back and simplified the portfolio. We did a deep dive on the strategy 4 years ago, simplified the portfolio, started to exit some of the noncore products and we made a small acquisition in M&N Plastics to round out our capabilities in connection systems. And that's helped us grow the business and improve the margin profile of the business. So that capability was initially just in North America. Now we're replicating that in North Africa for the European market. That was a key catalyst of pinning the [indiscernible] Award with the [indiscernible] Battery Systems [indiscernible] key driver of growth. [indiscernible] systems, even with the lower volumes is still a very attractive business. So I think it's a combination of backlog, repositioning the portfolio, growing the connection systems and improving efficiencies. Those points taken together, really led to the 110 basis points improved margin by last year and 100 basis points we're guiding to this year. So a pretty meaningful improvement in the margin profile of the business. And then we're looking forward as well.

We're out of time. Jason and Erik and the Lear team, thank you so much for joining us.

Thank you, Dan.