Lear Corporation (LEA) Earnings Call Transcript & Summary

All right. Good morning, everyone. For those who don't know me, I'm Andrew Percoco, I lead Autos Research here at Morgan Stanley. And up next, pleased to be joined by Ray Scott, President and CEO of Lear; Jason Cardew, CFO; and then Jared Fedele, Vice President of Finance of Seating and E-Systems. So thank you guys for joining this morning.

Maybe just to kick us off, Ray, if you want to just give us a general update in terms of what you're seeing in the business, how the year has gone and kind of how you see the business transforming over time and then we can kind of continue the conversation from there.

Thanks. It's great to be here. It's hard to believe it's already middle September. But looking back at this year: one, I couldn't be more proud of the team. We -- the first half of this year was record revenue, $12 billion plus. We continue to execute on our core operating income improvement in what we're doing there. EPS up 23%. So really delivering on the measurables we've put in place. And when I think about where we're at, it's been this transformation within our manufacturing process is around idea by Lear. We opened up the advanced manufacturing center this year, which has just been incredible for not just the investor group, but also our customers. And having one location where we can really display our technologies and what we're doing in the manufacturing environment around automation and the digital transformation has been special. And that's really helped us with growth. And you think about the growth in the most recent announcements, that we've had with the Ford 250, 350 program when the -- I think, legendary programs in North America that is going to be great for our business long term. The most recent award that with the Audi business that we just announced, and we're continuing. We just had the largest India win that we've ever had in history with Mahindra -- Mahindra since our Q2 earnings announcement. So the wins continue, and they're very strategic, very selective, very specific on where we really want to grow, how we want to grow, with which customers we want to grow. So the combination of what we're doing with technology innovation, not just on the product side, but I think equally as important on the manufacturing side is really starting to take shape with our customers with growth. And so the recognitions we get with the supplier of the year both in Seating and E-Systems. I just -- I believe confirms what we're doing and how we're differentiating ourselves. So we still have a lot of work to do in the remainder of this year, but I'm proud of the accomplishments that we've managed already this year.

That's great. And maybe, Jason, for you, if we could zoom in a little bit in terms of the quarter and I think U.S., at least the demand in the U.S. has held up better than I think anyone is expecting it to, but obviously, to the global business, China dynamics is obviously very much in flux. So can you guys just help us think about the setup as you see it today relative to maybe what you framed a few weeks ago on the earnings call? And what are some of the puts and takes that you're maybe seeing across the business for the third quarter?

Sure, Andrew. We shared a framework of our third quarter outlook on our second quarter earnings call, we expected revenue of $5.8 billion to $5.9 billion, CD margins in the low to mid-6s and E-Systems margins in the low 4% range. And the quarter is playing out essentially in line with what we had anticipated at that point in time. As you highlighted, there's been a very resilient market here in North America, some weakness in China. If you look at retail sales in China, we're down 21% in July, 23% in August. So that's certainly presenting some pressures on volumes in the China market. But as we sit here today, we're right in line with that framework, maybe a little towards the low end in terms of the revenue closer to $5.8 billion and $5.9 billion, but really solid performance by the team and the things that we can control and execute on. And as Ray said, we're continuing to hit on all cylinders, both in terms of growth and performance.

That's great. And on the inflationary side, I think we've heard from some of your peers and some of the OEMs that, that continues to be a pressure for the business. But from your perspective, understand most of your costs have some level of pass-through. But any updates in terms of what you're seeing there? Maybe it's more of a fourth quarter dynamic than a third quarter dynamic, but just curious how the inflationary environment has, kind of, shaped up versus your prior expectations and how that might impact the P&L over the next few quarters?

Yes. I think over the last 10 years, we've worked very hard to put in place, pass through mechanisms with our customers. And we've largely insulated ourselves from the direct impact of that. Sometimes there's a timing lag. We don't see anything in terms of the current market dynamics on inflation that will impact the outlook for the second half of the year at this stage, though.

Okay. That's great. And then, Ray, you brought up some of the recent wins that you've had in your initial remarks. You've obviously shown clear progress in terms of the significant conquest wins that you've had across both Seating and E-Systems. Maybe just talk a little bit about what why you've been able to win some of those awards? What are you leading with to essentially get some of that business to Lear? And what are customers essentially looking for at this point when they're thinking about giving out programs to suppliers. And I'm also curious how that differs by region. North America versus China versus Europe, I'm assuming all have slightly different approaches to how they look at the market. So how are you, kind of, approaching it from your perspective?

It's a good question, and we've done a remarkable job. And I think this really is the credibility that we want to make sure that we are communicating to the investor group. And it is around the investments we've made. And so the Audi win, the Ford new business that we won, the NCAR, the truck business that we won in wiring, are really around this focus that our customers have around technology and innovation. And the domestic Chinese have really, I think, sparked a change, not just with the domestic Chinese and how they think about technology specifications the ability to drive different modular concepts for efficiency, customer preferences, weight, all the different ingredients that our customers are looking for to improve their products are aligning with what we've been at for 10 years. This journey we've been at to really change our manufacturing process around automation and the digital transformation has really started at a perfect time. So the work that we put in place, the importance of us having an advance manufacturing center in place where we can show what's in production and what is the next generation of technology that will be implemented in our manufacturing plans have been the key. And so as we go through our customers right now, the alignment has been perfect. We've been at this journey and now our customers are looking at how we can change specifications, how we can get at these changes within the manufacturing plant to really change efficiencies within their products. And so they do a tremendous amount of work. The amount of work that when we go through these quote processes and the feedback we get from our customers on you are truly doing things that your competitors are not doing and their need for that innovation and technology is at an all-time high. And so we're being very selective. I think what's important, what we learned as EVs really collapsed in North America was how we select programs, the programs we go after have a legacy to them, a consistency in volume. When we're going to best capital, we want to make sure we're betting on the right platforms, the right programs by region. And so we've been very selective on these programs that we're winning. So we won $2.9 billion, $2.3 billion of that is in seating, $500 million plus is in E-Systems. E-Systems had arguably the best awards last year of $1.4 billion. So us being very selective, being recognized as having this ability to have technology as a differentiator has really paid off. And this Audi business, which I think it was interesting, I think about it all the time. There's a lot of skepticism around, can you really change the model itself, the sourcing model from directed to your control. The Audi, we have sourcing control over the comfort features. So we have a Comfort Flex system that will combine lumbar and massage. And when we bought IGB and Kongsberg, we needed that engineering capability. So when others talk about a modular solution, if you're using other components that are not yours, it's not a true modular solution the way we define it. That's what's differentiating us. And so having 45 contracts that's so important to the credibility that we talked about how we're differentiating ourselves. And so I mean I could talk about this all afternoon.

For the rest of the session.

Yes. Yes, I could because it's important. When we think about our growth strategy, and as we start to launch these programs in '28 and '29, I think investors should really think about the type of programs that we're investing in and how we're winning that business. And it is around the investments we've made IGB Kongsberg, as I mentioned, in the product side. What we did with WIP automation, the partnerships we have with Palantir what we're doing with automated taping with BMW that will launch later this year is all around technology in our manufacturing plant. So we're now having the evidence that backs up the investments we've made over the last 10 years.

Yes, that's great. And maybe on that piece on the innovation that you guys have obviously focused heavily on, it seems like that would align itself with how fast the Chinese OEMs move, right? And the innovation cycle that they operate on. But at the same time, I know you guys have talked about how you're slightly under-indexed to some of the export volumes that we're seeing, and that's obviously where most of the volume is going right now. Just talk about that kind of push-pull and why maybe you aren't more exposed to some of those volumes, just given the level of innovation that you're able to bring to the table, which I would probably argue is better suited to be aligned with some of the Chinese OEMs versus maybe some of your peers that haven't moved as quickly on kind of the innovation around some of the products that you provide?

Yes. Well. So we have targets. Right now, we're about 45% of our domestic Chinese business with a target of going to 50% next year, and we have a clear path to get there. I don't think that's going to be a problem. You're right. Right now, the under-indexing of what is being exported is a very focused strategy of ours to change. And I think the things that you're mentioning is that we do have these capabilities to produce parts much quicker to go to market much faster. The thing that we discovered too is as we acquired these companies and integrate these companies, on a JIT facility, for example, we manufacture now 80% of our own capital at a 20% to 30% discount to what we are acquiring and buying before that. And so we're much faster to market, much more capable to get our own technology on the floor for our customers. And we're seeing that with the domestic Chinese. And so it's been a big focus of ours. I think you'll start to see that change as our targets start to change, and we start to realize that there's going to be opportunities. And I also think longer term, when we think about the domestic Chinese policies are going to change. As domestic Chinese are showing onshore, [indiscernible] Motors in South America was a great win for us. I mean so we're starting to see -- and I just got a note today about picking up additional domestic Chinese. I can't talk about it right now, but hopefully soon, as we talk about it that we're starting to see, as they onshore, our capabilities work out perfectly for them. And so those new wins, I think, are going to continue for the remainder of this year and into next year.

Yes, those to Ray's point, the relationships, and it starts with the leadership we have in China, too, and the moves Ray made back towards the end of 2023. When you kind of put seating and E-Systems under 1 strong leader, you see this momentum being picked up. And if you take a step back, prior years, our COM revenue was 33% domestically, and then we'll go to 44%, and we have a line of sight to over 50%. And we've got this this local team for the local market, which is incredible because you know the intricacy is how fast the market moves. And due to this, we've picked up a lot of share and we're the clear leader in luxury in China right now in the domestic market. So we dominate in the mid to the upper end of that section and back on the whole export question. It's a tough question to answer right now. And if we were to kind of look at where we're at today, I would say we're under indexed. But the reason for that is historically, when the exports were going on the lower end of the market, and so now they're at the mid to the high end. So this is a big opportunity for us. And these relationships, the team has built in China with the COEMs, domestically is going to help us as they export out. And going back to the $2.9 billion the business we won, the net new business awards, $520 million of that was with the domestic COEMs. So those relationships help as you go out. And from a margin standpoint from the profile of the COEMs, how do they align to the global margins, just to touch on that for a second. They're in line with our segment targets that are out there. And the team is -- and Ray has mentioned, Jason, is that just we're very strategic on who we want to work with and why we want to work with them because we have to make sure we get a return in excess of our cost of capital. And the #1 driver for margin is the level of vertical integration. And the 1 benefit we have is obviously the [indiscernible] the vertical integration we have, but the COM sourcing model to the Tier 1s, and they allow to source Tier 2, Tier 3. So if you've got those capabilities, you have the ability to grow your margins. And so that's why we're selective with certain customers that we want to focus on to grow.

Yes. That's great. And I was going to ask about margins, but it sounds like the pricing environment is relatively healthy for those programs. It's not something that's decremental to margins. And the reason I bring it up is because I think there's a big debate in the industry around as you presumably win more business with the Chinese OEMs, that is potentially cannibalizing something, whether it's in Europe or South America, with the local OEMs. Is that margin accretive? Or is it destructive to the overall profitability of the business. And it sounds like as you sit here today, it's -- I guess net neutral is the way you would kind of frame it in a positive negative, it's kind of a neutral for you?

No, it's 100% correct, and that's why we're so strategic with the customers we work with. And if you take the South American example, what a lot of people don't realize, in South America, we're the leader in market share. So we're the #1 from a seating standpoint. And so what we're able to do, particularly on the [indiscernible] Motors award that we had is bring [indiscernible] Motors in, we already have the overhedged structure. We already have the capacity to bring them in. So you're doing it from a capital light standpoint, which also helps to return. So we see this as a big avenue as the Chinese continue to localize. And we already won with Chinese as they localize in Europe. So as they continue to localize, particularly in South America, we've got a heck of a lag [indiscernible] right now from a margin standpoint, from a capital standpoint, from a production standpoint.

And what's the pace of that localization? Is it happening quicker than you expected, slower than you expected? Or like what's their incentive to do it versus just continuing to export without some massive policy change in Europe. Just curious, from your perspective, how quickly that's been moving.

Yes, it depends. It's -- honestly, it's region by region specific, and it all depends on the regulations. I mean, we've been in talks with the OEMs, particularly with our local team in China and with our global teams and there's a handful of customers that want to localize and there's another handful that are going to keep on the export. But right now, it's going to be export until something happens from a policy standpoint that changes that.

Yes. That makes sense. I do want to shift gears a little bit to 2027. I know we're still a few months out and a lot to change between now and then. But I think on the last -- on the second quarter call, you guys kind of highlighted that you see a lot of growth coming in 2028 and '29 based on your backlog. But 2027 is a little bit more of an in-between year with some of the roll-offs within the portfolio. If you could just kind of double-click on that a little bit between E-Systems and Seating in terms of that portfolio contribution, the growth that you're seeing? And ultimately, like what should give us confidence that 2028 and 2029, will see the level of growth that you've articulated.

Yes. Starting with 2027. On the second quarter earnings call, we provided a lot of detail on our outlook, which it's a little bit early in the cycle to do that. But we thought it was important because we felt like there were some dynamics within our portfolio that the sell-side analysts and other investors may not appreciate, and we took the decision to be a little bit more forward-leaning in the level of detail we shared. And so despite the very strong backlog that we have for 2027 with over $700 million of new business rolling on, we do expect limited growth in 2027. And that's really a function of the continued roll-off of the E-Systems non-core products that we're exiting. It's the peak year of that roll off. We have $235 million of revenue that rolls off next year. There's about $250 million in the 3 or 4 years after that. So it's far and away the most significant year in terms of the impact of that. And then you have programs specific to our customer a platform-specific issues that are weighing on our outlook for revenue next year. We had several customers that had really strong years this year, and I highlighted all those details on the call. I won't go back through each of those, but that's kind of the other component that offsets the impact of the backlog rolling on and the dynamic between the 2 segments is pretty similar. In terms of the 2028 and 2029 outlook, and I think Ray touched on a little bit of this in his opening remarks. I think what should give investors confidence in our ability to achieve that level of growth that we've articulated for '29, which is getting back to that 3 to 4 points of growth over market, the quality of the programs that are in that backlog. If I just look at the Ford Super Duty, the Audi QA, BMW [indiscernible], just these handful of programs taken together between Seating and E-Systems that's more than $1 billion of backlog that's rolling on in 2029. So these are programs with a long history of success in the market, and we have a high degree of confidence that those are going to launch on time and at the volumes that we've embedded in the backlog. The other thing we've done is we've looked out at 2028, '29, '30 is we've taken a very conservative view on how market share changes between our traditional customers and the Chinese are going to play out. If you look at Mobility Global, I think they have the Chinese market share growing by 4 percentage points globally from 2026 to 2030. And we've built our plan around 6 points of market share shift. So we've really tried to, sort of, derisk that outlook and build confidence first for ourselves and then for investors in our ability to deliver that level of growth in 2029. On top of all of the backlog that we've already secured, we have a very strong pipeline of additional opportunities, conquest opportunities that Frank and Nick and the 2 segments are working on that we think will be realized over the next 6 months and further bolster that 2029 backlog. And we would expect at the end of this process, that 2029 will be a record backlog year for the company, again, both because of the quality the programs that have already been awarded and the line of sight we have to new business awards there, too.

That's great context. And on the non-core exits, it sounds like next year is, kind of, the peak, but do you feel like you have your hand around -- is there anything else, I guess, in the portfolio when you think about that, that could add to either 2028 or 2029. Just curious like how thoroughly you've gone through the portfolio to make sure you've got your handle on kind of what you're going to be rolling off and the timeline in which you're going to be doing that?