Cheap financing and low gasoline prices seem to have kicked car sales into high gear. This is benefiting most of the auto supply chain. Lear Corp. (LEA.N) is a major integrated supplier of seating components to car manufacturers. It also has a smaller electrical segment that has car makers as its customers. Let’s see what trends are in the driver’s seat.
U.S. auto sales topped 17 million in October, the highest since 2001 and may well be headed to a new record high for all of 2015, reports Reuters. Speaking about the state of the industry at Gabelli & Company Automotive Aftermarket Symposium on Nov. 3, Lear CEO Matthew Simoncini said: “I think it’s probably the most exciting time to be in the industry since I’ve been involved in it, going back 30 years. That’s why you’re seeing firms like Google and Apple try to penetrate into the auto industry … overall, the industry’s in a great place.” [source: StreetEvents Transcript]
StarMine Val-Mo likes it too
Among the collection of StarMine alpha models, the Value-Momentum (Val-Mo) factor is one of the best-performing. It combines valuation measures with momentum signals. Value is a mean-reverting factor – wait long enough and undervalued stocks tend to outperform. But value signals do nothing to help with timing. That’s where the momentum factors help out.
Val-Mo combines two of these trending factors: analyst revisions and stock price momentum. In this combination, investors get an edge in finding undervalued stocks that may benefit from improving sell-side sentiment and market sentiment.
Lear’s Val-Mo score ranks in the 96th percentile among all companies in North America. Both the valuation and the momentum sides of this equation look attractive. Driving the Analyst Revision Model score are upward EPS revisions. The I/B/E/S Mean EPS estimates have been increased for this quarter (Dec-15), this year, and for next year.
Source: StarMine
A drive through valuation land
Looking at the components above, Lear receives a high Intrinsic Valuation score of 81 due to its price being only 0.7 of what this model calculates to be fair value. In the case of Lear, the StarMine IV model reduces sell-side EPS estimates to adjust for the optimism bias that typically exists for growth companies and estimates that extend well into the future. Even after that haircut, the model comes up with a projected 12% five-year compounded annual growth rate. That compares to the trailing five-year CAGR of 19 percent. Notice above, when solving not for fair value, but inputting the current price and solving for growth, the market has priced in only 6.5% growth.
An appealing trend in Lear’s Intrinsic Value is the growth in that number since the beginning of 2013. It presently stands at $175 per share, compared to $72 back then. While this calculated value has shown Lear to be undervalued since 2011, never in the past 10 years has the discount to its market price looked much larger than it does today. Notice, however, the nice correlation between the direction of the IV history and that of the stock price, shown here as the grey area chart.
Speaking on the topic of valuation at the Gabelli symposium, Lear’s CEO said, “We’re undervalued. Everybody looks at the run that we have. We personally believe we’re undervalued for a few reasons. One, we’re in a dominant market position in seating. We’re in a growing segment in electrical, we have a team that’s been proven to execute, and we struggle with why we’re a discount for the space.” [source: StreetEvents]
Source: Eikon StarMine
Turning to the other value component in Val-Mo, Relative Valuation, we find ratios that also make Lear look undervalued. It trades at a next 12-month P/E of just 10.7 and a forward EV/EBITDA multiple of just 5.8. That’s a 22% P/E discount and 14% EV/EBITDA discount to its peer median – confirming in our measures the discount that Simoncini mentioned.
Would Warren Buffett own this company?
I think he would. It has many of the characteristics that Buffett says he likes in a company. Lear is a dominant provider in its market segment and appears to be well managed. The company has been growing in every year since 2009 and in electrical, has future growth potential.
Source: Eikon
Adjusting the passenger seat
Like many of Buffett’s investments, these qualities come at what seems, by our measures, to be a very reasonable price. While often described as a value investor, quality seems to also be one of the most important factors Buffett wants in his portfolio. Lear is growing its free cash flow generation and its return on operating assets is rising and better than its industry median – both measures of good earnings quality. Now to figure out why the humans aren’t traveling at the same speed as the quantitative Val-Mo model.
