Lear Corporation: No Bottom Yet (LEA)

By Philip Barton | December 14, 2006 AAA

Bottom fishers looking for recovery plays in the beleaguered auto parts industry should not nibble on Lear Corporation (LEA), not in 2007 and maybe not even in 2008.

Financial performance of LEA deteriorated steadily during 2006, even after management began the year claiming 2006 would be "better than 2005". Of course, its CFO resigned in February 2006.

Wall Street analysts looked for a "bottom" during the summer and expected 25 cents per share in earnings for Q2 2006, but LEA lost a dime. When Ford cut Q3 production plans by 3% in the late spring, the tenor of the year was set.

As rock group Led Zeppelin said, "The Song Remains the Same." LEA's earnings growth will continue to be impacted by pressure from lower production volumes, higher commodity prices and adverse foreign currency movements. Fitch Ratings auto analyst Mark Oline said on a conference call that "2006 was a year of turmoil in the auto industry and there is no reason to expect that 2007 or 2008 will be any different."

And IRN, a Michigan market researcher, forecasts U.S. 2007 sales of 16.3 million light vehicles, or cars and trucks. That would be the lowest since 1998 and a drop of 300,000, or 1.8%, from 2006's expected sales of 16.6 million vehicles.

The auto parts industry is a good advance indicator of the health of the overall auto industry, and the 2007 outlook suggests more margin pressure. "The stresses in the supply chain will continue throughout 2007, as lower production from domestic manufacturers, pricing pressures and high commodity costs prevent any significant improvement in operating results or financial position," Fitch said.

Since 2002, there have been 11 defaults by U.S. auto suppliers, including four in 2005 and one this year. The list includes Delta Corp, Dana Corporation (DCNAQ), Tower Automotive and Collins & Aikman. If you believe the leveraged buyout industry, the auto-parts industry is for sale at liquidation prices and it now controls $1.1 trillion in auto-parts supplier assets -- more than twice what they had five years ago -- according to Hedge Fund Research.

So the industry is being disassembled, either shut down and moved elsewhere or consolidated by hedge funds and financiers such as Carl Icahn and Wilbur Ross.

LEA has just sold its only potentially profitable systems business, North American interiors, triggering a $675 million Q4 charge and surrendering 75% of ownership into a joint venture led by Ross'International Automotive Components Group. Despite $4 billion of revenues during Q3 2006, LEA reported per share losses of $1.10, almost twice the consensus estimate of $0.61 in losses.

So now LEA carries a market cap of $1.95 billion, long term debt of $2.8 billion, and virtually no shareholders' equity. In addition, the swing back towards more fuel-efficient car sales from trucks works against a turnaround for LEA, which is geared toward Ford and GM's large SUVs. Moreover, truck resale values are slipping as used and on-the-lot inventory is at record levels. The rest of the industry is also reeling.

Toledo, Ohio-based Dana Corporation has already been operating under bankruptcy protection since March 2006. Dana was a leading supplier of drive train, chassis, structural, and engine technologies for every major vehicle and engine producer in the world. It's closing eight facilities over two years, sharply reducing its U.S. workforce and shifting production to Mexico.

Also, take a gander at a company operating in a much hotter segment, aluminum wheel-maker Superior Industries (SUP). It is also investing in Mexico and not the United States. Its Q3 2006 results were disappointing due to poor capacity utilization as a result of decreasing light truck volumes. Like Dana, it slashed more than 500 manufacturing jobs and closed its Johnson City, TN facility in September after 225 layoffs in June at another plant.

At the end of the day, this looks like another case where the number of survivors in the "catch the falling knife" profession are few and far between.

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