Barclays Industrial Select Conference 2019

Feb 21, 2019

Slides

Let's get going. We're very excited to have Lear at our Industrials Conference for the first time in quite a while. We're this year, we're joined by John Abzemire, Chief Technology Officer and Jason Cardew, VP of Finance for Seating. For those of you who don't know, Lear is one of the largest global suppliers of automotive seating and is also a growing player in vehicle electrical architecture through its E Systems segment, one of the largest bars in our coverage by revenue, 21,000,000,000 as well as with an attractive secular growth. You issued 2019 guidance, which combined a conservative end market outlook with very strong underlying growth over market. So with that, we'll turn it over for a five minute intro just because Leary is new to this conference, and then I'm going to talk to Jason and John about some of the trends. All right. Thanks, Brian. It's an honor to be here today. I want to start by sharing our safe harbor statement. And before we get started with fireside chat, I wanted to provide a brief overview of Lear Corporation. We're a large global automotive technology supplier of two critical automotive systems, seating and electrical and electronic systems. We have complete design, engineering and manufacturing capability in all key auto markets globally with 169,000 employees operating out of 39 countries. We have very low leverage and a proven ability to generate significant free cash flow. Our strong financial performance, coupled with our share repurchase program, has allowed us to deliver superior shareholder returns. In fact, over the last five years, our total shareholder return has significantly outpaced both the S and P five hundred and our automotive supplier peer group. And while the industry is clearly facing a challenging macro backdrop, we built this company to thrive in this environment and really separate ourselves from the competition. And our efforts are paying off. We have the largest consolidated sales backlog in our history, the most talented team in the industry and an incredible reputation for operational excellence. And while the industry is going through a transformational change, we've been investing in technologies and capabilities that will allow us to continue growing across all of the industry megatrends. And John Absmeier, our CTO, will share some details around that in just a moment. Before that, I'm going to show a brief video. Today, the gap between concept and reality is razor thin. Expectations are high. Results come faster. Lear is a global automotive technology company with a passion for turning concepts into reality that improve the human experience. We leverage our comprehensive advanced technology portfolio and advanced manufacturing processes to create answers from now to future questions. Our intelligent seating capabilities enhance the experience and proactively adapt features and functions for personalized comfort, wellness and safety. Our industry leading innovations allow flexibility and adaptability to tailor the vehicle experience to individual lifestyle, creating many opportunities for integration in shared mobility. We support cleaner and more efficient mobility with electrification technology. And our advanced connectivity and positioning between vehicles, infrastructure and pedestrians help make cities smarter. And with autonomous driving on the horizon, a high accuracy GPS enables precise positioning. At Lear, we're reshaping the way people think about transportation, applying a new frame of reference, and pushing the boundaries for what's possible. Because it's our passion, a passion that drives possibilities, and the possibilities are endless. Great. We have just one more slide. Sorry, Brian. So before we jump into the Q and A, I just wanted to share briefly a little bit about how Lear is positioned, which will be a good setup for the Q and A. But if you look across the autonomous, connected, electric and shared landscape, you know, these trends are affecting our industry greatly right now, and and Lear is very well positioned with everything from localization, services, and products that help autonomous and ADAS systems and vehicles figure out where the vehicle is, to connectivity with gateway modules, which are the central data hub in the vehicle for all all information, and connectivity modules as well as V2X with safety applications, V2X connectivity using both DSRC and cellular, into electrification where we work on power electronics, so inverters, converters, battery chargers, as well as battery management systems, and then across all of those with electrical architecture in wiring and connection systems. And then finally, with the shared megatrend, we're addressing that with configurability and personalization and bringing in health and wellness and lifestyle technologies into our products. So really across the board, we're addressing each of these megatrends, and we have all of the ingredients to invest, innovate, differentiate, grow and create value. So with that, a couple of examples of where we are participating with production programs. So we have basically a slide with four, here we go, four product launches that we've done or are coming in the near term. On the top left is a very important one for Lear. This is the Jaguar I PACE, which is the newest, most advanced electric vehicle on the market, competing with some of the early entrants with new fresh technology from Jaguar. And it has as you can see on the left hand side of that quadrant, a lot of content from Lear, onboard charger, connectivity, gateways, audio systems, and even a full seat package. On the bottom left is our Connexus system, which is the most advanced connectivity module in the market today, a four and a half g LTE connectivity module providing telematics as well as consumer content delivery over the air updates and so on for the Audi vehicles as well as 10 other platforms across the Volkswagen Group. And then the connectivity module or sorry, the gateway module rather, which is again that network hub in the car. These two left quadrants are in production today. On the right hand side, the top right is our Configure Plus technology, which is an untethered seat. So in other words, you can configure and move the seat around the cabin, which is important for shared mobility as well as new configurations that are being required with new business models at the OEMs and other service businesses. And then finally, bottom right, we announced in January our first partner on our localization platform, and that's Hyundai. And that localization platform is automotive grade, low cost hardware that sits in the car with a service using data that's publicly available like weather and atmospheric information to bring localization or vehicle positioning down to sub-ten centimeter accuracy, which will be required across all the ADAS and autonomous driving landscape. So I think in the Q and A, we'll get into details of all these, but just for the setup. So with that, I'll hand it back. Okay. Good. And for the setup, can we pull up ARS question number one? Do you currently own this stock? So 21, that's about what the conference has been running. Number two, general bias. So remember, we had 21% owning. Positive, neutral, many neutral, but more positive than owners. So be interesting if you can make some sales. While we go in, Jason, let's talk about the current production environment. Your guidance assumes was it, frankly, one of the most conservative of the auto parts bars? You assume top platforms in North America down 5%, China down 10%, EU down 1%, and particularly for North America, which could be more platform related, more conservative than other companies, but particularly for China. So maybe start with the hot topic first, which is China. Down 10%, what are you seeing now? What did you factor into your guidance? Yes. So as you mentioned, we did have China factored in with a 10% reduction for the year on our key platforms. And the year started off slow. It's in line with what we expected. We've seen continued weakness in China. If you look at the January sales, they're down high teens in January. And so we think our guidance is appropriate at a 10% reduction on our top platforms. And maybe take this opportunity to sort of round out what we're seeing for the first quarter overall, too. We haven't seen or heard anything that will really impact our full year guidance, but the first quarter is going to start off weak. We talked about on our earnings call that the first half sales would be down a little more than 5% and the second half would be up more than 10%. But if you break that down further in the first quarter, we see the first quarter sales down high single digits for this weaker production environment you referenced in China, but also some weakness in Europe as well. And then we have some company specific weakness with our backlog. Our backlog is weighted more to the second half of the year with the Chevy Blazer, the Ford Ranger and Mercedes GLE and GLS ramping up to full volume throughout the year. So you're going see only about 10% of our backlog hit in the first quarter. And also, foreign exchange, the first quarter is the toughest comp with the euro and the RMB, both about 8% weaker in the first quarter. And then we have the changeovers of some key platforms that led to some downtime in the first quarter. So all those factors taken together, we see Q1 revenue down high single digits and Q2 down less than that. And in terms of China, given IHS is still out there with like, I think, a 1% to 2% decline, what led you to want to be more conservative in China? I think just having experienced what we went through in the third quarter and fourth quarter of last year, I think IHS has sort of been chasing a number, and they've been bringing their number down consistently. We've seen it come closer to our assumptions. I think just the general weakness in demand that we saw throughout the second half of the year and into the first quarter, heard our customers talk about working off some excess inventory in the first quarter. They've spoken publicly about that. So all those things taken together, we thought that was the prudent assumption for our guidance. And in terms of second half, do you see any potential for the retail sales rate to stabilize and then comp becomes much easier? Yes. Think the comp is definitely easier. And then we see the full benefit of our backlog since a lot of it's back end loaded as those programs ramp up. We definitely see an improvement in our performance and our outlook in the second half of the year. And you mentioned softness in Europe in the quarter. Can you elaborate? Well, January sales, I think, for the industry in Europe were down roughly 5%, and we are seeing pockets of weakness in the production outlooks. The good news is, though, what we're seeing is our customers are starting to kind of re rate their lines or take shifts out. So there's more predictability on what the production will be. And we can start to restructure our business and align to that new volume run rate as opposed to down weeks or down days, which are very disruptive to the business and harder to respond to. I think that's that's something that will help a little bit in Europe specifically. So better decrementals. And one of the risks people are discussing at the conference is around potential tariffs on EU autos coming into The US. You have a very strong position, good news in German luxury. But bad news is what have you quantified your potential exposure to platforms that part of the volume is coming into The U. S? Yes. So we have very little imported material from Europe into The U. S. So it's in the neighborhood of 40,000,000 or $50,000,000 And most of that is directed by the OEMs. So generally speaking, where we're sourcing the material, we're sourcing it locally for The U. S. Market. So we see almost no direct impact from two thirty two tariffs on EU auto parts. If there's a tariff on vehicles, obviously, that will impact the competitiveness of some of the products produced in Europe. They're shipped into The U. S. And I think roughly 10% of U. S. Sales are imported vehicles from Europe. So certainly, that portion of our business will be impacted somewhat. Okay. Well, let's move over. Why don't I pause there and see if there's questions for the audience around kind of the macro and the high level guidance before drilling down into the technologies? Okay. Let's my first question for John is you came from Aptiv Delphi, and this role of Chief Technology Officer is new to Lear, at least I believe. It's been long standing between Glenn DeVos and Jeff Owens at Aptiv Delphi. Can you give a sense of what led Lear to create the position and kind of your discussions with Ray in terms of where he wants to take the company? Yeah. So I think it exhibits Ray's commitment to holding innovation and technology sacred. And really, as part of my lead in, I talked about the autonomous connected electric and shared trends that are happening. I think everybody talks about those, but they're now in our face in terms of those types of business opportunities are on the table. So it's it's important, I think, now more than ever, especially if we head into a cycle that that we hold that sacred, and and we're very well positioned to do that, obviously, both financially and operationally as well as from our capabilities that we've made in technology over the past several years. This is really an opportunity to really systematically put a process in place or put a systematic process in place around innovation. And so that's what I'm doing right now and setting up an organization that does both internal invention and innovation, working with partners and collaborations with start up and tech companies, making early stage investments in start ups as well as in venture capital funds and, of course, M and A. So those are kind of the four levers and the four areas that we're looking across. And we announced in January our initiative called Lear Innovation Ventures or Live Possibilities. That's really encompassing all of those four levers that we can pull to move the needle for the future. And a lot of the focus in the past has been on the core technologies and businesses that Lear is a leader in, of course, in Seating, but also in E Systems. And now what we're looking at is new business opportunities that are high growth, high margin and low capital intensity, things like software and services and data, things with recurring revenue streams that aren't necessarily tied to the SAAR or tied to vehicle volumes. These are areas that are complementary to current Lear capabilities and product offerings, but that extend our business opportunities. So when you got here, what did you find about the state of Lear on the E Systems side in terms of its positioning vis a vis vehicle electrification and then sort of vehicle connectivity and big data in the car? Yes. Spectacular. Actually, first of all, the team is outstanding, and I've said it before, but I'll reiterate the team at Lear is top notch. So that was one of the first things I recognized. Secondly, I recognize that Lear has a lot of the foundational work done, especially in connectivity and electrification that positions us very well to take advantage of some of these software and data opportunities. If I just dive into connectivity briefly, because you talked about data and software and our position there, with connectivity modules being the central point of contact between off board or between the cloud and the car, with gateway modules taking all the data from new sensors and new systems in the vehicle and really being the single hub or the network switch in the car, if you will, to do that, we feel like we have a great opportunity to add value for the OEMs. And with creating differentiating technology and adding value for the OEMs, it gives us a business opportunity that we can also take advantage of. So we can do things like preprocessing of the data in the gateway modules. We can look at monetization paths for the data. We can do over the air programming and cybersecurity through those connectivity and gateway modules. So it's really about expanding and ability to to And business. We're we're the And it's been more focused on, I won't say black box, but the traditional Tier one model for electronics has been the software and the hardware packaged together as a product and sold as a onetime sale to the OEMs. Now that the architectures of the cars are evolving and changing, we're seeing this centralization of functionality happen where you're getting bigger computers that are mostly defined by software. And so they're up integration of various controllers in the car into one domain module that has software defined features and functions. And that basically is now an opportunity for us, where in the past, we couldn't separate hardware and software in terms of the value provided to the OEM. Now the OEMs have to separate the hardware and the software sourcing. So they become business opportunities for software that are a different business model than our traditional onetime sale hardware. So that's the area that we're growing into is now how do we disaggregate hardware and software. I think we're very well positioned, but that's definitely a focus for us going forward. And is part of your backlog software only, or is that something to work on? So it's it's not in the backlog, but we are entertaining RFQs today. So I think it's sort of in the next cycle, the next business cycle. But those opportunities are coming significantly as the OEMs are rearchitecting the next generation of vehicles. And would that be a content per vehicle story? Would it be an annual fee? I mean, just Both. A sense of how meaningful this could be? Yeah. It's it's both. I mean, you can look at different types of of software enterprise licenses or per vehicle licenses. You can also look at recurring streams when you have to do updates or maintenance on on vehicles, also analytics and service. So looking at what what the car is doing and what how you could improve the experience of the user. Because at the end of the day, this change in model for the OEMs is about creating a better user experience for the consumer so that they can differentiate brand and they can retain customers. GM made a public statement that 1% customer retention means $700,000,000 in revenue for them. So it's a significant value just for that piece of doing analytics and sort of service and maintenance. That's not to mention if you look at, you know, looking at e commerce and other ways to monetize data for consumption of information in the car. And, you know, in terms of the data, what role do you see clear there and the kind of mass flood data that Yeah. Great questions. So we're we we don't think that we're gonna be a data aggregator or a data owner per se. We're going to enable our products and our service offerings to help the OEMs to create new revenue streams with that. So we're looking to facilitate monetization of data, but also to bring in software content that we can have a recurring revenue stream from. In your video, you had a clip of autonomous driving. I mean, what is Lear's current and planned future role in that brand? Yeah. So I've personally led two significant autonomous driving development efforts, and I can tell you this is a problem that's going to cost tens of billions of dollars to actually deploy in the market. So, you know, there's very few companies in the world that have that on their balance to to be able to fund that over the next decade. I think it's going to take a village. It's going to take a lot of companies. So Lear is not focused on this sort of full stack development. We're more focused on certain high value, high margin areas that that are coming with autonomous driving that are underserved today. Localization is is a perfect example. Today, in autonomous cars, without exception, they're using a sixty to a hundred thousand dollar system for localization or for positioning that has a military grade IMU or inertial moment unit. It has a a real time correction service that requires infrastructure so that you can do triangulation. And these systems are highly expensive, and and the monthly subscription for these correction services are very high. We're looking at a solution that is automotive grade off the shelf hardware for GPS or GNSS that's that's low cost. So the embedded system is is already automotive ready and low cost. And then the the service that we provide is more of a software and an algorithm that uses data like atmospheric information and weather conditions and general location information to the normal GPS accuracy of of three meters, which is 10 feet, and brings it down to 10 centimeters or four inches. So lane level accuracy, meaning you can keep the vehicle in the lane with this solution. And and so these are the types of technologies that we're working on. Another one is V2X. Obviously, there's a lot of activity there. But we have made an acquisition of a company called Arata several years ago or a few years ago that that brings full V2X capability with both DSRC or dedicated short range communications as well as cellular because the differences are across OEMs and in different regions for the two types of protocols, as well as the safety applications that take in sensor information, fuse that together, and can deliver a a a, you know, a more safe experience driving the car. Let's go to some of the m and a obviously, the ARS questions, one of us will try m and a. Number three, get the audience's opinion after hearing your job for through cycle EPS growth and impairs being the Tier one automotive suppliers. So it's interesting. There's still half the audience who aren't sort of in line with peers. Now the other peers are benefiting from content growth trends. Maybe, Jason, could you talk just very briefly about the growth in seat? Yes. I think our backlog is probably the best evidence of our ability to continue growing the seat business. And we have 23% of the market globally right now, and we're continuing to gain share. So backlog comes in two forms. It's either OEMs introducing a new vehicle or you're taking business from a competitor. If you look at our seating backlog right now, dollars 2,400,000,000.0, dollars 2,200,000,000.0 of that is in just in time seating and half of that or $1,100,000,000 is conquest business we've taken from competitors. And we're we have significant quote activity in the pipeline that would suggest that we should continue around that same pace of growth over the next several years. And so we believe we can grow the Seating business four to five points above the market. It's going be driven by the content expansion within seating and taking market share primarily, but also some of the underlying trends in shifting away from pass car to SUV is certainly supportive to our growth as well. And the very public troubles of one of your larger your largest competitor, is that neutral, positive, negative? And we now have a Lear alum running it? Yes. I think that on balance, that's a near term positive for us. I don't think there's a glaring example where we're going to go and take a big program away from them necessarily, but it's more around how you're competing for new business that the OEMs are offering. I think that our current reputation for launch execution and the strong financial performance of the company gives customers a higher degree of comfort that we can execute a program and support them. And certainly, that should be an advantage for us in the near term. Number four? What should you do with excess gas? Share repurchases, which, of course, have been a layer of trademark since your emergence from restructuring several years ago, debt paydown. Interesting bolt on M and A and larger M A. Do you want to and John, now that the support for that? What do you have in mind, if anything? Well, I mean, what do we have in mind? Obviously, we're not going to make an announcement or anything, but we obviously, we're looking at opportunities on a daily basis for M and A as well as investments. So it's high on the radar, and it's something that we're constantly looking for things to strengthen and grow the business. But from a capital allocation perspective, I'll hand it to Jason. Yes. Certainly, our priorities remain the same. We're going to invest in our core business first through capital expenditures and then through bolt on acquisitions as well. If we see an opportunity to round out our capabilities in a region that we don't have today or give us access to a customer and through the diversification of the customer portfolio, those are particularly appealing to us. That's what you've seen us do over the last several years, that's worked out quite well for us. And certainly, with our recent announcement of increasing our share repurchase authorization back to 1,000,000,000 point dollars over the next three years, we're going to return excess cash to shareholders between our share repurchase program and dividends. I think we've returned $5,000,000,000 over the last, since we initiated the program in twenty eleven, 'twelve. Okay. ARS five. Multiple of earnings to trade at. 10 to 12 x. K. Number six. Most significant investment issue. Core growth margin. Now number two, I did want to drill down a bit on. E Systems has been soft in terms of good margins, but not sort of what we're used to for the last couple of quarters. And it looks like the sped of E Systems has left, and Ray's stepping in temporarily to run. I mean, what is going on in the so good news is lots of growth. A lot of it's gonna be in that E Systems area that you're working on, John. Bad news is short term margins took a turn for the worse. Yes. I think the E Systems business is still extremely strong. We have a deep team. We have deep experience in operations and engineering, program management, And we're still performing quite well. And I think as we talked about on our fourth quarter earnings call, the biggest driver of the margin decline year over year was volume and mix. So we had some mature, high margin programs, particularly in China and also in Europe, that saw significant volume declines, and that drove 90% of our margin compression. And if you look at our 2019 outlook of roughly 12%, sort of more of the same. That's the biggest driver of the margin decline year over year is volume and mix, and everything else is kind of a wash. We have a little bit of a headwind on tariffs and commodities, five basis points, a little bit on R and D as we continue investing in the business, particularly with electrification and connectivity and this backlog of $400,000,000 that we're launching over the next three years. But on balance, we see this year around 12%, and we see opportunities to work that number back up in the coming years.