Lear Modellearning model
Lear: Stock buybacks as value creation or appreciation? It' up to you - Lear Corporation (NYSE:LEA)
As a result of the 2011 aggressively implemented buy-back programme, EPS has grown twice as fast as net profit, and Lear Corp. In the absence of a discernable rift and the planned completion of the buy-back programme, new market participants should refrain from this type of shares and current market participants should consider securing their profits.
Which is Lear's model? The Lear Corp. is a worldwide provider of vehicle seats, electric distributor solutions, electric component solutions, high performance electric and hybrids. In terms of sales, Lear is the world's number 2 in the installation of automobile seats. Electric System Group covers the rest of the company and sees the greatest opportunities for expansion.
Rising demands for luxuries and capabilities, the switch to hybrid automobiles and all types of electrically powered automobiles, and increased interest in vehicle-tovehicle and vehicle-to-infrastructure technology are driving electricity system expansion. Class Lear supplies all large car manufacturers and its can be found in 400 car makes around the world. China's rise as an important automotive industry could act as another catalytic converter for Lear's continued expansion.
But it is in fierce global and Chinese automotive supplier competition. Here, the automotive market is also facing a number of challenges. Two facts about the automotive parts business we should keep in the back of our minds. Firstly, the economic activity of the branch is fiercely contested. Recognising this, Lear has implemented a strategic approach of horizontal incorporation by taking over several vehicle seat and electric component businesses.
Lear is also working to improve operating efficiencies and lower production costs. Secondly, the automotive sector is cycle. Lastly, the sector bottomed out during the Great Depression, causing the bankruptcies of several large automakers, such as General Motors and Chrysler (NYSE:FCAU). Automotive suppliers, such as Lear, were badly affected when vehicle unit selling collapsed during the downturn.
In 2009 Lear went through an insolvency reorganisation. In recent years, there has been a car selling booming, giving Lear and other car parts companies boost. Those backwinds won't last forever, and finally the car manufacturing sector and thus Lear will decelerate. Lear launched two programmes in 2011 to deliver more value to its stockholders.
Firstly, it has introduced payment of the dividend. Secondly, it began a huge $3.4 billion stock buyback programme. Those programmes have been helping Lear generate noteworthy stock appreciation. Had you been investing in 2012, the overall returns to shareholders would now have been around 250%, a result of a mix of stock repurchases, dividents and business momentum from the recent automotive distribution booms.
Stock buy-backs increase the stock market value, but can also bias many of the fundamental data that is used by investor to assess the value of an asset - a phenomena that we will examine several ways in the course of this review. A number of reputable companies and research firms, among them the consultancy McKinsey, believe that focusing on stock buy-backs is more an act of value extracting than value adding.
Their argument is that although the equity prices rise because of the buy-backs, profits are much more elusive because the buy-backs kill the net asset value and do not generate it. Finally, the markets will listen and the overpriced equity will fall towards the real net asset value. Buy-back programmes are not uncommon. Businesses like to buy back assets that make it hard, if not impossible, for investors to prevent them.
Let's therefore look at Lear's programme against two of his rivals in the car parts sector, Magna International (MGA) and Delphi (DLPH). On the basis of Morningstar information, Lear has bought back 29% of its stock since 2012. Outside the automotive parts sector, Foot Locker (NYSE:FL) (which I analysed last week) has only bought back 12% of its stock since 2012.
Notice: Lear's insolvency reorganization in 2009 changed many of the fundamental parameters. In order to be equitable with Lear, we will not be dealing with dates until 2010. Lear making cash? After the 2008 downturn and the ensuing Lear insolvency in 2009, Lear's revenues, results of operations and net profit have risen steadily. What is Lear's efficiency in a company?
They are the trademarks of businesses that can always achieve above-average yields. Figures below 20% (yellow dashed line) indicate that a company operates in a hard-fought area. Figures between 20% and 40% (green dashed line) indicate a very competetive sector and figures above 40% indicate the existence of a potentially ditch.
Lear's current learner contribution is about 11% and has risen continuously. On the basis of my above rule of fist, Lear operates in a fiercely contested sector. However, believe me, see page 28 of the 2016 Business Review, which expressly states: "We are active in a fiercely contested sector.
" However, margin gains indicate that Lear has been working hard to build a tight business rift. Figures above 80% (yellow dashed line) indicate a fiercely contested sector. The SG&A for Lear is minute. On the basis of my above rule of fist, both characteristics of Lear's SG&A help to make a trench present.
The Lear has research and develop ment cost, but they are low and will be converted to SG&A. It is unlikely that Lear will be able to significantly reduce SG&A cost, but there may be scope to further increase profit margin. Since automobiles are becoming more and more reliant on electric power supply solutions and the need for these solutions is growing, Lear will have the ability to expand this part of its operations, which may lead to a further increase in profit margin in the longer term.
When browsing through the financial statements again, it should be noted that the contents per car (average amount of dollars of Lear items in each car produced) have increased. However, I have misgivings about the cycling character of the car manufacturing sector. What of Lear's triumph is due to his commercial practice?
What is the impact of the recent car sale booms? What is Lear's preparation for meeting an unavoidable deceleration in car consumption? What is Lear's profit? As with the above mentioned viability indicators, these indicators are used to identify the existence of a trench and to assess the viability of LEA in relation to its sector.
Golden dashed line represents sector average (from Aswath Damodaran's great database) for these metrics. We must be careful at this point in our review when it comes to possible biases from Lear's huge stock buy-back programme (a 34% decline in the number of equities in circulation since 2010).
Stock buy-backs cut Lear's liquidity, which in turn leads to a reduction in wealth. At the same time, the buyback reduced Lear's shareholders' funds by the same amount. The ROA is head-to-head with the sector averages, while the ROE exceeds the averages. What should prospective buyers ask is what percentage of Lear's ROA and ROE is due to its operating policies (real profitability), and what percentage is due to stock buy-backs (illusory profitability)?
Fortunately, we have a return on investment that is resistant to the impact of stock repurchases. Over the past seven years, my 15% guideline for return on investment has been constantly exceeded and is currently near the branch averages. Lear's ROIC suggesting a trench? However, look at the automotive parts market trend analysis.
Averages are far above my general rules of-that is, most car parts firms have trenches? How about Lear? If Lear is as lucrative as the avarage car parts business, how can Lear have a ditch? Had Lear had a real trench, his ROIC would always be above the sector averages.
Instead, the automotive parts sector as a whole is flourishing due to the present booming automotive distribution market. In summary, Lears ROA, ROE and ROIC perform well in comparison to my rule of my hand and the sector averages. But I have the gnawing sensation that ROA and ROE are excessive due to the stock buy-backs.
Although ROIC is high, it does not point to a rift, as Lear only performs as well as the sector averages. As Lear seems to be working really hard to carve a small trench, I have the feeling that there isn't one at this point. After you have verified Lear's viability and effectiveness, it's finally your turn to the four-letter preferred term of all: debts.
Oranges indicate the average for the sector. So what's Lear's encumbrance? Enterprises with lower indebtedness have more resistance and greater agility in difficult economic conditions. In this sense, we now turn to Lear's debts. But before we look at the figures on debts, we should ask ourselves, what does Lear use debts for?
Looking through the financial statements, it seems Lear is incurring debts to help finance acquisition (most recently through the acquisition of Eagle Ottawa) necessary to implement his strategic plan of deep-penetration. In addition, it borrows at lower interest rates to repay earlier debts at higher interest rates.
They are both rational uses of debts, now let's see if these debts are overseeable. In the last seven years, Lear's long-term overall indebtedness has increased. Recent financial figures show that Lear has enough liquid funds to repay almost half of his long-term liabilities immediately, indicating that this indebtedness is quite overseeable.
In order to further examine the indebtedness load, I have provided figures for two key figures: the indebtedness rate and the gearing rate. Our indebtedness rate has risen, but is well below 1, which is gratifying. Indebtedness has stayed almost stable over the past seven years, another comforting indication that the level of indebtedness is contained.
Shares repurchased may also have an impact on indebtedness figures. Gearing is defines as the relationship of asset to capital, and the relationship of borrowed capital to capital is the relationship of borrowed capital to capital. In both cases, therefore, reduced capital as a consequence of buy-backs can swell conditions and make Lear's indebtedness appear larger and riskier.
Strong indebtedness rates indicate greater leveraging and higher risks. However, Lear's figures look good even before we try to explain possible hyperinflation. In summary, Lear has a fair and well-managed indebtednessload. Will Lear's profit per shares and Cashflow increase? However, as stockholders we own only a small part of the business, which is why it is up to us to review some points on a stock as well.
First, we can see a graphic illustration of Lear's huge stock repurchase programme in operation. Between 2010, the first year after the Lear insolvency, until today, there was a decline in remaining stocks by 34%. However, according to the company's financial statements, stock buybacks will be continued at least until the rest of 2017.
On the next two charts, we show basic net loss per common share and free cash flows per common stock. We must be careful when looking at per stock figures when it comes to possible bias caused by the fast decline in the number of stocks in circulation. In order to get an impression of the scale of this effect, we can reconcile the increase in net profit with the increase in EPS.
So if we try to determine the real EPS increase with EPS, we more than double it. As already mentioned, Lear has increased its earnings over the last seven years, as shown by the figures for net profit and free cash flows. The comprehensive stock buy-backs, however, have a biased effect on EPS.
The EPS is an important element of current measurement indicators, such as the price/earnings rate (P/E), and is used in measurement methods such as discount calculation. The Wall Street likes to buy back stocks. The Lear is not alone in its efforts to cut the number of stocks in circulation. Per stock figures show a bias in figures in absolute but less in comparative numbers (compared to other companies) as many firms also buy back stocks, though not as aggressive as Lear.
Lear surpasses its rivals in shares repurchased. So when we are discussing evaluation schemes, we need to be conscious of it and include it in our interpretations. What is Lear's development of our profit? At the end of the day I like to talk about dividents, because if the fundamental data doesn't inspire you, the story is not relevant - you shouldn't buy the shares.
When it comes to paying our shareholders a dividend, I concentrate on sustainable development and organic expansion. I use the EPS and FCF per shares distribution rate as a representative for this. The Lear buy-back programme has had a beneficial impact in this area. With buy-backs driving up EPS and FCF, payouts rates are lowered and the starting path for aggressively growing dividents is broadened.
In 2011 Lear introduced dividends and since then has increased the dividends to around 20% per year. Lear's actual disbursement rates are 10. Since the beginning of the dividends, both key figures have been constantly low. This low distribution rate indicates that Lear has sufficient leeway to maintain the aggressiveness of the dividends' increase and that the dividends should stay secure when revenues weaken.
Share price/earnings ratios (PER), price/book value ratios (PER), price/turnover ratios (PER), price/free cash flow (PER) and return on equity (if any). In the case of the dividends return, higher dividend is associated with lower share values (see Dividenderendite = annually dividend/share price), so that the chart is reversed, with higher numbers indicating low valuation and lower numbers indicating high valuation.
Out of the five historic key figures analysed, P/E and P/FCF are each computed on the basis of the per stock information and are distorted by the stock repurchases. On the basis of the size of the stock repurchase programme, I am optimistic that these two indicators should be higher (more overvalued) than they are.
Reverse P/B, reverse P/S and dividends are not affected by the stock repurchase programme. Dividends are significantly below their value. To sum up, when we try to take into account the impact of the stock repurchase programme, we have three indicators (P/E, P/S and P/B) indicating that LEA is oversubscribed and two indicators (P/FCF and dividends yield) indicating that LEA is underubscribed.
These charts show how LEA is performing compared to similar businesses and how this group of businesses stands compared to the S&P 500 mean (solid line ), which is an approximation of the overall markets and is used as a benchmark. A dotted line in blue indicates the sector mean. Share price/earnings relationship (P/E ratio), share price/book value relationship (P/E ratio), share price/turnover relationship (P/E ratio) and dividends paid.
Out of the four key figures analysed, only the P/E is potentially affected by the stock repurchase programme. The four enterprises for which a P/E is available are evenly spread over the sector as a whole. LEA's P/E is below the sector averages, but if we take into account the distortion created by the stock buy-backs, the P/E should be slightly up.
Purchases do not affect P/S, P/B and dividends yields. In the case of P/B and P/S, all enterprises are evenly distributed over the sector mean (note that for P/B, the sector mean line overlaps the S&P 500 line). In terms of the dividends paid, the company is distributed among the S&P 500, but all are below the sector averages.
Price-earnings ratio valuations could be slightly higher considering the bias caused by the stock buy-back. In terms of dividends, the liaison fund is overexposed compared to most of its rivals and the S&P 500. In summary, it can be said that on the basis of the competitor's pricing model, at present LA is subject to a fairly adjusted value. Please note: Blauer Diamant = LA; Schwarze Punkte = rival company; Schwarze Linie = S&P500; orange dotted line = sector averages.
I used these basic hypotheses for my first DCF model: First annual 12% increase over three years. 1 ) Lear has a proven track record of aggressive revenue gains, so let's say Lear can maintain that momentum until the car manufacturing sector decelerates. 2 ) The car manufacturing sector will eventually have to decelerate, so we expect it to take another three years for that to happen. 3 ) The automotive sector will have to decelerate.
Perpetual 2% increase. Selected to correspond to the US economy's approximately average annually growing population. It was a shared topic of this overall review that the LEA figures per stock could be biased due to the stock repurchase programme. I used these basic hypotheses for my second DCF model: 12% per year over three years.
But I am prepared to dispel Lear's doubts and expect that sound automotive market expansion will drive EPS without the effect of stock repurchases. Perpetual 2% increase. Remember that the DCF is nothing more than a model of mathematics supported by past achievements and driven by hand-held beliefs about the past.
Somewhere between the figures of these two schemes may be the true answer, suggesting that LEA is slightly to slightly downgraded at the present state. Let us participate in another quest in rating modelling just for pleasure. On this occasion, we will apply a two-stage dividends discounting model. The model eliminates the would-be issues that could arise from the distortion in EPS caused by the stock buy-back.
Moreover, we will not try to use this model to forecast the futures. Instead, we will be determining what input will provide us with the actual share prices. As soon as we have done that, we will have an inkling of the assumption that the LEA has already included the LEA upside. The following hypotheses resulted in an inner value of $149.29 for the two-stage dividends discounting model - almost exactly at the actual share value.
Actual dividend: $1.60 per Morningstar. This is a standard bank lending and borrowing rates used in dividends discounting schemes. 7% per annum increase in airport dividends.
In comparison to other traditionally dividend-growing businesses, this makes sense. Assuming that the current prices are a proper proxy for the LEA's net asset value, the current expectation is that the dividends will increase by 20% per year for a ten-year period. That is high, but not inappropriate, considering how low LEA's current distribution rate is.
However, LEA must still earn enough in order to further increase the dividends. Cars are a sector that is subject to cycles. As soon as the busts arrive, LEA must lower its dividends grow rates as profits and free cash flows are lowered. LEA is between fair (reasonable economic growth) and overpriced ( forecast is too aggressive) on the basis of the rating of the dividend discounting model, according to how bullish you are for the short-term automotive world.
Well, now that we've completed our Lear review, let's see how LEA is going against my six investment principals. A clear and comprehensible company model and goals? Yeah and no. The model is easy and uncomplicated. Learn produces and markets automotive seating and electric lighting equipment. I' m sceptical about his share buy-back bonanza.
Yeah, the share went into the Stratosphere. The mechanical purchase of more shares per year, regardless of the current share prices, infringes any value investor principle. In addition, many analysts believe that share buy-backs do very little to enhance long-term return. I am not necessarily against buy-backs, but the scale of Lear's buy-back policies makes me insecure.
ROA and ROE are my best bet, and ROIC is at the level of the sector as a whole and above my best bet. Many of the indicators, however, such as ROA, ROE and all share-based indicators (including P/E), are potentially biased due to the concentration on stock repurchases.
Wondering if buy-backs were the best use of available funds. Maybe Lear should pay off his debts in an aggressive way and top up additional money to survive the unavoidable low that comes with entering a cycle sector. Lear says that the company operates in a fiercely contested market.
The ROIC is reaching my goal, but seems to be following the sector averages. An enterprise with a trench should beat the sector. A low level of indebtedness and careful use of debts? In a responsible manner, Lear uses its debts either to finance acquisition activities or to re-finance current debts. Lear's debts are relatively small in terms of amount in real terms, and its indebtedness rates are appropriate.
Sustained and rising dividends? The LEA has an EPS-based distribution rate of 10. 6 percent and an FCF-based distribution rate of 11 percent, which leaves ample room for dividends to grow. Talking of expansion, LEA has increased its annual dividends to around 20%. LEA has room for multi-year dividends to grow at this rate, even if turnover slows down.
Dividends are an area where the stock repurchase programme is helping. As a result, the distribution rate is reduced, the security of dividends is increased and there is sufficient room for further dividends to grow. There are major differences of opinion between the evaluation schemes that have been tried, so I am not convinced that LEA has an appropriate evaluation to launch a policy.
Three out of five key figures in the historic measurement model proposed an excessive measurement. LEA seemed to be either fairly or downgraded in the competitor's pricing model. There were two different DCF model tests with different EPS assumption, one with actual EPS and one with EPS reduction (to take into consideration the effect of stock buybacks).
DCF proposed that LEA could be fairly to overpriced ( according to which rate of EPS assumption you prefer). Eventually, when I performed a reverse dividends discounting model to ascertain what kind of expansion valuations were embedded in the share price-it proposed that LEA could be equitable to be overexposed.
When I want to be prudent and I want to avoid those schemes that could be affected by potentially excessive numbers per equity, I would tend to be too high. Unless Lear continues its bullish buy-back policies after 2017, profit expansion will decelerate, investor confidence will look under the bonnet, and the equity will weaken when the markets realize that the buy-back programme has not led to a noticeable recovery in the bottom line.
Perhaps their rating is just predicated on an anticipated short-term rise in the share prices - the last boost of the buy-back programme upwards - before it ends in 2017. Prior to starting or stopping a LEA engagement, you must determine whether the share buy-back programme was a value added or value acquisition measure.