One of the cheapest stocks in our Large Cap 1000 Stock Screener is Lear Corporation (NYSE:LEA).
Lear Corporation (Lear) is a supplier to the global automotive industry. The company is engaged in supplying seating, electrical distribution systems and electronic modules, as well as related sub-systems, components and software, to automotive manufacturers. The company’s segments include Seating and E-Systems. The company serves the automotive and light truck market. The seating segment consists of the design, development, engineering, just-in-time assembly and delivery of complete seat systems, as well as the design, development, engineering and manufacture of all seat components, including seat covers and surface materials, such as leather and fabric, seat structures and mechanisms, seat foam and headrests. The e-systems segment consists of the design, development, engineering, manufacture, assembly and supply of electrical distribution systems, electronic modules and related components and software for light vehicles across the world.
A quick look at Lear’s share price history over the past twelve months shows that the price is up 27%, but here’s why the company remains undervalued.
The following data is from the company’s latest financial statements, dated March 2017.
The company’s latest balance sheet shows that Lear has $1.210 Billion in total cash and cash equivalents. Further down the balance sheet we can see that the company has short-term debt of $49 Million and long-term of $1.889 Billion which equates to total debt of $1.938 Billion. Therefore, Lear has a net debt position of $728 Million (debt minus cash).
If we consider that Lear currently has a market cap of $9.964 Billion, when we add the minority interests of $133 Million and net debt totaling $728 Million that equates to an Enterprise Value of $10.825 Billion.
If we move over to the company’s latest income statements we can see that Lear had $1.470 Billion in trailing twelve month operating earnings which means that the company is currently trading on an Acquirer’s Multiple of 7.36, or 7.36 times operating earnings. That places Lear squarely in undervalued territory.
The Acquirer’s Multiple is defined as:
Enterprise Value/Operating Earnings*
*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.
While come investors may be concerned about the company having more debt than cash on its balance sheet it’s important to note that if we take a look at the company’s latest cash flow statements we can see that Lear generated trailing twelve month operating cash flow of $1.610 Billion and had $561 Million in Capex. That equates to $1.049 Billion in trailing twelve month free cash flow, or a FCF/EV Yield of 10%, compared to a net debt position of $728 Million.
The company’s financial strength indicators also indicate that Lear remains financially sound with a Piotroski F-Score of 7, an Altman Z-Score of 3.77, and a Beneish M-Score of -2.73.
Something else that seems to be overlooked is that Lear’s current revenues of $18.893 Billion (ttm) are an historical high. The company’s current net income of $1.033 Billion is also the highest in the past five years with the exception of one year 2012 when net income was $1.283. However, closer inspection of 2012 financials show that in that same year the company had free cash flow of just $272 Million compared with the $1.048 Billion (ttm) that we see today. The reason is that Lear has become much more operationally efficient with historically high gross and operating margins resulting in significant increases in operating income and operating cash flow. Lear also has historically high EPS of $14.39 (ttm), book value per share of $48.35 (ttm), and dividends per share of $1.40 (ttm).
Additionally, it’s also worth taking a look at Lear’s annualized Return on Equity (ROE) for the quarter ending March 2017. A quick calculation shows that the company had $3.057 Billion in equity for the quarter ending December 2016 and $3.331 Billion for the quarter ending March 2017. If we divide that number by two we get $3.194 Billion. If we consider that the company has $1.033 Billion (ttm) in net income, that equates to an annualized Return on Equity (ROE) for the quarter ending March 2017 of 32%. All of which has been achieved without issuing new debt.
Lastly, there’s one more thing that investors should be aware of and that is Lear’s shareholder yield. In addition to the company’s ability to generate loads of free cash it has also allocated capital wisely. This is demonstrated with the $620 Million (ttm) spent to buy back shares and $100 Million (ttm) spent on dividends while the share price remains undervalued. That equates to a buy back yield of 6% and a dividend yield of 1% which together provide a shareholder yield of 7%.
In summary, Lear is a company with historically high revenues and free cash flow. It also has historically high EPS of $14.39 (ttm), book value per share of $48.35 (ttm), and dividends per share of $1.40 (ttm) yet the company trades on a P/E of 10 compared to its 5Y average of 10.4**. Moreover, Lear has a FCF/EV Yield of 10%, an Acquirer’s Multiple of 7.36, and an annualized Return on Equity (ROE) for the quarter ending March 2017 of 32%, while providing a shareholder yield of 7%. All of which indicates that Lear is currently undervalued.
** Morningstar
About The Large Cap 1000 U.S. Stock Screener (CAGR 18.4%)
Over a full sixteen-and-a-half year period from January 2, 1999 to July 26, 2016., the Large Cap 1000 U.S stock screener generated a total return of 1,940 percent, or a compound growth rate (CAGR) of 18.4 percent per year. This compared favorably with the Russell 1000 Total Return, which returned a cumulative total of 259 percent, or 5.6 percent compound.
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