"Altruistica": Seeking a return to full financial disclosure and regulatory oversight. A financial market analysis blog for "entertainment purposes" only by an experienced CFA seeking new hedge fund engagements for investment writing and analysis. The author has experience investing internationally, running a hedge fund, making angel investments, and helping launch five startup companies. Investors should do their own due diligence.

13 December 2006

Lear (LEA) -Little Prospect of Near Term Recovery on Auto Woes

LEA : $30- Little Prospect of Near Term Recovery on Auto Woes

Unrelieved stresses in the supply base in 2007 and a hesitancy by original equipment manufacturers to grant long-term contracts to suppliers in weak financial condition are expected to lead to more bankruptcies over the intermediate term,”
Fitch ratings agency, November 2006

Bottom fishers looking for recovery plays in the beleaguered auto parts industry should not nibble on Lear Corporation (LEA:NYSE), 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 a quarter in earnings for Q206, 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. As domestic automakers ended 2004, they were highly optimistic about the coming sales plan for the year. Then 2005 turned into a profit disaster as the Big Three’s efforts to clear inventory using rebates and cash incentives led to record losses. Bondtracker 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. Unrelieved stresses in the supply base in 2007 and hesitancy by original equipment manufacturers to grant long-term contracts to suppliers in weak financial condition are expected to lead to more bankruptcies over the intermediate term,” the ratings agency said.

Since 2002, there have been 11 defaults by U.S. auto suppliers, including four in 2005 and one this year, including Delta Corp, Dana Corp (DCN), 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 $1.1T 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 vulture “financiers” such as Carl Icahn and Wilbur Ross.

Ross, known for investments in distressed industries, has turned his focus in recent years to the auto parts sector. He has also invested in the steel, coal, textile and financial services industries. The buyout firm Ripplewood Holdings, along with private-equity firm Cerberus Capital Management and hedge fund Appaloosa Management, which already owns a 9% stake in Delphi, are angling for a Delphi take under. Billionaire investor Carl Icahn of American Real Estate Holdings (ACP) wants to buy more of Dana Corp's (DCN) $2.25B unsecured debt, but lawyers aren't returning calls. Icahn, who bought half, or $101.25M, of the Toledo, Ohio, auto-parts supplier's debt in March, has increased his stake in General Motors Corp (GM) in the past year, and bought a 4% stake in LEA during the summer.

LEA has just sold its only potentially profitable systems business, North American interiors, triggering a $675m Q4 charge and surrendering 75% of ownership into a joint venture led by Ross’ International Automotive Components Group (IAC). So all that is left of Lear is its electronics and seating businesses. And another vulture financier, Carl Icahn controls 2.64m shares of LEA after the company sold him $200 million of common stock in a private placement to funds his firm manages. And, mysteriously or not, Deutsche Bank raised its price target on Lear to $28 from $19 in mid October on the Icahn speculation. The offering included 8,695,653 shares of Lear common stock issued at $23.00 per share. So DBAB facilitated the generation of at least a $70 million profit for hedge funds, not including those funds which bought the stock before the deal was announced when it began rallying sharply off $18 in late September. In a word, incredulous.

Despite $4 billion of revenues during Q306, which was $100 million light, LEA reported per share losses of $1.10, twice the consensus estimates of $0.61 in losses. So now LEA carries a market cap is $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 to Ford and GM large SUVs and has now lost the revenue opportunity for GM’s Dodge Ram trucks starting in 2009. 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 (DCNAQ-NAZ) is already 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 US workforce with any remaining production being shifted to Mexico.

* Then take a gander at a hotter segment- aluminum wheel maker Superior Industries (SUP:NYSE). It, too, is investing in Mexico and NOT the U.S. It’s Q306 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.

The number of survivors in the “catch the falling knife” profession is few and bloodied.


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