LEA idea from TMF Falling Knives.

A quick look made me want to dig deeper. Lear Corp is a massive business which operates in the out of favour automotive industry, providing seating, electrical and electronic products.

Key Statistics show:

• Price closed at $1.67 Down 0.31 (15.66%) That’s down from a yearly high of $34.62 and prices over $40 in 2007
• Book value $14.67
• High debt of 2.34B with debt/equity of 2
• Current ratio of 1.05 indicates company may struggle to pay back it’s short term liabilities. This may be the reason why LEA is being priced for bankruptcy.

Business trends are bad with profitably disappearing, but the most important aspect is to check they can survive. Quickly checking Lear’s investor relations site I see they are still expecting to be cash flow positive this year and are aggressively reducing costs.

Q3 2008 Earnings Release. They address liquidity

“Lear’s cash position and access to liquidity remain strong, and the Company has no near-term debt maturities. In addition, the Company expects to generate positive free cash flow in the fourth quarter and for the full year of 2008. The Company’s primary liquidity sources are:

  -- Cash and cash equivalents (at 09/27/08)    $ 523 million
  -- Revolving credit facility                  $ 1.3 billion

At September 27, 2008, there were no borrowings under the Company’s revolving credit facility. In October, Lear elected to borrow $400 million under its revolving credit facility to protect against possible short-term disruptions in the credit markets. These funds have been temporarily invested in safe, short-term investments.

With no near term maturities and ample liquidity bankruptcy appears unlikely in the near term. However, they are a high fixed cost business with sales that are dependent on automotive sales. Those sales are amongst the hardest hit in a recession and if the current recession deepens then Lear will continue to loose money, their debt will grow and bankruptcy for protection could become an option, especially if one of their major customers fails. However, they appear to be reducing costs in response to their bad market conditions and are very upbeat about their future.

Q3 2008 Conference Call Transcript
Management were upbeat about their liquidity, though their comments on covenants are a warning flag that should be investigated.

“While we do not believe that covenant compliance is a near-term concern, we would like the flexibility to more aggressively pursue restructuring actions with a favorable payback, particularly given the steep decline of production, at the same time, we also appreciate the risk of further production cuts. While we do not see the need to enter the market now for covenant relief, we will closely monitor industry and market conditions and respond proactively.”

When quizzed about the covenants they appeared elusive, but Robert Rossiter - Chairman, Chief Executive Officer and President did state, “And we are absolutely confident that we’re going to make it through this period.”

A quick look at the balance sheet highlights the danger.
Stockholders’ Equity is $1,131.6M, but with goodwill of $2,052.4M it appears like they have failed to create value in their years of business. While liabilities are always 100% guaranteed, their nearly $2B of accounts receivable are less than guaranteed.  A Ford or GM bankruptcy would seriously impact their liquidity and make survival very difficult.

Conclusion
The possible returns are large if Lear survives and current stock holders remain undiluted. However, there is also significant risk that a prolonged recession will lead to the company breaking covenants and possible bankruptcy. Add on the risk from GM and Ford and it is no wonder the possible rewards are so high. With Lear you’re speculating on a short recession and  a bailout of Ford and GM. It appears a good company to have on a watch list and while returns won’t be as great after the picture becomes clearer the risk/reward profile should be significantly improved. For me there is simply too higher risk of complete loss of capital. I see no need to invest in such speculative opportunities.