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LEA an attractive swap candidate

| February 7, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Weakness in global vehicle production – down 6% in 2019 – has begun to put pressure on auto suppliers. Now lowered growth expectations for China driven by the coronavirus outbreak could lead to further downward sales and earnings revisions in the sector. Lear Corporation (LEA – Baa2/BBB-) maintains the strongest credit profile in the BBB auto parts universe, though its bonds trade wide relative to peers. Swapping out of APTV into LEA provides a substantial g-spread pick-up and moves investors into a credit with better leverage and coverage metrics as well as stronger liquidity.

Moving out of Aptiv PLC (APTV– Baa2/BBB/BBB) into LEA provides for a pick of roughly 60 bp g-spread in the 10-year part of the curve and approximately 45 bp in the 30-year part of the curve, while only losing one notch rating on the S&P side.

Exhibit 1: BBB auto supplier curve

Source: Bloomberg

Credit metrics strongest relative to peers 

LEA ended the most recent quarter with total leverage of 1.3x and net leverage of 0.5x.  While BorgWarner Inc.’s (BWA – Baa1 (n)/BBB+ (*-)/BBB+) gross leverage is a tick lower than LEA’s at 1.2x, LEA maintains a stronger cash position than BWA putting its net leverage two ticks lower than BWA’s (0.7x).  Furthermore, BWA recently announced that it would be acquiring Delphi Technologies PLC (DLPH – B2 (*+)/BB- (*+)/BB (*+) in an all-stock transaction, which is expected to push BWA’s pro forma gross and net leverage to 1.6x and 1.1x, respectively. APTV’s credit profile is the weakest among the three as it is currently levered 2.0x on a gross basis and 1.9x on a net basis.

LEA’s strong cash position adds to its overall liquidity and provides a solid cushion in a potentially weakening environment. LEA’s capital allocation policy lends to its cash position as the company has been less aggressive than peers with respect to shareholder remuneration.  LEA spent roughly 84% off free cash flow on dividends and repurchases in 2019 and has forecast a similar return rate in 2020. APTV has been a bit more aggressive with respect to shareholder remuneration, with over 100% of free cash flow spent on buyback and dividends in 2019. That said, APTV saw its cash position decline from $567 million at year-end 2018 to $412 million at year-end 2019.

Exhibit 2: APTV/BWA/LEA credit stats

Source: Company reports, Amherst Pierpont Securities

China/Asia Exposure

As the number of coronavirus cases continues to rise and has now more than tripled the cases of SARS throughout its year-long epidemic, exposure to China is being more scrutinized by the investment community.  While all the IG auto parts suppliers derive revenues from Asia, none of them break down the country exposure. APTV is the currently the most exposed to the continent as it generated roughly 27% of revenues from Asia in 2019. BWA follows a close second with 25% of revenues from Asia, while LEA’s exposure is approximately 20%.

In APTV’s 10K, the company identified China as a key geographic market, stating that if they were unable to maintain their position in China or if vehicle sales continue to decrease, financial results could be “materially adversely affected”.  On APTV’s earnings call on 1/30/20, management forecast China vehicle production to decline 15% for 1Q20 and 3% for the full fiscal year. The double digit decline includes the extended Chinese New Year shutdown, according to management. LEA is forecasting China vehicle production to be down slightly less for the year, at 2%.

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