Summary
- 4Q22 revenue was in line with expectations, but margins were weaker than expected due to higher engineering costs and operating inefficiencies.
- Despite challenges, MGA has the potential to overcome them and emerge stronger, particularly (I believe) through investments in electric vehicles and advanced driver assistance systems.
- However, MGA's management needs to improve communication with investors and provide a clear understanding of the company's strategy in order to regain credibility and put the company on a path.
Summary
In my opinion, Magna International (MGA) 4Q22 report was not very strong, particularly regarding margins. However, there is some positivity to be found as I think the disruption caused by COVID-19 could decrease in 2023 because of China's reopening. Despite my overall negative view of MGA's earnings in the fourth quarter of 2022, I still think the company has the ability to overcome these challenges and emerge stronger. In particular, I am of the belief that MGA's investments in electric vehicles and advanced driver assistance systems [ADAS] are the right decision for the long-term, as they provides additional revenue stream, extend growth runway. However, I do not plan on investing until I see signs of a turnaround from MGA.
Earnings overview
MGA's revenue for the fourth quarter of 2022 was $9.6 billion , which is similar to the expected revenue of $9.5 billion and aligns with the negative pre-announcement. MGA's sales grew organically by 13%, outperforming the 5% growth in global light vehicle production, which is weighted for MGA's exposure and represents an 8 point outperformance. In terms of sales by segment, Body Exteriors & Structures had an 11% increase y/y to $4 billion, Power & Vision had an 8% increase y/y to $3 billion, Seating Systems had a 4% increase y/y to $1.3 billion, while Complete Vehicle sales decreased by 12% to $1.3 billion.
Adjusted EBIT margin was 3.7% coming in at $356 million, which was less than the $424 million expected by consensus. Higher engineering costs associated with MGA's electrification and ADAS business, as well as inefficiencies at a European facility, are to blame for the decline in adjusted EBIT. This was mitigated to some degree by the income from increased sales and the net favorable commercial resolutions. EPS came in at $0.91, >10% below the consensus estimate of $1.03.
Earnings takeaway
The FY23 guidance given by MGA came as a surprise to me, especially considering the multiple misses in FY22. That said, I have a view that this might be the trough for MGA given everything that could go bad has gone bad: MGA miss margins guidance, suspended buybacks, and guided to higher capital intensity. Worse off, MGA is facing several challenges that have hurt investors' confidence in the company's path forward. One of the key issues is the lack of a clear strategy that could help to reassure investors. In addition, execution-related margin headwinds plagued 2022, and MGA does not anticipate recovering those expenses in full by 2025. The good thing is, Although some of the headwinds are specific to MGA, such as lower sales and increased engineering costs, the entire industry is also facing similar challenges in production schedules and wage inflation. As such, there are two levers to propel MGA earnings from here.
Although there are concerns about MGA's current situation, there are signs that the company's management is taking steps to improve communication with investors. For example, the recent profits warning has reset expectations which management can hit, as long as there are no major market disruptions beyond its control. However, it is important for the management to follow through on its commitments in order to regain credibility. This will require MGA to improve its EPS beyond the levels projected in the 2023 guidance, while also keeping capital intensity at a reasonable level, rather than at the elevated level that was previously guided. By delivering on its commitments, MGA can regain investor confidence and put itself on a path to sustainable growth.
Restructuring
MGA is a large global supplier with various revenue streams, but its margins have been declining since 2017. Despite management not commenting on a change in strategy, the recent change in management has created the possibility for a discussion around restructuring the company. This could involve redirecting capital towards more profitable business and reducing CAPEX, as well as shifting resources away from businesses that faces the risk of being commoditized.
Valuation
To begin, the current stock price does not offer a significant margin of safety for investors. At 11.5x forward earnings ratio, it is 2x higher than its 10-year average of 9.5x. However, I do believe that MGA will be able to adapt to the increasingly challenging environment for automobiles over time. The key to unlocking its potential is improved communication from management. The company needs to better explain how its strategy leads to operational excellence and address any execution issues in the short term. Until this happens, I would not recommend investing in MGA.
Conclusion
In conclusion, 4Q22 report was not very strong, particularly in terms of margins. However, there are some positive factors to consider, such as the potential decrease in disruption caused by COVID-19 in 2023 due to China's reopening. Despite the challenges faced by MGA, such as lower sales contributions and increased engineering costs, the company has the potential to overcome these challenges and emerge stronger. Investments in electric vehicles and advanced driver assistance systems are likely to provide additional revenue streams and extend the growth runway in the long term. However, it is important for MGA's management to improve communication with investors and provide a clear understanding of the drivers of results. Until there are signs of a turnaround from MGA, improved communication from management, and a better understanding of the company's strategy, I would avoid MGA.
For further details see:
Magna International: Management Needs To Step Up On Communication