2023-09-01 14:03:59 ET
Summary
- Magna International Inc. reported strong Q2 2023 results, beating revenue and earnings expectations.
- The company's outlook for light vehicle production levels has increased.
- We examine the updated guidance and valuation in light of the rally from the June lows.
Note: All amounts discussed are in U.S. Dollars unless specified otherwise
On our last coverage of ( MGA , MG:CA ), we gave it a buy rating and ignored the doom that seemed to be hanging over the company after the poor quarterly results. Specifically, we said:
You have a cheap valuation, alongside a good tailwind for MGA. We think that creates a buyable opportunity. Ideally, you don't want to use the first day of a big selloff to buy, so perhaps waiting improves the odds. Also combining the waiting with option premiums in the $50-$55 range can get you a bulletproof entry. We rate Magna International Inc. shares a buy, with the caveat that you want to use a wider margin of safety here and only enter via options.
The stock took some time to bottom out after that, but did create a solid return from that point and kept up with the broader S&P 500 (SP500). Note the data below is for the TSX-listed stock in Canadian dollars.
Seeking Alpha-Returns Since Last Article
We look at the selloff in reaction to the recently released Q2 2023 results and update our thesis.
Q2 2023
After a rather poor start to 2023, MGA was in form and delivered a whopper of a beat on both top and bottom lines. Revenues beat by $630 million and adjusted earnings came in at $1.50 per share, 28 cents ahead of consensus. The gain in revenues from last year was broad-based, with all areas of the globe increasing high double-digits.
We did not get to see the impact of pricing on the slide above , but we did get to see the margin changes in the next slide. The bulk of the EBITDA margin expansion came from higher volumes, as MGA's fixed costs created leverage on the upside. Interestingly, input costs fell a bit, and that comes from Q2 2022 levels where the Russian invasion had still many commodities flying high. Overall EBIT margins of 5.5% were a big relief relative to 3.8% seen last year.
Interestingly, cash flow and free cash flow went in the opposite direction. This is not the most useful measure on a quarterly basis, but it does influence how active MGA will be in the capital markets to repurchase shares. You can see below that last year MGA bought back $212 million of shares in Q2-2022, while this year's activity was marginal at just $2 million. No doubt that that was influenced by low free cash flow.
MGA's Outlook
Investors might have been surprised that the stock sold off post Q2 2023, as MGA followed the double beat with a solid increase in guidance for light vehicle production levels.
Total sales will now be closer to $43 billion versus the earlier midpoint of near $41 billion. If there was some disappointment here, it likely came from EBIT margins just moving up a shade from 4.9% (midpoint) to 5.0% (midpoint) relative to previous guidance.
The stock was up more than 35% from the June lows to the earnings, and it is very reasonable to expect some profit taking as well.
Our Outlook
MGA completed the acquisition of Veoneer Active Safety for $1.525 billion on June 1, 2023. This is a big purchase for MGA and pushes its debt to EBITDA well above its usual comfort range. At 2.19X, MGA is going to be focused on deleveraging going forward and share repurchases will be minor.
The current consensus is for about 6% revenue growth in both 2024 and 2025.
This looks achievable. Some might wonder what exactly will create auto sales growth when the probability of a recession in this timeframe is almost 100%. The answer to that is where auto inventories stand, or rather sit.
Those are abysmal levels and have only improved marginally from our last update. They need to be built up at some point, and we think MGA's revenues may actually run countercyclical for the first time in its history. So, we buy the revenue possibility. Even a 3% increase in volumes and 3% price increases will get us there easily, and logically volumes need to increase a lot more if we have to replenish that stock above.
What we are not exactly buying here are the earnings estimates. Here we see true hockey stick estimates with torrid 25% annualized growth all the way to 2025. That kind of earnings expansion will require a solid margin expansion, and one we think will be difficult.
Verdict
For MGA, the price to sales ratio is the king for cyclical turning points. So regardless of our skepticism towards the earnings estimates, we still think the stock is cheap.
What is the wonderful part of our thesis here is that Magna International Inc. does not need to do a lot to deliver upside. If it can meet those sales forecasts, and just maintain its price to sales ratio (which is in the middle of its historical range), you can see another 15% upside by the end of 2025. Couple that with a 3% dividend yield, and you have prospects for 8-9% annual returns here. Nothing to write home about and certainly nothing that should get anyone excited in an era of risk-free rates at 5.5%. But we would look for more upside and our $75 price target is still achievable if MGA's earnings estimates turn out to be accurate. The key risks come from a protracted UAW strike and a deep recession where car inventories remain low and don't build at all. The beaten down valuation would provide some buffer, but MGA could trade as low as $40 in that scenario. As before, we are maintaining our buy rating on Magna International Inc. with the caveat that options will continue to provide superior risk-adjusted returns as they have till now.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
For further details see:
Magna: You Still Have Some Upside Here