Magna International Stock: Chugging Along (TSX:MG:CA)

Investing in automotive suppliers is tricky as these are typically commodity-like low margins businesses which suffer from great economical cyclicality. Moreover, many of these suppliers are facing huge changes to their business models with EVs rapidly becoming more important as economies turn green, including the vehicle fleet which becomes electrical.

One of these names is Magna International (NYSE:MGA)(TSX:MG:CA), a name which I have not covered for quite a while, in fact it was 2015 when I concluded that Magna announced a $1.75 billion deal to acquire German-based Getrag Group in order to add some real German technical expertise to its line up.

A Quick Recap

With the purchase of Getrag, Magna would double down on growth in the powertrain area, with this becoming more important given upcoming regulation with regard to fuel efficiency and vehicle emissions. Often an in-house manufactured item, Getrag was one of the last large independent suppliers, bringing a lot of technical expertise and relationship in Asia to the plate.

The $1.75 billion deal was just the equity component of the deal, with net debt making that the price tag of the deal would increase to nearly $2.5 billion. This was a big number with sales of Getrag seen at $1.9 billion at the time, albeit accompanied by decent operating margins around 10% of sales.

Pro forma debt would rise to nearly $3 billion, less than the reported EBITDA number of the combination. The 409 million shares outstanding traded at $54, for a $22 billion equity valuation, or $25 billion enterprise valuation. This was equal to about 7 times EBITDA and 11 times earnings on a revenue base of $38 billion.

With Magna having posted some sales increases and higher margins in recent years (at the time) optimism was improving, albeit that the business remains cyclical and of course had huge upcoming transitions to be done. That said, the move to acquire Getrag appeared to be a proactive stance to bolster the competitive set of skills in a new world order.

Zero Returns

In the seven years since I last had a look at Magna, shares have been trading dead flat, that is if we compare the current price compared to 2015. In the meantime, shares had fallen to the thirties in 2016, as shares hit a high around the $100 mark in spring of 2021, now back to $55 again.

Forwarding to early this year we see that the company has not seen structural gains. In fact, even as 2021 sales rose 11% to $36.2 billion, it came in two billion short compared to 2015. The company doubled operating profits in 2021 to nearly $2.0 billion, with earnings of $1.5 billion equal to $5 per share as the company reduced the share count to 303 million shares. Moreover, the company has strengthened the balance sheet, now containing just about a billion in net debt.

The company guided for 2022 sales at a midpoint of $39.6 billion, marking further anticipated gains, with net earnings seen at a midpoint of $1.8 billion. This looks like quite a strong outlook, with the business being quite diversified with sales generated from body exteriors & structures, power & vision, seating systems and complete vehicles.

The upbeat guidance of 2022 was quickly thrown out of the window after first quarter sales and earnings fell, driven by weakness across the globe amidst continued supply chain issues as the company retraced its full year outlook. This was largely driven by cuts in the European automotive production outlook, the result of the energy crisis which resulted following the war between Ukraine and Russia.

The full year sales guidance was cut by $1.5 billion to $38.1 billion, with net earnings seen around $1.4 billion, a four hundred million reduction from the initial outlook. The company actually hiked the sales guidance by three hundred million alongside the second quarter results, amidst inflationary impacts.

The company cut the full year sales guidance to $37.9 billion again alongside the third quarter results, with the midpoint of the earnings guidance now cut further to $1.35 billion. This is the result of continued disruption, softer growth and a strong dollar, among others. The company has resorted to more buybacks again, having reduced the share count to 288 million shares to drive earnings per share. Net debt rose to $2.3 billion amidst worsening free cash flow generation, albeit that it remains quite manageable. The 288 million shares now value equity at just $16 billion here, or the entire company at just over $18 billion if we include net debt (excluding lease liabilities).

Another Deal

After trying to acquire Veoneer in the summer of 2021, a deal which did not proceed at the time, Magna has made another attempt to acquire (part of) the business late in 2022. The company reached a deal to acquire the Veoneer Active Safety business from SSW Partners in a $1.525 billion deal, adding key Advanced Driver Assistance Systems capabilities (ADAS). The acquired activities are expected to add $1.1 billion in sales in 2022 which works down to a 1.4 times sales multiple (comparing to Magna’s valuation around 0.5 times sales). That said, real growth is seen, with the activities set to generate revenues of around $1.9 billion as soon as 2024.

The problem with Magna is that the business has not really made many revenue gains over the past seven years, albeit that the company has maintained balance sheet integrity, with retained earnings used to buy back quite a few shares. Right now earnings multiples come in around 19 times earnings as the company is making targeted deals, now with Veoneer to drive some growth and guarantee its future positioning, needed following the rapid changes in the underlying operations.

Given all of this, the valuation is much more compelling than it was in the past, yet one should not get lured into appeal by just by low earnings multiples. Magna appears to be doing alright, having a balanced approach to capital returns and transformation changes. While I would rather err on the positive side here given where we stand today, I am not too happy to commit serious capital here, for the simple reason of long term underperformance (as an industry).