A) Introduction
Magna International (MGA, Financial) is one of the largest automotive parts manufacturers in North America. We believe the stock will outperform the S&P 500 over the next twelve months due to its attractive valuation, solid growth profile, and track record of crushing analyst estimates. There are significant growth catalysts that should buoy the stock moving forward that we'll discuss as well, such as the increasingly healthy North American consumer, Magna's aggressive share buyback plan, and the company's visionary CEO.
In this report, we'll be outlining why investors should use the recent correction in Magna's stock price to open up or increase their current long positions. Based on traditional value metrics that have been empirically shown to predict stock returns, Magna is strongly undervalued relative to the market. Magna has a solid growth profile and has been crushing analyst estimates recently. Again, the metrics used to highlight this have been empirically shown to predict returns, and are thus are extremely important to analyze. As we go through the report, we'll provide links to the academic papers or books that underpin our analysis so investors can see themselves why each metric is important. Investors looking to dig deeper into academic research, can check out our post here, which outlines the major academics and their research.
B) Valuation Breakdown
We'll start with an analysis of Magna's valuation profile, looking at five valuation metrics each with a strong predictive ability. This is important to look at as legendary investor James O'Shaughnessy showed in his book "What Works on Wall Street" that valuation metrics were the most important metrics that predict stock returns. Cheap stocks beat expensive stocks by a wide margin on average. A breakdown of Magna's valuation profile is shown below:
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On both a revenue and earnings basis, Magna looks very undervalued relatively. With a sales yield of 169% and an earnings yield of 8.33%, it is clear that Magna is trading at a discount relative to the overall market averages (52% & 4.7%). At least on a sales basis, this discount reflects a broader Auto Components industry group trend, which averages a sales yield of 167%. Magna trades more in line from a book value basis, with its P/B multiple of 2.5x mirroring the overall market average. The company's dividend of 1.7% is decent, but could be much better given its low dividend payout ratio (approximately 20%). Magna is instead using this money to fund aggressive share buybacks, which as we'll discuss later on, are a much better usage of capital. Overall, our algorithms rate Magna as "Moderately Undervalued." Holding everything else equal, we expect Magna to outperform the S&P 500 by over 5.7% over the next twelve months based on how stocks with similar valuations have acted in the past.
C) Growth Breakdown
There are a variety of different growth metrics that have been shown to predict stock returns. Most important among them is price momentum. Winning stocks keep winning (based on six-month price performance), and losing stocks keep losing. As outlined in James O'Shaughnessy's book "What Works on Wall Street", EPS growth and return on equity/assets were also shown to have predictive ability, albeit to a lesser extent. Magna International's growth breakdown is shown below:
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Besides short-term momentum (i.e. 6-month price performance), Magna has a very solid growth profile. Over the last twelve months the stock gained 8.81%, which is better than the automotive components industry group (-2.67%), consumer discretionary sector (4.65%), and overall market (1.94%) averages. This is despite a very rough last six months, in which the stock lost almost 7%. Magna is increasing the bottom line impressively, growing trailing twelve month EPS by 29% relative to 10% average growth in the overall market. This profit figure leads to an impressive return on equity of 20.4% and a return on assets of 10.1%. Again, these figures are significantly higher (more than double) the overall market averages for ROE and ROA. Overall, we rate Magna as a "Slight Growth" company. Holding everything else equal, we expect Magna to outperform the S&P 500 by over 1.39% over the next twelve months based on how stocks with similar growth profiles have acted in the past.
D) Earnings Breakdown
Next, we'll see how Magna has been performing relative to analyst expectations recently. We've found through historical back testing that stocks that have a history of beating analyst expectations are much more likely to beat estimates in the future. This is key as stocks that beat analyst estimates often see big jumps in price, and vice versa for earnings miss. Magna earnings estimate breakdown is shown below:
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With last quarters 12.5% beat on analyst consensus EPS estimates and its 5.19% beat on revenue estimates, Magna has now beaten EPS & revenue estimates twelve times in a row. This is an outstanding streak of beats, and makes the probability of them beating estimates again this quarter close to a certainty. Magna releases next quarter earnings in 63 days, with the analyst consensus calling for $2.16 EPS and $8.35 billion in sales. Our quantitative earnings model expects Magna to beat these EPS estimates by over 7.5%, and for them to beat revenue estimates by a small margin. This earnings model is based on a statistical back test of what factors have predicted earnings beats in the past, and estimate beat track records were found to be the best predictor of earnings beats moving forward.
E) Qualitative Analysis & Conclusions
Now that we've analyzed the numbers, it's time to have a qualitative discussion of potential growth catalysts that could propel the company moving forward. We believe the most important catalyst that will ensure Magna outperforms the market is the company's aggressive share buyback plan, which is expected to be 20 million shares or 10% of the total float. Share buybacks limit downside moves in the stock price, as you can be sure management will utilize them during any severe market corrections. Additionally, they will reduce the amount of shares in existence, which will allow them to increase their current pace of EPS growth as well ensure that the company keeps beating on estimates. Share buybacks have also been empirically shown to predict stock returns, so at the very least you have history on your side.
Magna also has the benefit of industry tailwinds in its favor, as the US unemployment rate continues to drop and GDP growth continues to accelerate. This makes consumers wealthier, thus stimulating demand for automobiles and the components that make them up. Lastly, Magna's CEO Don Walker is one of the most competent managers. Besides being shareholder friendly and recognizing the undervalued nature of his company's shares, he has been named as one of the Financial Post's outstanding CEO's of 2014.
Overall, our models rate Magna International as a "Moderate Outperform" over the next twelve months. This is due to the stock's attractive valuation, solid growth profile, and track record of crushing analyst estimates. Share buybacks limit downside in the stock and spur further growth, while the continued acceleration in economic growth should continue to help the company.
