Magna International Inc. (TSX:MG) has taken a pretty big hit recently. With problems coming from many different directions, it’s actually surprising to me that Magna stock has held above $70.
It’s pretty clear that the auto industry is in disarray, but is Magna’s stock price cheap enough to think about buying it as a value play?
Macroeconomic headwinds are taking Magna stock down
Like it or not, the world has dramatically changed. It’s no longer easy-going for companies like Magna. In fact, the days of booming auto sales and strong margins seem like a distant memory, with little hope of recovery anytime soon.
One of the major macroeconomic changes that’s hitting Magna International stock is rising interest rates. Higher interest rates mean a higher cost of borrowing to purchase a car. This takes its toll. Just as low borrowing costs (interest rates) boosted auto sales for so many years, today, higher interest rates are hitting auto sales. For example, just five years ago, I bought a new car, which I was able to get 0% financing on. Today, auto financing rates can be as high as 6%. This makes a huge difference in affordability. Higher interest rates will continue to negatively impact auto sales.
In Magna’s latest quarter, sales increased 5% to $9.6 billion. Although one can say that it could be worse, this compares to sales increases that were well above 15% 10 years ago. It’s pretty clear that rising interest rates are taking a bite out of sales.
Cost inflation hitting Magna International stock
Moving on from the negative effect that rising interest rates are having on Magna, let’s consider inflation. Cost inflation is another big issue that Magna is dealing with right now. In fact, according to the company, input cost inflation is at levels not seen in decades. This has manifested in the company’s margins. Its earnings before interest and taxes (EBIT) margin came in at 3.7% in Q4 2022 versus 5.6% in the same period last year.
This decline is quite dramatic and emblematic of a huge problem. Supply chain disruptions were a major problem in 2022, energy cost inflation was massive, and semiconductor chip shortages continued to negatively impact production. This led to very volatile production schedules, which led to big inefficiencies at many of Magna’s facilities.
These cost pressures are expected to continue into 2023 and in my view, it will take some time to rebalance and stabilize. In fact, one of the ways in which this will be rectified is if and when prices begin to more adequately reflect Magna’s new cost environment. But then, the vicious cycle continues and demand destruction will escalate as prices rise.
High capital intensity as Magna invests in growth
The last bit worth mentioning here is Magna’s free cash flow generation. Always an efficient operator producing loads of free cash flow, some of us who have followed this company for years might have trouble recognizing it today.
Magna’s Q4 2022 free cash flow declined 53% to $340 million. This was driven by the aforementioned pressures as well as Magna’s investments into its long-term growth profile. For example, Magna is investing in new innovations to position itself in the new world of zero carbon vehicles.
A different world
For a long time, we were used to seeing impressive financials from Magna – strong cash flows, a solid balance sheet, strong margins and efficiencies. This is not the case anymore; the ultimate sign that times are changing. The auto business is cyclical one. And clearly, the cycle has turned. This takes years to play out, and so Magna will take years to work its way out of this downcycle.
In closing, Magna is in the throes of a cyclical downturn driven by rising interest rates and cost inflation. Trading at 11 times this year’s expected earnings, Magna’s stock price is nowhere near attractively valued at this time. This is true especially considering that I believe that Magna’s earnings estimates have significant downside risk.
