A trade deal might be closer than ever. Is it a good time for MGA?

Market news for the last while has seemed to be almost completely focused on the trade war between the U.S. and China – to the point that investors seem to be getting what some might call “trade fatigue” – which could be a point where even if or when a deal is made, the broad market might sell off in the short term. That could put more bearish momentum on a market that has been rallying strongly for most of the year so far, but is starting to show signs that the trade war has started to have a negative effect on the economy.

In the near term, I wouldn’t be surprised to see the market retreat some more; the market’s almost uninterrupted bullish momentum up to this point this year almost certainly should see at least a short-term pull back, since ebbs and flows are a necessary part of trends over any time frame. In the longer term, however, a trade deal should be a positive for the market in general, and for stocks in industries with particular exposure to the effects of global trade. That includes the auto industry, which late in 2018 was primarily affected by tariffs imposed by the U.S. against Mexico and China; however trade with China has bled over into a variety of industries, including autos. That means that trade peace, if it comes within the next several weeks, should act as a tailwind to drive the economy, and stocks in general higher for most of the year and possibly into 2020.

Magna International (MGA) is a an auto components supplier, based in Canada that has followed the broad market’s rebound this year to surge more than 15% higher. With a small retracement over the last week or so, the stock appears set to use support at its 38.2% retracement line as a springboard to move even higher. A trade deal could be just the catalyst the stock needs, even if broad market fatigue does translate to greater price uncertainty in the near term. The stock has a solid fundamental profile, with an interesting value proposition working in its favor, as well.

Fundamental and Value Profile

Magna International Inc. (Magna) is a global automotive supplier. The Company’s segments are North America, Europe, Asia, Rest of World, and Corporate and Other. The Company’s product capabilities include producing body, chassis, exterior, seating, powertrain, electronic, active driver assistance, vision, closure, and roof systems and modules, as well as vehicle engineering and contract manufacturing. The Company has over 320 manufacturing operations and approximately 100 product development, engineering and sales centers in over 30 countries. It provides a range of body, chassis and engineering solutions to its original equipment manufacturer (OEM) customers. It has capabilities in powertrain design, development, testing and manufacturing. It offers bumper fascia systems, exterior trim and modular systems. It offers exterior and interior mirror systems. It offers sealing, trim, engineered glass and module systems. It offers softtops, retractable hardtops, modular tops and hardtops. MGA has a current market cap of about $17.1 billion.

Earnings and Sales Growth: Over the last twelve months, earnings grew almost 15%, while Revenues were mostly flat, but positive at 1.25%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long term; however it is also a positive mark of management’s ability to maximize a company’s business operations. In the last quarter, the picture turned negative, with earnings and sales both decreasing about -6.5%. The company has cited tariff concerns as a near-term headwind, and so the decline could be an early indication of impact from tariffs on costs, both for MGA as well as for its customers. The company operates with a narrow, but consistent margin profile, with Net Income consistently running at about 5% of Revenues over the last twelve months as well as the last quarter.

Free Cash Flow: MGA’s free cash flow is healthy, at a little more than $2.1 billion. This number has been somewhat cyclic from one quarter to the next, but has shown a general, upward stair-step pattern of growth going back to the last quarter of 2016 and translates to an impressive Free Cash Flow Yield of 12.3%.

Dividend: MGA pays an annual dividend of $1.46 per share, which translate to an annual yield of 2.77% at the stock’s current price. 

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MGA is $34.11 and translates to a Price/Book ratio of 1.54 at the stock’s current price. The stock’s historical average Price/Book ratio is 1.82, suggesting the stock is undervalued by about 18%; at par with its average, the stock should be trading at about $62 per share. The stock is also about 15% below its historical Price/Cash Flow ratio, which provides a supportive target price a little above $60 per share. That would put the stock in range to test its all-time highs and in position to start making new ones.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above shows the stock’s price activity over the past year. The diagonal red line traces the stock’s downward trend from May until December 2018; it also provides the basis for the Fibonacci retracement lines shown on the right side of the chart. The stock is sitting almost on top of its 38.2% retracement line right now after dropping off of a pivot high at around $55 per share. That immediate resistance is the level that the stock would need to break above in order to sustain its current bullish momentum. A drop below support around $52 could see the stock test its next support in the $49 to $50 range, with its 52-week low around $43 within reach if it drops below that point.

Near-term Keys: a break above $55 should be taken as a strong short-term signal the stock’s new upward trend should keep going; that could be an excellent opportunity to buy the stock or work with call options with an eye on $58 as a short-term price target. Take a drop below $50 as a strong signal to short the stock or buy put options, with a target price in that case around $43. From a valuation perspective, the stock is pretty attractive right now; if the stock’s current support breaks down, however, the value proposition will quickly get much, much better, which means that following a “buy the dip” strategy would probably be a smart move.