EUR 850.00 For Business Accounts Only

Morningstar | Magna 1Q Results Disappoint, Reduces 2019 Outlook; $60 Fair Value Maintained

No-moat Magna reported first-quarter 2019 diluted earnings per share before special items (EPS) of $1.63, $0.21 lower than the same period last year and $0.07 short of the sell-side consensus EPS of $1.70. Revenue of $10.59 billion represented a 1.9% decrease compared with $10.79 billion reported for first-quarter 2017. Management also reduced 2019 revenue and margin outlook, on average, by 3% and by 0.6 percentage points, respectively, relative to prior guidance. The news sent shares lower by 10%, taking Magna stock from a 3-star rating to a 4-star rating. With the shares now trading at a 20% discount to our unchanged $60 fair value estimate, we view the stock as attractively valued relative to our forecasts for revenue, cash flow, and return on invested capital.

While Magna revenue declined by nearly 2%, the result was solid considering global light vehicle production declined 7% in the first quarter. Revenue declines came from all but one of Magna's operating segments with Body Exteriors & Structures, Power & Vision, and Seating Systems posting 6.7%, 3.4%, and 2.5% decreases, respectively. A 16.1% increase in the Complete Vehicle operating group served to only partially offset declines in the other groups. However, adjusted EBIT (before special items and including JV equity income) plunged 18% to $720 million for margin contraction of 130 basis points to 6.8%. The drop in profitability was attributable to a higher proportion of low margin Complete Vehicle group business, higher development costs for autonomous technologies in the Power & Vision group, as well as higher costs on a hefty new business launch schedule in the Seating group, plus the unfavorable operating leverage across all groups, except Complete Vehicle, on reduced global light vehicle production.

Magna returned $403 million in cash to shareholders during the quarter, including the repurchase of 5.6 million shares worth $284 million, plus $119 million in common stock dividends. We forecast free cash flow (cash from operations less capital expenditures) of approximately $1.8 billion and $1.7 billion in 2019 and 2020, respectively. Consequently, we expect additional share repurchases and an increase in the dividend.

Management reduced 2019 guidance including revenue that is now in a range of $39.1 billion-$41.3 billion, representing roughly a 3% decline from the prior range of $40.2 billion-$42.4 billion. Management now expects adjusted EBIT margin to be within a range of 6.7% to 7.0%, down 60 basis points from the prior guidance range of 7.3% to 7.6% as vehicle assembly mix continues to grow, development cost for autonomous technologies increases, and on softening operating leverage from softer global light vehicle production. In addition, JV equity income guidance range is now for a range of $150 million-$195 million, down $45 million from $195 million-$240 million prior guidance on reduced Getrag transmission business in a weaker Chinese market.

Our forecast for the year was already at the lower end of management’s prior guidance. We had already forecast 2019 revenue of $41.0 billion versus management's new range of $39.1 billion-$41.3 billion. Our JV equity income estimate was at $218 million, but we reduced our estimate to $150 million, the lower end of management's new guidance. Our profit assumptions result in a 6.8% adjusted EBIT margin, also at the low end of management’s new guidance and down 50 basis points from our previous forecast. Despite our lower 2019 forecast, our normalized sustainable midcycle adjusted EBIT margin assumption remains intact, at 7.2%. During the past 10 years, adjusted margin high, low, and median have been 8.3%, negative 1.8%, and 6.6%, respectively. Representing a 60 basis point expansion over the 10-year median, our normalized sustainable margin assumes Magna benefits from cost reduction and restructuring actions already taken, and growth in higher margin business lines.

We believe Magna will continue to benefit from the increase in customers' use of global vehicle architectures. In our opinion, the company’s electrified powertrain and autonomous driving technologies represent significant growth opportunities for Magna, but the relative size of these businesses compared with the overall total restrains consolidated revenue growth. The company is one of the most diverse suppliers in the auto industry following decades of auto supplier consolidation, yet it has maintained an ultraclean balance sheet compared with other vendors. Even so, we think the company has not adequately utilized financial leverage to its benefit, failing to optimize its cost of capital.

Due to the potential for both higher content penetration and acquisitions, we think Magna revenue growth will surpass the long-term average annual growth in global vehicle demand that we forecast at an average annual rate of 1%-3%. However, owing to its relatively higher-cost capital structure, despite a slight shift to lower-cost debt capital, we remain concerned about Magna’s ability to generate excess returns on invested capital through the economic cycle, resulting in our no-moat rating.