EUR 850.00 For Business Accounts Only

Morningstar | MG Updated Forecasts and Estimates from 22 Feb 2019

No-moat Magna reported record full-year 2018 diluted earnings per share before special items of $6.71, $0.77 higher than the same period last year and $0.03 better than the sell-side consensus of $6.68. Record revenue of $40.8 billion represented a 12% increase over the $36.6 billion reported for 2017. The 3-star-rated shares of Magna currently trade at a 4% discount to our $57 fair value estimate. Accordingly, we view the stock as reasonably valued relative to our forecasts for revenue, cash flow, and return on invested capital.

Revenue growth was healthy across all Magna operating segments, with body exteriors & structures, seating systems, and power & vision and complete vehicles posting 5.5%, 6.0%, and 6.2% growth, respectively. Owing to the launch of new models, vehicle assembly revenue was especially strong, catapulting 69.7% versus the prior year. However, adjusted EBIT margin (before special items and including joint venture equity income) contracted 80 basis points to 7.5%, as we expected, on a higher mix of lower-margin vehicle assembly business but also due to higher launch costs from new seating facilities, favorable customer pricing resolution in the prior-year period, and higher research and development spending for autonomy and electrification technologies.

Management's 2019 guidance is unchanged. The company expects revenue of $40.2 billion-$42.4 billion, which represents a 1.5% decline compared with a 3.9% increase in 2018. Management expects adjusted EBIT margin to be 7.3%-7.6%, down from 8.3% last year as vehicle assembly mix continues to grow and on softening operating leverage as global production eases compared with 2017. Even so, its joint venture equity income guidance is $195 million-$240 million, down $37 million-$82 million from 2018 on reduced Getrag business in a weaker Chinese market.

Magna returned $2.3 billion in cash to shareholders during the year via the repurchase of 32.6 million shares worth $1.83 billion plus $448 million in common stock dividends. We forecast free cash flow (cash from operations less capital expenditures) of approximately $2.0 billion and $2.1 billion in 2019 and 2020, respectively. Consequently, we expect additional share repurchases and an increase in the dividend.

Our forecast for the year was already roughly in line with management’s guidance. We had already forecast 2019 revenue of $41.4 billion versus management's range of $40.2 billion-$42.4 billion. Our joint venture equity income estimate is at the upper end of management's guidance at $235 million. Our profit assumptions result in a 7.5% adjusted EBIT margin, in line with management’s guidance.

Our investment thesis is intact. 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.

Given the potential for higher content penetration as well as acquisitions, we think Magna's revenue growth will surpass the annual growth in global vehicle demand, which we forecast at an average rate of 1%-3%. However, owing to the company's 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.