Good news if you've been waiting to invest in Magna International Inc.: Falling U.S. vehicle shares have been weighing on the share price of the Canadian auto-parts giant over the past year.
The bad news? The shares likely have further to fall before they offer an ideal buying opportunity.
Magna is highly exposed to changes in vehicle sales. At times when sales are expanding, Magna sells more chassis, seats, powertrains and electronics to the world's biggest auto manufacturers – and the company's profit swells.
But when sales decline, sales and profit can get hit and so can the share price.
The past several years have been very good to Magna: Between November, 2012, and August, 2015, the share price rose 280 per cent, following the 22-per-cent gain in annualized U.S. auto sales over the same period.
Now, auto sales are declining and Magna's share price has been struggling. In July, U.S. total light-vehicle sales were down 7 per cent from a year earlier, according to Autodata Corp., an information-services provider. Since December, when annualized sales rose to a peak above 18 million, sales have fallen about 8 per cent.
The decline is making some investors nervous. Magna's share price is flat this year and is down more than 20 per cent from its high in 2015.
Valuations are also reflecting some unease. Magna's stock trades at just 8.2-times trailing profit and 7.9-times estimated profit, according to Bloomberg.
That might look cheap. But the low price-to-earnings ratio is reflecting the market's sense that profit could decline. In other words, the price isn't low; earnings are high.
The recent decline in auto sales might reverse, or at least stabilize, with a solid U.S. labour market and ongoing economic expansion. In its second-quarter financial results released last week, Magna forecast North American light-vehicle production of 17.4 million in 2017. That's down only slightly from a production forecast of 17.7 million when the company released its fourth-quarter results in February.
If the forecast is right, Magna's shares look like a compelling buy right now: The company is a diversified world leader in auto-parts manufacturing and the share price should rise to new heights if the business cycle resumes.
But there are sound reasons to expect vehicle sales to get worse, which would lead to production cuts. Declining sales correspond neatly with rising U.S. interest rates: The Federal Reserve has raised its key rate three times since December, and higher borrowing costs could be scaring away consumers at a time when many of them are stretched financially.
According to a recent article in Quartz, U.S. auto loans totalled $1.2-trillion (U.S.) in 2016, up 9 per cent from 2015 to a record high. The average amount financed is now more than $28,000. About 20 per cent of these vehicle buyers are subprime borrowers with weak credit histories.
Add it up, and auto sales look vulnerable to a downturn that has already begun. The big question, though, is how severe will the downturn get?
When Magna released its second-quarter results last week, it was hard to spot much concern. Revenue rose to a record $9.7-billion, up 3 per cent over last year, even as North American light-vehicle production declined.
During a conference call with analysts, Magna executives stressed that the company can adjust to shifting production volumes given its diversification.
"It really depends on where the reduction comes, what car line, what our content is, and then what type of product we've got in there as well," said Donald Walker, Magna's chief executive officer. "But one of the fundamental things about Magna is we're a very decentralized company. Every plant runs fairly autonomously."
That's a good reason to stay focused on Magna: It's a great stock. But with vehicle sales falling, it's better to watch the action from the sidelines for now and look for a better buying opportunity ahead.