Magna Q2 Results Hit by Industry Headwinds, Tweaks 2022 Guidance; Slight FVE Increases to $82

Business Strategy & Outlook

Magna International is one of the largest, most diversified auto parts suppliers in the world. However, large and diversified is no guarantee of better returns for investors. While breadth in product and services can be advantageous with regard to cross-selling–commercial activities that bolster content per vehicle and market penetration—one can see only limited evidence that Magna’s diversified strategy has benefited investors in the form of higher margins and returns on invested capital. Many suppliers focus on a particular area of the vehicle. In sharp contrast, Magna’s capabilities are so broad that the firm could nearly design, develop, supply, and assemble vehicles all on its own. In 2021, the firm manufactured roughly 125,600 vehicles, generating $6.1 billion in revenue and $287 million in adjusted EBIT for a margin of 4.7%. While Magna’s Complete Vehicle segment has a growth opportunity with startup electric vehicle companies, the operation is highly capital intensive with limited margin, constraining return on invested capital.

Diversifying into so many areas increases the risk that management resources become spread too thin, allocation of capital resources may be less than optimal, and the firm becomes less effective at developing expertise in any one area. One can be more confident in Magna’s ability to generate long-term excess returns on invested capital if its product offering was more focused but its customer base and geographical manufacturing footprint were better diversified. One would also like to see more disclosure regarding research and development, especially with certain parts of the business focused on powertrain electrification and autonomous technologies. Even though the Magna will benefit from these industry disruptive technologies, the degree of Magna’s product diversity dampens consolidated top-line growth and ROIC expansion potential from electric powertrain and vehicle autonomy. Even so, the firm’s healthy liquidity and balance sheet are able to support operations through severe industry downturns, such is the case with the coronavirus pandemic and microchip shortage.

Financial Strengths

Magna has a clean balance sheet with limited debt and ample liquidity. With average total debt/total capital at 11% for the past decade, interest expense is low, reducing risk to profits during a customer production downturn like that of the COVID-19 pandemic and the microchip shortage. Even so, the company has an inefficient capital structure, not taking advantage of the tax benefit of interest expense. With limited leverage on the balance sheet, Magna could make a relatively large acquisition if the right opportunity were to present itself. Magna’s capital needs have been primarily funded through equity and cash flow. The company has a $750 million undrawn unsecured revolving line of credit that was amended in December 2021 to mature in December 2022. Magna has a $1 billion U.S.-dollar denominated and a EUR 500 million euro denominated commercial paper program. Including 2021 year-end cash balance of $2.9 billion, total liquidity, excluding commercial paper programs, is $3.7 billion. Netting cash against debt, net debt/EBITDA at the end of 2021 was 0.3 times.

Bulls Say

High switching costs and significant barriers to entry enable sticky market shares.
Incremental revenue from contracted new business provides revenue growth slightly above global industry production volume and should bolster operating leverage in the near term.
As automakers consolidate purchases with fewer suppliers, large vendors such as Magna are in the best position to gain share because they can offer a wide range of parts, modules, and complete systems.

Company Description

Magna International prides itself on a highly entrepreneurial culture and a corporate constitution that outlines distribution of profits to various stakeholders. This automotive supplier’s product groups include exteriors, interiors, seating, roof systems, body and chassis, powertrain, vision and electronic systems, closure systems, electric vehicle systems, tooling and engineering, and contracted vehicle assembly. Roughly 46% of Magna’s revenue comes from North America while Europe accounts for approximately 43%.

(Source: Morningstar)

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