The TSX Composite Index has been bearish in the last two years, with small bouts of dips and rallies keeping the two-year growth almost flat. In this subdued market, a few stocks surged while a few went into a downturn. Companies with debt on their balance sheet and those sensitive to economic activity saw a decline. Among them was global automotive components supplier Magna International (TSX:MG). The stock fell 23% year to date, underperforming the TSX Composite Index, which surged 7.7% on hopes of interest rate cuts.
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Why did Magna underperform the TSX Composite Index?
Magna operates in the automotive space, where the demand is slow. High inflation affected consumer spending, and high interest rates made financing expensive. With lower disposable income, many households had to postpone their car purchases. Magna supplies components to light passenger vehicles. Its performance is linked to consumer confidence, the economic situation, and easy financing options.
The global economic situation is mixed. While car sales, especially electric vehicles (EV), picked up in the eastern countries of China and India, they fell in Europe and were slow in North America. Since Magna supplies power, vision, seating, and body exterior to top automakers, its sales depend on automotive production volumes and sales. These situations are not under Magna’s control.
Automakers slowed their production in 2024, which increased Magna’s input cost. Moreover, the underutilization of manufacturing facilities increased costs further. At times like these, the company resorts to restructuring to boost operating efficiency. Magna restructured its operations last year, which helped it maintain its adjusted earnings before interest and tax margin at 4.3% in the first quarter.
How much longer will Magna underperform?
While Magna has improved its fundamentals, the business environment is not yet favourable for automotive companies to flourish. The automotive industry is cyclical. It is yet to see the transition to EVs, hybrid cars, and hydrogen cars in future. These technological upgrade cycles bode well in a strong economy where people have the buying power for high-ticket items like vehicles.
Magna’s stock surged 4% in the last week (July 4-11) over hopes of an interest rate cut by the Fed. However, this surge is temporary. There is more downside for Magna stock, as demand for cars has not yet picked up. If the Fed does not cut interest rates, the stock price could fall below $60.
Is Magna a stock a buy at the dip?
Magna has strong fundamentals. The management has maintained liquidity of US$4.1 billion (US$1.5 billion in cash reserves and US$2.7 billion in undrawn credit facilities) sufficient to withstand the cyclical downturn. This high liquidity offsets the risk from US$4.5 billion in long-term debt. Also, the company continues to remain profitable, even though its profits have fallen.
Magna is using its US$9.3 billion retained earnings from the cyclical upturn to pay and grow dividends. It shows that management focuses on shareholder returns, making it a stock to buy on the dip and wait for a cyclical upturn to earn capital gains.
If you invest in Magna at the dip, you can lock in a 4.3% dividend yield that grows annually and an opportunity for 120% to 180% capital appreciation in a cyclical upturn.
