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The analysts at Bank of America Merrill Lynch (BAML) tell us that the auto industry is in for a world of hurt.
BAML’s crystal ball foretells a “swift and material” downturn in U.S. auto sales. U.S. auto sales peaked at 18.1 million units on annual rate in November 2016. Auto sales for August totaled 16.1 million.
According to BAML, it’s all downhill from there. Sales will drop to 13 million units on an annualized rate by 2021.
Many investors share BAML’s foreboding outlook. Price-to-earnings (P/E) multiples across the sector have dipped to single digits.
I see an opportunity.
Outside the United States are vigorous markets. Auto sales in China are up 4.5% year over year. They approach 2.5 million annually. CAAM (China Association of Automobile Manufacturers) expects the growth rate to hold at 5% through 2017 and beyond.
Closer to home, new car registrations in the European Union increased 8.4% to over 1.14 million units in the first three months of 2017. All major EU markets posted strong growth. EU car sales are expected to improve as the year moves along.
Best Value in Auto Sector Stocks
Inside the United States, a lot of folks are rolling across the highways and byways in decrepit machinery. IHS Markit, a market research firm, reports that the average age of a light vehicle is 11.6 years compared with 9.6 years 15 years ago. U.S. autos have never been so old.
The best investment value in the auto sector stocks is also one of the cheapest. It’s also off the front line.
Canada-based Magna International (NYSE: MGA) is a leading parts supplier to the auto sector. Magna serves the sector, so its fortunes aren’t tethered to any individual automaker.
Magna’s sales are spread among the top three automakers in the United States and the top three in Germany. General Motors (NYSE: GM), Ford (NYSE: F), and Fiat Chrysler (NYSE: FCAU) are the lead customers in the States; Daimler (OTC: DDAIF), BMW (OTC: BMWYY), and Volkswagen (OTC: VLKAY) lead the German constituency.
Magna is the most solid value that you’ll find among auto sector stocks (and possibly the entire market). Its shares trade at only 8.9 times current earnings. Its dividend has grown at an 14.9% average annual rate over the past five years. No automaker can match the dividend growth. Few can match the value multiple.
Magna will continue to grow earnings. It’s on track to earn $5.80 per share this year. The consensus among Wall Street analysts ̶ which includes those down on auto sector stocks ̶ is for $6.40 per share in 2018.
This puts the forward P/E multiple at 7.7. The peer-group multiple is 10.
Given earnings-growth expectations through 2018, Magna’s shares appear cheap by any measure.
Tariff Stupidity
The outlook for U.S. automakers is one reason the shares appear cheap. NAFTA could be another. Magna’s management believes its shares are being held in check over concerns related to NAFTA.
I’m unsure if management is right on NAFTA concern. There is reason to worry, though. President Trump stupidly slapped Canadian lumber exports to the United States with a 20% tariff. The concern is that Trump could extend the stupidity to other Canadian industries.
Trump could extend the stupidity, but I expect that he won’t. Magna complements the U.S. auto industry. It’s not a competitor (at least not a competitor to the “Big Three”).
Magna is a leader among its peers in auto sector stocks, and yet its shares trade below its historical and peer-group average earnings multiple. If pessimism on U.S. auto sales recedes even marginally, Magna shares are sure to pop higher.
The prospect of a pop is nice, and so is the dividend. The Magna dividend, which yields 2.2%, grows at a double-digit rate annually. The Magna dividend only adds to the value proposition.