Magna International Should be on your Buy List

DSR Quick Stats

Sector: Consumer Cyclical

5 Year Revenue Growth: 10.53%

5 Year EPS Growth: 20.82%

5 Year Dividend Growth: 38.98%

Current Dividend Yield: 2.33%

What Makes Magna International (MG.TO) a Good Business?

Magna is more than an international automobile part supplier, it also designs, develops, manufactures, assembles and engineers automobile parts. Magna sells to OEMs (original equipment manufacturers) across 26 countries. It offers a wide variety of 86 products that go from seating to roofing systems.

Ratios

Price to Earnings: 7.861
Price to Free Cash Flow: 23.61
Price to Book: 1.651
Return on Equity: 22.80%

Revenue

Revenue Graph from Ycharts

By looking at the past 10 years of revenue history, we can clearly see how Magna has been affected positively and negatively by the automotive industry. Since the company sells 50% of its parts to Detroit automakers, the whole business is definitely linked to the fate of automakers.

How MG.TO fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

The company hasn’t been on my radar until recently. I previously looked at it back in 2012 and included it to my 2012 Best dividend stocks ebook (the stock soared 45% that year). The MG.TO dividend yield has been very low for a while but the company kept increasing it. The recent stock price brought the stock back onto the radar screen with a more interesting yield. MG.TO meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

source: Ycharts

The pause in 2010 is not a real one. This is how the graph reacted to a stock split. However, I did my research and the company paid dividends in 2010 too and their wasn’t a dividend cut either.

The company has often been ignored by dividend investors due to its low dividend yield. But keep in mind that while the stock has grown over 110% over the past 5 years, management almost tripled its dividend payments. I guess you should be able to live with a yield under 3% based on their solid background, can’t you? MG.TO meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

The company was able to maintain both payout ratio and cash payout ratio at very good levels. More importantly, both metrics are very stable through time making the dividend growth perspectives even better for the future. MG.TO meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

Magna sells auto parts, this is already the definition of repetitive business. The company has been able to generate a significant amount of cash flow out of its business activities. Since they have successfully built strong relationships and developed expertise with the largest automakers, it makes it harder for clients to switch to another auto part supplier. Finally, as far as large auto part suppliers go, Magna makes it very convenient for their clients as it can ship many parts within a single order.

What Magna International does with its cash?

In addition to rewarding its shareholders with dividend payments, the company use its money for capital expenditures as well as making strategic acquisitions. This is largely a result of our excellent track record of converting earnings into strong cash flow from operations. Even during the severe downturn we faced in 2008-2009, they were able to generate impressive operating cash flow.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is evaluation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

Fear or a stagnating economy led to a drop in the PE valuation for Magna. It think the market is currently overreacting and this creates a great entry point. Let’s see if the dividend discount model calculation shows the same conclusion:

Input Descriptions for 15-Cell Matrix	INPUTS
Enter Recent Annual Dividend Payment:	$1.32
Enter Expected Dividend Growth Rate Years 1-10:	10.00%
Enter Expected Terminal Dividend Growth Rate:	7.00%
Enter Discount Rate:	10.00%

I’ve used an aggressive 10% dividend growth rate for the next 10 years and then reduced it to 7%. The company has plenty of room to increase its payout in the upcoming years and I believe the need for auto parts will only increase. Here are the results of my calculations:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
	Discount Rate (Horizontal)
Margin of Safety	9.00%	10.00%	11.00%
20% Premium	$109.51	$72.34	$53.78
10% Premium	$100.38	$66.31	$49.30
Intrinsic Value	$91.26	$60.28	$44.82
10% Discount	$82.13	$54.25	$40.34
20% Discount	$73.01	$48.22	$35.85

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

The company seems to be trading with a 10% discount. MG.TO meets my 5th investing principle.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchased shares of a company  are no longer valid, I sell and never look back.

Investment thesis

MG is a leader in the auto parts industry and this serves it well as many manufacturers now tend to concentrate their processes with fewer suppliers with wider product offerings. This is exactly where Magna stands in the market. While MG relies on Detroit automakers for about 50% of its sales, the overall automobile business is looking brighter in the near future. Low oil prices have helped new cars sales which leads to more sales for Magna.

Finally, there is a high switching cost for automakers to change manufacturers such as Magna. This makes their niche a highly repetitive and stable market. The stock price dropped by 17% over the past 12 months and this makes MG highly interesting.

Risks

Being linked to Detroit automakers could be a great thing and a bad thing at the same time. In the event the US economy would slow down due to interest rate increases, Magna would be a direct victim. Margins are also under pressures as these big players always expect discount on annual repetitive orders.

Overall, the investment thesis is strong enough to support the buy of MG.TO.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segments helps me to categorize my investments into a “conservative” or “core” section or into a “growth” section. I then know exactly what to expect from it; a steady dividend payment or higher fluctuations with a great growth potential.

Because Magna is currently trading at a very low PE ratio and shows strong dividend growth perspectives, I believe MG.TO would fit into a growth portfolio. You can continue to expect double digit dividend growth over the short term and there is definitely a good upside for its price value if the economy grows steadily as expected.

Final Thoughts on MG.TO – Buy, Hold or Sell?

Overall, I think Magna shows a strong profile and meets my 7 investing principles. This is why I think MG.TO is a buy right now.

Disclaimer: I do not hold MG.TO in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

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