The current trading multiples for Canadian auto parts manufacturers “look attractive in the context of [a] mild recession (followed by recovery),” according to Scotia Capital analyst Mark Neville. “While it is not necessarily our job to forecast recessions, it certainly feels like the risk of a recession as we enter 2023 is elevated (i.e., the Fed is aggressively tightening in the face of softening economic data, the yield curve is inverted, etc.),” he said. “Our estimates assume a mild recession in 2023 and modest recovery (not V-shaped) in 2024.
“On that basis, we find trading multiples for the group of North American auto suppliers undemanding. If one is more bullish on economic prospects, then multiples would likely appear extremely attractive – e.g., MGA currently trades at approximately 7.5 times P/E [price-to-earnings] on consensus 2024 estimates, in what would be a recovery scenario (i.e., consensus estimates assume more than a modest recovery in 2024, in our view). In a recovery scenario, we believe the stocks would likely trade well above 7.5 times.”
In a research report released Wednesday, Mr. Neville warned current multiples would be a larger concern if a a deeper and more protracted economic slowdown emerges, given the potential a recovery in industry sales would be “potentially multiple years away.”
“Looking back over approximately 45+ years of data, a few things became clear: (i.) interest rates alone don’t appear to have a meaningful impact on the level of auto sales (a view we long held), (ii.) the broader economy (i.e., jobs and GDP growth, etc.) largely dictates the direction and level of industry sales, (iii.) in the event of a deep and protracted economic downturn, similar to the early 1980′s, early 1990′s, and 2008/2009 recessions, industry sales would likely see meaningful declines and could take multiple years to recover, (iv.) recent industry sales levels have been limited by supply chain constraints, but the level of sales is not historically weak (i.e., not at recessionary levels) or much different from the level of sales heading in the early 1980′s and early 1990′s recessions; so, while inventory restocking should provide some support to production levels (e.g., we estimate approximately one million units), in our opinion, the restocking argument alone would not be enough to support a bullish thesis in the event of a deep and protracted recession,” he said.
After introducing his 2024 financial estimates, Mr. Neville increased his target prices for companies in his coverage universe due to adjustments in his valuation base.
“With macro (and, therefore, earnings) risks elevated, we continue to prefer large cap autos to small, and less financial leverage to more,” he said.
His changes are:
* ABC Technologies Holdings Inc., “sector perform” to $6 from $5.50. Average: $5.50.
* Linamar Corp., “sector outperform” to $90 from $80. Average: $78.20.
* Magna International Inc., “sector outperform” to US$75 from US$65. Average: US$72.12.
“MGA trades at 13.1 times P/E on our 2022 estimates,” he said. “While we forecast essentially flat industry production volumes, we expect a meaningful improvement in profits in 2023E (e.g., we forecast 26-per-cent growth in adjusted EPS for MGA) as inflationary costs are (at least partially) recovered and production schedules should become more predictably (even if not at a higher level). In our opinion, if the market was convinced that 2022 was the trough, MGA (and the other suppliers) would be trading at higher multiples.”
* Martinrea International Inc., “sector perform”) to $16 from $13. Average: $14.67.