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posted on 29 June 2016

Canada's Best Auto Stock

by Chad Fraser, Investing Daily

Investing Daily Article of the Week

When American investors think of Canada, they typically think of oil and gas. That's only natural. For years, energy products were the country's biggest export, totaling C$128.6 billion in 2014.

Unfortunately, that was the high-water mark. Oil prices peaked in June 2014 before starting their long downward grind, bottoming out last February.

The result was a 35% nosedive in Canada's energy exports in 2015, to C$83.8 billion, a five-year low. But despite the suffering in the oil patch, the country's overall exports barely budged, slipping just 0.8% last year.

For that, Canada can thank strong growth in other areas, particularly automobiles and related parts, where exports surged 17%, to C$87.1 billion, stealing the top spot from oil and gas.

A Longtime Automotive Powerhouse

In many ways, it was a case of back to the future. Prior to the oil boom, the auto business drove Canada's economy, particularly after the signing of the Canada-U.S. Auto Pact in 1965.

That deal dropped tariffs on U.S. vehicles and parts entering Canada if Ford, General Motors and Chrysler (now Fiat-Chrysler) built a certain percentage of their cars north of the border (essentially one car made for every one sold in Canada). As a result, Canada's share of North American production rocketed from 5% in 1965 to 18% by 1992.

However, the World Trade Organization struck down the Auto Pact in 2001, and strong manufacturing growth in low-cost countries such as Mexico further eroded Canada's share.

The high Canadian dollar, driven by the oil boom (Canada's currency has recently had a strong correlation to the movements of crude prices), didn't help. By 2014, 14% of the cars made in North America were rolling out of Canadian factories, a low not seen since the late 1980s.

But fast-forward to today, and the Canadian auto sector is enjoying a rebound, thanks to a low Canadian dollar and strong global auto sales.

The Canadian dollar will continue to swing with oil prices, but global car sales are expected to keep climbing. According to a June 6 report from Bank of Nova Scotia, a record 74.5 million cars will roll off dealer lots around the world this year, up 3% from 2015. The bank sees the biggest gains coming in Europe, where sales jumped 14% last month.

A Canadian Automotive Leader

There isn't a lot of choice for investors looking to invest in distinctly Canadian car companies, but one stock stands out: Magna International Inc. (NYSE: MGA, TSX: MG).

Founded in 1957 and headquartered in Aurora, Ontario, Magna supplies the global auto business with everything from seats to chassis.

Don't let the company's northern domicile fool you. Magna is a global operation, with 306 manufacturing facilities and 92 development and sales centers stretched across 29 countries. It also owns Vienna-based Magna Steyr, which assembles entire vehicles under contract.

Magna's customer list includes Detroit's Big Three, as well as overseas carmakers such as BMW, Honda, Toyota and Tesla Motors.

The company is riding along with rising global car sales: First-quarter revenue rose 15%, to $8.9 billion, or 19% excluding currency rates (Magna reports in U.S. dollars, but also does business in euros and Canadian dollars, and the greenback rose against those currencies).

Magna benefited as carmakers ramped up production in North America (up 10%) and Europe (up 7%) during the quarter. For the full year, management expects revenue in the range of $35.5 billion to $37.2 billion, the midpoint of which is up 13% from the company's 2015 total.

Earnings per share (EPS) from continuing operations came in at $1.22, up 11% from a year ago and ahead of the consensus forecast of $1.19.

Magna isn't afraid to reward shareholders: The stock yields 2.5% today, which isn't very exciting compared to the S&P 500 average of 2.2%. But the quarterly payout has doubled in the past five years, from $0.125 to $0.25, including a 14% hike in February.

Magna is also an avid buyer of its own stock, spending $300 million on repurchases in the first quarter, in addition to the $515 million it spent in 2015. In the last five years, the company has bought back 18% of its outstanding shares.

Apple in the Mix?

Adding some intrigue to the Magna story is that, according to an April report from German newspaper Handelsblatt, the company has held talks with Apple about potentially manufacturing the long-rumored Apple Car at Magna Steyr.

It makes sense for Apple to outsource production to Magna, which doesn't make cars under its own banner and therefore wouldn't compete directly with the tech giant's new ride.

Magna also has other expertise it could bring to the table: its Magna Electronics subsidiary, for example, makes systems that can detect objects in a car's path, read road signs, automatically park a vehicle and keep it in its own lane on the highway.

Meantime, analysts are bullish on Magna's prospects, with an average 12-month target price of $60 on the stock, well above today's level of around $39. The stock trades at 7.6 times the company's projected 2016 EPS, so it's a relative bargain as well.

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