2 Canadian auto stocks to buy

Here are two top Canadian automobile stocks to buy—one a consumer goods stock with new car dealer franchises in eight provinces, the other a global body parts and systems manufacturing stock with facilities in 29 countries around the world.

AutoCanada (TSX—ACQ) is expected to earn more this year and next. It will use part of this money to buy dealerships at attractive prices and diversify its sales by region and by brand. The company remains a buy for long-term share price gains and modest dividends.

That’s because the company is expected to earn more money this year and next. It pays dividends and is expanding. When energy prices recover, its Alberta dealerships should become more profitable than ever.

One of Canada’s largest automobile dealership groups

AutoCanada operates 60 automobile dealership franchises in eight provinces. They sell 19 different kinds of vehicles from North American, European and East Asian manufacturers. In 2015, its dealerships sold 62,800 vehicles. The company also processed about 848,000 service and collision-repair orders from 912 service bays.

In the six months to June 30, AutoCanada reported earnings of $21.4 million, or 78.1 cents a share, for its shareholders. This was up by 3.4 per cent from $18.5 million, or 75.5 cents a share, a year earlier.

On October 4, AutoCanada agreed to acquire Wellington Motors of Guelph, Ontario. This firm operates a Chrysler, Dodge, Jeep, Ram, and Fiat dealership. With a 12-car showroom, it sold 968 new vehicles and 402 used vehicles last year. Wellington Motors also has 16 service bays. It should add $61 million a year to AutoCanada’s revenues. The transaction is expected to close in late October. In the dozen months to June 30, it acquired five dealerships.

AutoCanada trims its capital spending plan

In the second quarter, AutoCanada trimmed its capital plan by a quarter. Over the next five years, it plans to do $145.3 million in capital spending. The company expects this reduction to let it maintain a “strong balance sheet”.

AutoCanada chief executive officer Steven Landry said: “During a period of reduced economic activity, we have the ability to be opportunistic in our acquisition strategy and to focus on acquisitions that are accretive and grow our portfolio. We will diversify across Canada through the acquisition of flagship stores in major markets.” Geographical diversification lessens AutoCanada’s risk. In the first half, for instance, new vehicle sales in Alberta fell by 6.2 per cent from last year. By contrast, new vehicle sales nationally were up by six per cent. AutoCanada also wants to diversify its brand representation.

AutoCanada aims for “operational excellence”. Chief financial officer Chris Burrows said: “Despite the economic slowdown in Western Canada, overall revenue and gross profit has increased.” To raise its profit margins, the company hopes to cut its operating costs by $15 million a year. Management wrote it’s “considering innovative ways we can save money through shared services and central purchasing”.

AutoCanada is upbeat about its outlook. Management wrote “we look ahead to the rest of the year with further optimism”. This seems justified.

It carries a lot of debt

AutoCanada’s net debt-to-cash-flow ratio of 11.5 times means the balance sheet is stretched.

This is largely due to revolving floor-plan facilities of $532 million. Exclude this and the net debt-to-cash-flow ratio improves to 3.5 times.

With cash of $77.6 million, the dividend looks safe. It yields a modest 1.6 per cent.

AutoCanada looks nicely valued

In 2016, AutoCanada is expected to earn $1.78 a share. That would represent a rise of 8.5 per cent from the $1.64 a share it earned last year. Based on this year’s estimate, the shares trade at a reasonable price-to-earnings, or P/E, ratio of 13.7 times.

In 2017, the company’s earnings are expected to climb by 15.7 per cent, to $2.06 a share. Based on this estimate, the shares trade at a better P/E ratio of 11.9 times.

That seems cheap for a company that should see its earnings grow steadily in the years ahead.

The consensus recommendation of four analysts is that AutoCanada is a ‘buy’. We agree.

A global automotive manufacturing stock

Magna International (TSX—MG; NYSE—MGA) is a global automobile manufacturing stock with 309 manufacturing facilities and 99 product development, engineering and sales centres in 29 countries. It produces active drive assistance, body, chassis, closures, electronic, exterior, power-train, roof, seating and vision systems and modules. The company also offers complete vehicle engineering and contract manufacturing.

Magna is expected to earn record profits this year and next. This will give it the means to continue to raise your dividends each year. Magna remains what’s known as a ‘dividend aristocrat’. Magna also remains a buy for further long-term share price gains and modest, but growing, dividends.

Record earnings for this auto manufacturing stock

In the six months to June 30, Magna’s shareholders earned a record $1.050 billion, or $2.63 a share (all figures in U.S. dollars unless preceded by a C). This was up by more than 10 per cent from $993 million, or $2.39 a share, a year earlier.

In the first half of 2016, Magna spent a net $582 million to buy back its own shares. By June 30, it had 389 million shares outstanding. That’s down by 22 million shares from a year earlier. The company was authorized to repurchase up to another 22.3 million until November. Share buybacks accelerate the growth in earnings per share, of course.

In the first half, Magna’s sales advanced by 15.3 per cent, to $15.664 billion. But regular operating costs rose by a higher 15.7 per cent, to $17.023 billion. Exclude the impact of the strong U.S. dollar and its sales went up by 18 per cent. The company does lots of foreign business in currencies other than the U.S. dollar.

Magna’s Asian sales jumped by 34 per cent, to $1.245 billion. European sales went up by a strong 21 per cent, to $6.754 billion. North American sales rose by 11.4 per cent, to $10.397 billion. Sales in the rest of the world fell by over a quarter, to $192 million. But these sales pale next to sales in the company’s major markets.

Magna’s higher earnings are confirmed by its higher cash flow. First-half cash flow jumped by nearly 22 per cent, to $1.631 billion. This fell short of capital investment of $755 million, the $1.813 billion acquisition of global auto transmission systems supplier Getrag Group, and dividend payments of $193 million.

Strong balance sheet, positive outlook

Magna can easily cover this shortfall thanks to its strong balance sheet. Its net debt-to-cash-flow ratio is a safe 0.9 times. This is well within our standard comfort zone of two times or less. It can also accommodate the company’s planned capital investment of $1.045 to $1.245 billion in the second half.

In all of 2016, Magna’s earnings are expected to go up by 10.8 per cent, to $5.23 a share. This works out to C$6.95 a share. Based on this earnings estimate, the shares trade at an attractively-low price-to-earnings ratio, or P/E, ratio of only 8.1 times. In 2017, the company’s earnings are expected to rise by 13 per cent, to $5.91 a share, or C$7.85 a share. Based on this estimate, the shares trade at an even better P/E ratio of 7.1 times. Just keep in mind that P/E ratios are less useful with cyclical stocks, such as the automotive sector.

Magna is keeping up with the times. Chief executive officer Don Walker said: “We plan to remain highly focused on innovation to strengthen our competitive positioning for the Car of the Future.” The company has the financial and technical resources to move to the technological forefront.

The consensus of nine analysts is that Magna is a ‘Strong Buy’. We rate it a buy.

 

The MoneyLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846