Linamar: No longer oversold, but watch for a pullback

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July has been a shaky month for the S&P/TSX composite index; however, the recent market retracement has driven down stock valuations for many stocks, and for some, this pullback presents a buying opportunity for investors.

On Tuesday, I identified Linamar as one such undervalued stock: It was technically oversold with a relative strength index reading of 28, it was trading at a price-to-earnings (P/E) multiple in line with its historical three year average, and month-to-date, the stock price was down 9 per cent, underperforming the S&P/TSX composite index (down 3 per cent), and shares of Magna (down less than 1 per cent). However, on Wednesday, the stock rallied more than 8 per cent.

While shares of Linamar are no longer a strong buy, I am still recommending the stock – on another pullback.

The company

Linamar is a global manufacturing company serving the automotive and industrial markets. The stock has been a stellar performer, outperforming the S&P/TSX composite index for the past three calendar years.

In terms of operations, the company is a solid operator led by a strong management team. Management is targeting double-digit revenue and earnings growth for 2015 and 2016.

Last quarter, the company reported record sales of $1.28-billion, up 22.5 per cent year-over-year, and record earnings per share of $1.73, up 42 per cent year-over-year. Net margins reached 8.9 per cent and management is anticipating margin improvements will continue. On the first-quarter conference call, management raised its 2015 net margin guidance to a range of 7.75 per cent to 8.25 per cent, from previous guidance of 7.25 per cent to 7.75 per cent given in March.

The company's balance sheet is strong with net debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) of 0.7 times, providing the company with the financial capacity to fund continued growth.

Furthermore, the company achieved a return on equity (ROE) of 21.2 per cent in 2014 and ROE reached 26 per cent in the first-quarter.

Positive industry fundamentals

Car sales remain robust aided by a low interest rate environment. Sales of new cars and trucks in Canada remain at record breaking levels. In June, total light vehicles sales reached 177,857 units, setting another monthly high in sales according to a report by DesRosiers Automotive Consultants.

Most of the company's revenues are from North America. In terms of revenue breakdown by geography, in 2014, 58 per cent of Linamar's sales were from Canada, and when combined with U.S. sales, this figure increased to 69 per cent.

Dividend

The company pays shareholders a quarterly dividend of 10 cents per share, equating to a yield of 0.5 per cent.

Valuation

After Wednesday's rally, the stock is now trading at a reasonable valuation on both an enterprise value to EBITDA (EV/EBITDA) basis and on a price-to-earnings (P/E) basis. The stock is trading at an EV/EBITDA multiple of 6.3 times the 2016 consensus estimate, above its historical three-year average of 5.5 times. On a P/E basis, the stock is trading at 11.6 times the 2016 consensus estimate, above its historical three-year average of 10.8 times.

Stock watch

The stock has a relative strength index reading of 52 now, which is a technically neutral level. There is solid technical support at $73.75, near its 200-day moving average, and technical resistance at $80, then just above $82, near its 50-day moving average.

Analysts' recommendations

There are seven "buy" recommendations, two "hold" recommendations and no sell recommendations. The average one-year price target is $91.38, implying a potential price return of over 23 per cent. Seven of the analysts have target prices in the $90 to $97 range.

Analysts have been revising their sales and earnings estimates up for this company. The current earnings per share estimate is $6.40 for 2015 and $6.90 for 2016.

The bottom line

The company will be reporting second quarter earnings on August 5, after the market closes. The consensus earnings per share estimate is $1.84. Linamar has reported better-than-expected earnings for the past nine consecutive quarters and I believe we could see yet another beat this quarter. The recent pullback in the stock price represented a "table pounding" buy for the stock. However, while Wednesday's rally erased the deep valuation discount, shares of Linamar remains an attractive investment for investors, and if there is another pullback in the stock price, I would recommend buying it.

Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market. E-mail any stock suggestions that you want profiled to jdowty@globeandmail.com