If you've been complaining that stocks are expensive following an eight-year bull market, behold a curious exception: Martinrea International Inc., a Canadian auto-parts company, has a valuation that is out of line with the broader market.
This bargain status makes the stock a compelling opportunity.
The global auto-parts sector makes most of what goes into today's vehicles, leaving auto manufacturers as little more than glorified assemblers.
But it's hard to see any lofty status in Martinrea's stock. The shares trade at a mere 6.5 times trailing profit. Compare that to the benchmark S&P/TSX composite index, whose price-to-earnings ratio is about 22.
The stock also trades at just book value, also well below the benchmark index.
By both measures, Martinrea is cheap next to its peers. Canada's Magna International Inc. and Linamar Corp. both have higher P/E ratios and price-to-book ratios. International rivals such as Lear Corp., Dana Inc. and Delphi Automotive PLC are even pricier, suggesting that Canadian-based auto-parts companies are deeply out of favour.
They won't always be.
It is tempting to blame their status on U.S. President Donald Trump, who has introduced tremendous uncertainty to the sector. Mr. Trump wants to renegotiate the North American free-trade agreement, and has warned auto manufacturers that they will face hefty border taxes on vehicles imported into the United States.
But these stocks were volatile long before Mr. Trump posted his first tweet as POTUS – and have embarked upon a rally in recent months that appears to be driven by greater optimism over the health of the U.S. economy.
Martinrea exemplifies the trend: It has risen 47 per cent since the U.S. presidential election in November.
So why is the stock's valuation still low? The company is a relatively small and undiversified player, with a market capitalization of just $844-million. Magna is about 25 times larger. Martinrea's sales for all of 2016 approached $4-billion, well shy of Magna's $36.5-billion (U.S.).
This small size may be contributing to bumpy results. In the fourth quarter, ended Dec. 31, sales fell nearly $45-million (Canadian), or 4.3 per cent, from last year, as Ford and Chrysler cut production volumes on certain vehicles.
Profit for 2016 fell to $1.07 a share, down nearly 14 per cent from last year.
This sort of setback is not unusual for the company, which is why the stock has been volatile. Consider the peaks and troughs of the share price since March, 2012: down 39 per cent, up 94 per cent, down 45 per cent, up 107 per cent, down 38 per cent, up 59 per cent and then down 53 per cent, before the latest rally in November.
Over all, the stock is down over the past five years, compared with strong gains for Magna and Linamar.
No wonder investors have been reluctant to give the stock a higher valuation. Peter Sklar, an analyst at BMO Nesbitt Burns, also points out that the company is saddled with relatively more debt than its peers, giving it less financial flexibility at a time when some observers are worried that the automotive cycle is at a peak.
So, there are good reasons the stock is cheap. But there are equally strong reasons to expect the price will rise.
For one thing, Martinrea's recent profit dip looks temporary.
According to Bloomberg, a consensus of analysts estimates that profit will rebound to a record high of $1.88 a share this year, which means the estimated P/E ratio on the stock is just 5.2.
For another, the stock's current rally looks as though it has legs. The past two rallies, in 2014 and 2015, took the share price above $14. It was well below those peaks on Thursday, at $9.77.
Lastly, it's hard to believe a competitor isn't looking at Martinrea as a potential takeover target, given the trend toward industry consolidation. According to the consultancy PwC, the number of auto supplier mergers and acquisitions valued at $500-million or more has risen fivefold since 2013, reflecting the fact that this is a growth industry.
Players are armed with cash, and Martinrea looks cheap.
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