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Top 1000

Magna's big bet on the billion-dollar market for driverless cars

The auto parts maker sold $450-million worth of "driver assistance systems" last year. Next stop: building full autonomous vehicles

Top 1000 Rank #4 | 2016 Revenue $36.7 billion (U.S.) | 2016 Profit $2.0 billion (U.S.)

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Say what you will about America's economic recovery, but in one area it's not lacking steam. Auto sales have been surging, with 17.5 million vehicles leaving dealership lots last year—an all-time high, and up from 10.4 million in 2009. The robust demand has helped create plenty of value for auto-industry shareholders, and that includes parts maker Magna International Inc., whose stock has climbed by more than 250% over the past seven years.

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But are the good times over?

Experts believe the U.S. auto industry has reached its cyclical peak as consumers have sated their hunger for new cars. In January, Morningstar projected that vehicle sales would drop by 2.5% this year, and drop they have—down 4.7% year over year as of April.

Magna had done an admirable job of positioning itself to benefit from the recent sales boom: It cut costs through layoffs in 2009 and kept its balance sheet clean during the Great Recession. It also dumped founder Frank Stronach, who had taken the company in questionable directions, including an ill-fated foray into horse racing. This conservative approach should now help the Aurora, Ontario-based company weather a more challenging environment, and capitalize on big opportunities in new markets and new technologies.

Many analysts are bullish on Magna's prospects. Mark Suarez, an analyst with Toronto's Accountability Research, believes that North American production will weaken, but he still expects Magna's sales to rise through 2018. That's partly because the company has made significant inroads into China and India over the past few years—auto markets that are seeing strong growth and where Magna has much room for expansion. While the company is a significant player in the U.S. and Canadian auto-parts markets, it currently gets just 6% of its sales from Asia. "The room for improvement, especially in China, is incredible," says Suarez.

Magna also has a full pipeline of projects that should keep plants running even if auto sales dip, says David Tyerman, an analyst with Cormark Securities. Last fall, the company announced a contract to manufacture half of BMW's 5 Series cars, while a deal with Ford, revealed in March, will see it create a carbon-fibre frame that replaces 45 steel parts. Magna's 2016 purchase of Getrag, a German automotive transmission supplier, should boost growth too. Tyerman expects transmission-related sales to double by 2019.

But the biggest shift for Magna has only begun. Autonomous vehicles are the future, says Swamy Kotagiri, Magna's chief technology officer, and the company must adapt in order to survive in the long term. "We're looking at providing more features and products that could ultimately lead to full automation," he says. For example, Magna is improving its driver assistance systems—cameras that alert drivers when they're about to veer off the road, keep the car on cruise control and more. This product line generated $450 million in sales last year, but Magna envisions it becoming a billion-dollar business.

While Kotagiri puts self-driving cars at least a decade away, he wants investors—as well as Google, Apple and others that could potentially supplant Ford and GM—to know that Magna is ready to build them. "We have the core understanding of the different systems in a car," he says. "Whether it turns out [we work] with automotive manufacturers that exist today or someone else, we're hoping to provide the solution."

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For now, the market is not looking that far ahead. It's more concerned about an auto-sales decline and is valuing Magna accordingly. The company's shares currently trade at about five times enterprise-value-to-EBITDA—down from its range of six to seven a few years ago. Magna is also trading at about 7.5 times price-to-earnings, which Tyerman says is low for a business he expects to grow earnings by double digits. Additionally, Magna is generating massive amounts of free cash flow—about $1.1 billion for 2017, estimates Suarez, which he expects the company will use for share buybacks and dividend increases.

Some observers are nervous about how a decline in U.S. vehicle sales or a broader economic downturn will affect the company. In May, Zacks Investment Research downgraded Magna from a "buy" to a "hold." Nevertheless, Suarez and Tyerman argue that this is a good time to buy the stock. The shares are inexpensive, the company is still growing, it has an eye to the future and its cash flow is strong. "This is a highly capable business making a great return on invested capital," says Tyerman.

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