Share tips: Buy into China’s car boom

published 26 July 2012

China is the world's largest automobile market. Volumes are set to jump 8% this year with more than 19 million vehicles whizzing off the forecourts. Growth in America could be even stronger, with sales up 10% to 14 million. Between them, the two regions could more than compensate for the predicted 7% decline in western European sales, to 13.5 million units.

Consultants at Alix Partners expect volumes to hit 15.9 million in the US and 25.2 million in China by 2015. If they are right, some of the clapped-out valuations across the sector start to look daft.

Take components supplier Magna. It manufactures a whole host of parts, including interiors, electronics, doors, chassis and power-train systems, along with offering full assembly. The North America division (50% of revenues) is the jewel in the crown, spinning off plenty of cash and enjoying operating margins of 9%.

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However, it is the European arm that offers the greatest prospects. It accounts for 40% of sales, but has only just started making profits again. The board has identified a turnaround strategy to lift profit margins from 2% into the mid single digits over the next three years.

This will be a challenge in light of the continent's woes. But fortunately the division is far more reliant on strong German brands (VW, Daimler, BMW) than troubled producers such as Fiat, Peugeot and Citroen.

Magna is also expanding rapidly into emerging markets. It plans to open 11 new plants in China, four in South America and another four in India between 2011-14. Further growth should come from in-sourcing more production. In May, Magna signed a prestigious deal with Nissan to assemble (from 2014 onwards) the new Infiniti model, an entry-level compact car.

Magna International (NYSE: MGA), rated a BUY by Canaccord Genuity

Wall Street is penciling in 2012 turnover and underlying earnings per share (EPS) of $29.7bn and $4.93 respectively, rising to $31.8bn and $5.50 by 2013. That puts the shares on undemanding price/earnings (p/e) ratio of less than 8.5, with a 2.4% dividend yield. I rate the stock on an eight times through-cycle earnings before interest, tax and amortisation (EBITA) multiple, assuming sustainable margins of 6% versus 5.8% in the first quarter of 2012. After adjusting for net cash of $884m and a $430m pension deficit, I get an intrinsic worth of $60 per share.

Earnings could be dented by the cyclical nature of the industry, technological change, currency fluctuations and counter-party risk in the event any large manufacturer went bankrupt. But there's still plenty of potential upside with Canaccord posting a target price of $66. Second-quarter numbers are due out in early August.

Rating: BUY at $40.60

Paul Hill also writes a share-tipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI or phone 020-7633 3634.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.