Magna International – Post split analysisThe purpose of this report is to analyze the financial health of Magna International. We will be exploring the investment thesis and credit ratings associated with its recent financial results.

Key Takeaways

Valuation Summary1) Base Case – US$ 115.572) Worst Case – US$ 83.443) Best Case – US$ 155.38

Buy recommendation if price falls to around ~ US$97 but hold at the current prices. Investors often forget that auto parts suppliers such as Magna Intl operate in an environment

with high capital spending as well a cyclical and highly competitive industry Positive forecasts for automobile industry with lower oil prices and increased sales in Q4 2014. A Stock split that was announced which is a positive indicator of the financial health Financial health and structure analyzed using various tools

Company Profile : Magna International Inc. (Magna), incorporated on November 16, 1961, is a diversified global automotive supplier. The company designs, develops and manufactures automotive systems, assemblies, modules and components, and engineers and assembles complete vehicles, primarily for sale to original equipment manufacturers of cars and light trucks. Its capabilities include interior systems, exterior systems, seating systems, powertrain systems, closure systems, roof systems, body and chassis systems, vehicle engineering and contract assembly, vision systems, hybrid and electric vehicles/systems, electronic systems, and through its Magna E-Car Systems partnership (E-Car Systems). Magna operates in three geographic reporting segments: North America, Europe and Rest of World. In January 2011, the Company acquired Automobiltechnik Durbheim, a manufacturer of tapping plates, which assist in the fastening of bolts. The acquired business is located in Germany and has sales to various automobile manufacturers. In May 2011, it acquired a 51% interest in Wuhu Youth Tongyang Auto Plastic Parts Co., Ltd., a supplier of exterior products, mainly front and rear bumpers. In June 2011, it acquired Continental Plastics Co., a supplier of interior products, mainly door panel and seat back assemblies

Automobile Industry and ForecastThe underlying drivers in the automobile industry remain solid with oil prices falling and sales increasing, especially for cars that consume more fuel. This can be seen by the increase in sales of vehicles such as Fords- F150. In a global context, there seems to be growth in sales last year by approximately 6%, with China and the United States showing double digits growth. Momentum has picked up across Western Europe as well. Magna’s major operations are in North America. The pickup in passenger vehicles sales in North America, catalysed by better job

market, elevated consumer confidence and increase in disposable income because of falling oil prices all add to Magna’s prospects. As in Canada, light trucks led the way, with SUV sales surging 23% above a year earlier, largely due to a 45% spike in purchases of large SUVs.

Figure 1 International Sales Outlook

This figure above shows distribution of forecasted car sales for 2015. United States looks like a favourite in increased sales because of promising economic activity. The recent job report did have an impact on consumer sentiment and only time can tell us what the exact impact on the economy will be. The likelihood of an interest rate hike in the states is promising yet unlikely

Figure 2 North America Outlook

Overview of North America, biggest region for Magna. Sales to grow at a steady rate in the three main regions here.

Financial Health and Capital Structure – OverviewAs an investor, Magna has a clean balance sheet with limited debt and ample liquidity. It is impressive to see that over the past few years it has managed to maintain a debt to capital ratio of less than 10 %. From our model, we expected this situation to improve as predicted and to decrease by approximately 1% per year till 2017. As for interest expense, we see that earnings are 80 times interest, and expected to grow. This is concerning because the capital structure is inefficient – that is, not taking advantage of the tax benefits of interest expense. Considering the nature of the market, Magna is in a good condition especially if it were to expand, take over and invest in Capex. Most of the company’s capital needs have been made through equity and cash flows. The company has an undrawn $2.25 billion revolving line of credit. Minimal amounts outstanding on bank term debt and other outstanding indebtedness averages less than $500 million on a balance sheet with total liabilities and owners' equity of more than $17 billion.

Z-Score Analysis Method-Data input

2014 2015 2016Working Capital = Current Assets - Current

Liabilities

Current Assets 9,923.0 10,110.2 12,092.9 Current Liabilities 7,309.0

Working Capital $2,614 $10,110 $12,093Total Assets $19,846.0 $20,220.

4 $24,185.

8 Retained Earnings $5,011 6,400.7 7,931.9 Operating Income 2,209.0 2,081.7 2,292.3

Market Cap. + preferred stock $18,305.6 $20,419.8

$22,838.1

Total Liabilities 2,209.0 2,081.7 2,292.3 Sales 28,228.6 30,530.0 34,931.1

Z- score Results 7.42 8.93 8.94

The importance of using Altman’s Z score test may have waned over time but its merits can still be seen through its frequent usage by various rating industries. When compared to its peers, Magna scores higher on this scale and also higher than the bankruptcy limit of 3.0. It is well above this number. This number is based on five various financial ratios and is a good, quick way to have a look at the financial health of Magna. The strength of this score shows a good

buying opportunity for the long run and the company is less likely to become insolvent in the future.

Balance Sheet Analysis2014 2015 2016 2017

Current Ratio 1.36 1.43 1.71 2.02

Quick Ratio 1.00 1.06 1.33 1.65

Working Capital 2614.0 3053.5 5001.7 7250.0

Debt/Equity 0.11 0.09 0.07 0.06

Long Term Debt to Equity 0.011 0.010 0.009 0.008

Magna has maintained a low-leveraged balance sheet and generated solid cash, enabling $1.7 billion in share repurchases during 2014. However, its margins relative to other global auto-parts suppliers as well as its ability to generate excess economic returns have not been as impressive, owing to the company's capital-intense, vast worldwide network of decentralized operations.The balance sheet remains strong with $225 million in cash, net of debt as of December 31, 2014. They also have an additional $2.3 billion in unused credit available to us. The working capital looks healthy, and so does its quick ratio. This shows Magna’s ability to pay debt in time, which could imply good capital management. The inventory levels were low, which shows signs of efficiency not explicit in any reports published by the company. The management has committed to increasing efficiency which will be vital in this industry, especially since the dominant design for manufacturing exists. Overall, the company has good liquidity both in the short term and long term, and any bonds issued by this company in the future should be of high quality.

Figure 3 Leverage Analysis

Eyeballing the data, we can see that Magna stands out in this front. So internally and externally, when compared, we see that Magna has a lot of potential leverage that can be used for the future. Investors must look out for Q1 2015 results, and personally Magna is only an attractive stock if these values change drastically. Lack of debt, cover ratios and low gearing ratios means the company is holding back on expansion. The company has the potential to surprise in the long run and this could be an intrinsic value that has been mispriced by the street which should lead to a higher valuation, P/E ratio in the near future.

Figure 4 Liquidity Analysis

Peer Evaluation

1) Case per Share- we can account for this change in the future to the stock split, so this indicator doesn’t tell us much. But before this Split, Magna did have lesser cash per share compared to the rest. This is a good sign that excess cash is being used, but on the flip side, it could indicate delays in cash payment. Hence the effects for Cash per Share doesn’t tell us much

2) What is interesting is that despite Magna’s excellence, it has similar CR and QR ratios to the biggest competitors – that is JCI and DLPH – but to the rest, this ratio is lower by approximately 5 to 7 percent and is expected to grow.

3) We can project Magna to have a greater payout ratio by 2017 of at least 27%.

Income Statement AnalysisKey Ratios 2012 2013 2014 2015 2016 2017 2018 2019

Gross Profit Margin

11.53% 12.38% 13.06% 12.19% 12.19% 12.19% 12.19% 12.19%

Net Profit Margin 3.46% 4.63% 5.27% 4.36% 4.37% 4.37% 4.37% 4.37%

Earnings Per Share

4.2 6.1 6.8 6.1 6.7 7.3 7.9 8.6

Times Interest Earned

80.73333

117.7333

157.7857

141.9336

156.2912

172.1013

189.5107

208.6811

Return on Stock Holders Equity

10.33% 13.28% 14.90% 11.92% 11.57% 11.27%

Long Run- Indicators looks good for Magna, with margins likely to increase with expansion domestically and internationally. Increased efficiency and scalability could further propel margins. We haven’t taken into account the impact of the spit on shareholder returns. Remember, with the stock split, the shareholders receive the same nominal amount but over two times the stock they owned. So return on shareholders is expected to fall, and to a uniformed investor, they could look at the stock as unattractive when in fact there is a good opportunity. It is evident that improving customer base should be Magna’s priority and is something the management has planned to do as stated in their Q4 2014 update.

Figure 5 Profitability Analysis

This figure is concerning: Magna on average is underperforming in these key areas. The operating margins are expected to widen – that is, the difference between the average and Magna. Delphi Automotive stands out with impressive figures on margins. It is impressive because it is one of the bigger firms that is still able to generate higher margins. This may be the main reason for the undervaluation or poor opinion of Magna. But if you take a closer look, the difference between gross profit margins and Ebitda margins show that Magna may have better cost controls. The difference between those two is on average 4 percent while it is 8 percent for the industry average. There is some positive in the above figure, but only if Magna makes a decisive operational or strategic move.

Cash Flow Projected2015 2016 2017 2018 2019 Term.

EBIT 2,081.7 2,292.3 2,524.2 2,779.5 3,060.7 3,370.3 Tax Expense (392.7) (432.7) (476.8) (525.3) (578.7) (640.4)

Unlevered Tax on Interest -2.79 -2.79 -2.79 -2.79 -2.79 0.00Unlevered Free Cash Flow

(DCF Valuation)$1,686.17 $1,856.74 $2,044.56 $2,251.39 $2,479.1

3$2,729.91

Evidence of healthy projected cash flows gives the company a good corporate credit rating with relatively low risk.

Forward Multiples

Figure 6 Multiples

The forward multiples do indicate that the street don’t expect Magna to grow much. Keep it mind again the PEG ratios are P/E ratio + Annual EPS growth, EPS is expected to fall because of the stock split. Hence the sudden fall in PEG ratios can be explained by the stock split. Though the stock split won’t have an impact on the P/E ratio because both values are affected by the same factor. Hence the decline in P/E shows that the street doesn’t see much potential in Magna, but renewed optimism in automobile sales and Magna’s potential strategic plans are some reasons as to why Magna might be undervalued.

Risks –Currency Impact

Higher USD is set to impact Magna Weakening of the Euro resulted in a smaller proportion of lower margin European business

relative to forecasts Falling Euro and Cad has had an impact of almost 8% on reported sales in USD Might be offset by increased sales in the future January results seemed rocky, with decline in sales dollars - personally I feel that they have a

chance to improve margins in foreign operations Transaction Benefits for Canada to US- In the short term, it does have a negative impact as it

translates sales and profitability while in the long term, with the Canadian dollar being down, it should give Magna the ability to be more competitive and win more business in and out of Canada

Risk- Economics Uncertainty

Economic uncertainty in Europe and in the U.S. Significant reliance on GM, Ford and Chrysler Limited exposure to developing markets Execution risks related to acquisitions The company is positioned for acquisitions to increase customer base, but with obvious risks Any exposure to Asian markets should be taken as a positive, rather than a downside and is a

good indicator of the firms strategic direction

Raw Material costs could fluctuate and become an issue in the long run so the company needs to hedge this risk

Q4 2014 Earning- Key Take Away Best quarter of 2014 EBIT from European operations increased by 3% and this growth has been sustained for more

than 2 years EBIT from North America was 10.6% for Q4 and 10.1% for the year Adjusted EBIT of $52 million U.S for the fourth quarter and for 2014 Magana reached $162

million - an increase of 91% over 2013 to a margin of 8.2% for the year $881 million in cash from operations prior to changes in non-cash operating assets and liabilities

and an additional $118 million in non-cash operating assets and liabilities Investment activities amounted to $716 million, comprised of $670 million in fixed assets, $23

million to purchase subsidiaries, and a $23 million increase in investments and other assets Two-for-one stock split and an increase in the quarterly dividend with respect to common

shares 16% increase in dividends from Q3 2013 Repurchased 17.5 million shares returning an additional $1.8 billion to shareholders