What's next for companies riding the auto-sales boom?

Canadian parts-makers and other auto-related companies are riding high.

Catherine Multon 3 July, 2014 | 6:00PM
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The auto-manufacturing industry is in high gear, and Canadian-based parts-makers and other auto-related companies have gone along for the ride. But have their stock prices raced ahead of the fundamentals?

On June 3, Autodata announced that U.S. auto sales in May rose 8.3% over the same month in 2013. Canadian auto sales rose 5.3%. Auto Alliance, an advocacy group for the auto industry, notes that if North American auto sales increase this year versus last, it will mark only the third time since the Second World War that auto sales have increased in five consecutive years.

Among the beneficiaries of the auto-industry boom have been Canadian-based auto-parts providers, of which the largest and best known is Magna International Inc. MG.

In the year to June 26, Magna has outperformed the S&P/TSX Composite Index with a gain of 32.2% versus 10.4% for the index. This continues a trend that has seen a 54% return over one year, more than doubling the index's gain in the same period, and a two-year gain of 186.3% versus 29.6% for the index.

Magna has been a favourite among investors in Canadian value-oriented stocks for the past two years. However, Magna's relevant valuation metrics, such as forward price-to-earnings (12.9 times), price-to-book (2.4 times) and price-to-cash flow (9 times) have risen just enough that Magna is now rated as a strong "hold" for value investors -- continue to own the stock if you currently own it, but if not, shop elsewhere for stocks offering better value.

Meanwhile, Magna is rated among the best growth stocks in Canada. Based on its trailing four quarters of reported earnings, Magna has grown its book value at a rate of 14%, which allows the company to invest in new projects in order to continue to grow earnings.

Magna has virtually no debt. Its cash-flow-to-debt ratio is 26.3 times versus 0.4 for the industry median. Finally, the company pays dividends. Its expected dividend yield is 1.44%.

The Canadian star of the auto-parts industry is Linamar Corp. LNR, whose products include engine and transmission systems. Linamar stock has risen 40% in the year to date to June 26, and 109% over one year.

Even after its stellar gains on the TSX, Linamar's fundamentals remain excellent. The price-to-trailing-earnings ratio of 16.1 times and the price-to-trailing-cash-flow of 7.7 times are both lower than the industry median and the S&P/TSX Composite. Furthermore, Linamar's quarterly earnings momentum is 14.3%, well ahead of the 1.8% for the industry median and 4% for the benchmark.

Linamar's attractiveness is based in part on its quarterly report released on May 7, which revealed a quarterly earnings surprise of 15.4%. In turn, this excellent report led the analyst community to raise their earnings estimates for fiscal 2014 by 12.4%. Consistently reporting positive values for these indicators has helped Linamar stock remain in the fast lane in recent quarters.

The only mild negative for the shares of this highly successful company is its expensive price-to-book-value ratio of 2.7 times. Despite this, investors of all stripes should consider owning Linamar.

A related play on the auto industry is AutoCanada Inc. ACQ, the country's largest network of independent auto dealers. Shares of this company have sped ahead 73% in the year to June 26, 173.5% for one year and a whopping 560% over the last two years.

For investors looking for high-octane growth, ACQ remains a "buy" thanks largely to the forward growth of book value of 17.9%. Relatively few Canadian stocks can match or exceed this high growth rate. However, ACQ should be considered a "sell" for all other investors, due to still positive but moderating momentum of earnings, sales and estimate revisions coupled with extreme valuations.

AutoCanada's price to trailing earnings is 40.6 times versus 21 for the industry median and 18 for the S&P/TSX Composite; its price to book value is 8.8 times, and its price to forward earnings 30.8 times. On the basis of these revved-up valuations, ACQ is a stock only for aggressive investors.

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Catherine Multon

Catherine Multon  Catherine Multon is a contributing writer for Morningstar Canada.

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