This Auto Supplier Delivered a Surprise
Auto sales are a concern for many traders as the economy potentially slows. But those concerns may be misplaced according to recent news.
Reuters reported that Canada’s Magna International Inc (NYSE: MGA) recently reported profits that beat market forecasts as a big spike in vehicle assembly work more than offset declining global auto production in the fourth quarter.
Shares of Magna moved higher after the world’s third-biggest auto supplier said profits fell less than analysts had feared in the latest quarter, partly reflecting a lower share count from its buyback program.
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The company said it expects its performance to strengthen in the second half of 2019 from the first six months, reflecting its forecast for global vehicle output.
But trade wars will pinch that performance, with Magna’s 2019 tariff hit estimated at $45 million to $50 million.
“Tariffs continue to hurt us,” Chief Executive Don Walker said on a conference call with analysts. “Tariffs within the NAFTA region…(are) bad for all three countries, including the States, because their input costs become higher, and obviously, it’s less competitive.”
Magna also boosted its dividend by 11 percent, its tenth consecutive annual increase, and recorded $951 million in free cash flow in the quarter, while it spent $479 million to repurchase 9.9 million shares.
Total sales grew nearly 5 percent from a year earlier, to $10.14 billion, as complete vehicle assembly sales soared 39 percent to $1.7 million. Demand at the lower-profit unit was lifted by new launches for such automakers as Daimler and Jaguar.
Excluding one-time items, Magna earned $1.63 per share, down from $1.58 in the same period last year, but ahead of the consensus expectation of $1.59 per share, according to IBES data from Refinitiv.
Net income attributable to Magna fell to $456 million, or $1.37 per share, in the fourth quarter ended Dec. 31 from $559 million, or $1.54 per share, a year earlier.
Sales at Magna’s biggest unit, which makes vehicle structures, fell 4 percent to $4.18 million.
The company’s power and vision division, which also provides parts for electric and self-driving vehicles, recorded a 1 percent increase in sales to $2.9 billion.
Magna said it will invest $70 million in next-generation vehicles in 2019, down from $100 million in 2018, which will continue to erode margins in the power and vision unit.
Quarterly adjusted earnings of $1.63 per share bettered a consensus estimate of $1.59 per share, according to IBES data from Refinitiv. Net income attributable to Magna declined to $456 million from $559 million.
The results include a $60 million impairment charge, on a joint venture in Europe with Ford, reflecting declining demand for manual transmissions.
This news could help the stock continue its recovery after a steep sell off.
A Trade for Short Term Bulls
As with the ownership of any stock, buying MGA could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for MGA
Every day, we scan the markets looking for trades that MGA low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For MGA, the March 15 options allow a trader to gain exposure to the stock.
A March 15 $55 call option can be bought for about $0.90 and the March 15 $57.50 call could be sold for about $0.20. This trade would cost $0.70 to open, or $70 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $70.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in MGA the maximum gain is $1.80 ($57.50 – $55 = $2.50; $2.50 – $0.70 = $1.80). This represents $180 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $70 to open this trade.
That is a potential gain of about 157% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.