An engine block on display at the Martinrea International head office in Vaughan, Ont., on April 14, 2021.Tijana Martin/The Globe and Mail
As a small-cap investor, I was happy to note that The Globe and Mail’s Jennifer Dowty offered the option of a downloadable Excel file in her recent articles about analysts’ forecast returns and recommendations, a file that also included dividend yields and other data for all the stocks in the S&P/TSX Small Cap Index. She correctly points out that some of the forecast returns should be taken with a grain of salt, as they may be stale-dated, but this is still a great starting point for additional analysis by the individual investor. So, I promptly downloaded the spreadsheet.
The first stock that caught my eye was Martinrea International Inc. MRE-T, for several reasons. I already own it in my small-cap portfolio, it has an average return forecast of 68 per cent if it reaches the target price of $18 set by seven sell-side analysts and it is bizarrely classified as consumer discretionary on the spreadsheet. The company, in fact, manufactures a wide range of automotive component parts such as engine blocks, transmission housings and suspension modules. I don’t know about you, but that isn’t my idea of consumer discretionary spending in the shopping mall. Other components of the sector make more sense: Pet Valu, Canada Goose Holdings and Boston Pizza Royalties.
Setting aside this quibble, which doesn’t affect the outlook for the company, Martinrea’s valuation statistics are compelling. At a recent price of $11.30, the stock trades at 55 per cent of book value and three times its EV to EBITDA ratio (enterprise value to earnings before interest, taxes, depreciation and amortization – a broad measure of price to cash flow).
To be fair, most investors would regard Martinrea as an old-economy stock, but the company has not stood still. Over the past five years, revenues have grown at a little over 5 per cent a year, asset turnover has recovered from a COVID-19 slump and balance sheet leverage has been reduced steadily. As a result, return on shareholder equity has stabilized at around 10 per cent. Don’t forget, return on equity is based on shareholder book value and today’s investors are only being asked to pay 55 per cent of book value to own the stock. So, the return on our equity is almost double that number at 18 per cent.
When stocks trade at a bargain-basement price, there are always a few negatives on the horizon. In the case of Martinrea, the automotive industry customer base remains in some turmoil as the transition to electric vehicles is not going smoothly. Revenue for the six months ended June 30 was $2.6-billion, down 1.5 per cent from the same period in the prior year, while earnings per share were off 10 per cent at $1.10.
It is likely that revenue and earnings will face some headwinds until these and other supply chain issues are resolved, but the company appears to be well-positioned regardless of the outcome. In the second quarter report, the chief executive officer commented: “Our business is largely agnostic to propulsion type, which enables us to adapt to any mix of vehicles over time, and our North American-centric orientation and limited footprint in China is a positive in the current geopolitical environment.”
With a market capitalization of $840-million, Martinrea falls almost exactly at the midpoint of the S&P/TSX Small Cap Index, so typical trading volumes of about 140,000 shares a day should permit most individual investors to enter or exit the stock without major disruption. The company has been steadily buying back shares in the open market at a rate of about 2 per cent a year, including a 2.5-per-cent reduction in the most recent quarter. The dividend yield of 1.8 per cent is not overly generous, but with free cash flow of more than $100-million a year, there is no reason to fear a reduction.
The Excel spreadsheet contains a host of S&P/TSX Small Cap stocks with forecast returns in excess of the 68 per cent predicted for Martinrea, but few of them have the fundamental value ratios that make the company irresistible to a value investor. It remains a core holding in my portfolio.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.