Although Canadian consumers have had a tough time recently due to high inflation and interest rates, the future is looking brighter. That could be good news for consumer stocks.
The Bank of Canada has begun cutting interest rates and is expected to ease monetary policy further in the coming months. At the same time, inflationary pressures have eased significantly. This combination should give households more room to spend, particularly on mortgage payments, and in turn provide a boost to businesses that rely heavily on consumer spending.
Consumer cyclical stocks tend to outperform the market when consumer sentiment is positive, and their share prices can move higher during times of economic recovery. As of August 2, 2024, the S&P/TSX Capped Consumer Discretionary Index rose 5.85% year to date, easily outperforming the S&P/TSX Composite Index’s gain of 5.69%. This bodes well for the consumer cyclical sector.
Investors looking to capitalize on the resurgence of the consumer discretionary sector may find attractive investment opportunities in the following stocks, which are trading well below their estimated fair value.
Two stocks that fit into this category are:
- Magna International MG
- Spin Master TOY
Here’s a closer look at these two undervalued stocks.
Magna International
Analyst: David Whiston, CFA, CPA, CFE
Canadian auto parts maker Magna International produces exterior and interior trim, seating, roof systems, bodies and chassis, powertrains, vision and electronics systems, and electric vehicle systems, among other products. Nearly half of Magna’s sales come from North America, 38% from Europe, and the rest from Asia. GM, Mercedes, and BMW are three of the company’s six largest customers, accounting for 76% of its sales.
Factors such as falling interest rates and rising consumer confidence are boosting vehicle sales, which in turn benefit auto and auto parts manufacturers.
“Magna’s capabilities are so broad that the company can design, develop, deliver and assemble vehicles almost entirely in-house,” writes Morningstar strategist David Whiston in his analyst report. However, Whiston adds that while Magna’s “complete vehicle” segment has growth potential with new electric car manufacturers, the business is very capital intensive and offers limited margins, limiting returns on capital.
The company has a clean and solid balance sheet with limited debt liability, providing stability and support during severe economic downturns such as the coronavirus crisis and the chip shortage, the report added.
“Given the limited debt on the balance sheet, Magna could make a relatively large acquisition if the right opportunity presents itself,” says Whiston, who recently cut the stock’s fair value estimate from C$97 to C$89 to reflect lower revenue and adjusted EBIT margin forecasts for 2024 and 2026.
“Despite the bad news in the quarter, we believe Magna stock remains a good deal for long-term investors willing to ride out the negative sentiment that often surrounds auto suppliers,” says Whiston. “We also expect the company to announce a share buyback later this year or in early 2025, which could boost the share price.”
Spin Master
Analyst: Jaime M. Katz, CFA
Spin Master is a global leader in children’s entertainment, developing, manufacturing and marketing entertainment products. Its portfolio includes products, brands and entertainment items in numerous categories, including outdoor, wheels and action, preschool and plush, games and puzzles, dolls and interactive products.
The Canadian toy manufacturer, which sells its products in 100 countries, has several of its own brands, including Paw Patrol, Hatchimals, Rusty Rivets and Bakugan, and has recently expanded into several adjacent markets through strategic collaborations.
Spin Master has captured a 2% share of the fragmented, $100 billion-plus global toy industry. “With a multi-pronged growth plan focused on innovation in toys and digital games, greater penetration of foreign markets (over 40% of revenue), pursuit of strategic acquisitions, and development of evergreen global entertainment products, Spin Master has the ability to grow into new products and geographies,” said Jaime Katz, senior analyst at Morningstar.
These characteristics should enable the company to outperform the global toys and games industry, which Euromonitor forecasts will grow by 4% annually between 2024 and 2027.
According to Morningstar Katz, Spin Master is expected to generate around $265 million in free cash flow over the next decade, allowing the company to invest in its business and strategically acquire new assets. The company recently cut the stock’s fair value from $46 to $43.50 CAD “after processing first quarter results.”
In the long term, however, the company can increase its sales through product innovations, strategic acquisitions and growth in emerging markets.
