While Canadian consumers have had a tough time of late thanks to high inflation and interest rates, the outlook is looking brighter. That could be good news for consumer stocks.
The Bank of Canada has begun cutting interest rates and is expected to continue easing monetary policy in the months ahead. Meanwhile, inflation pressures have come down significantly. That combination should allow more breathing room for household spending, especially when it comes to mortgage payments, and in turn, give a boost to companies that heavily rely on consumer spending.
Consumer cyclical stocks tend to outperform the market when consumer sentiment is positive, and their stock prices can tick higher during periods of economic rebound. As of Aug. 2, 2024, the S&P/TSX Capped Consumer Discretionary Index increased 5.85% for the year to date, slightly outperforming the S&P/TSX Composite Index's 5.69% gain. This bodes well for the consumer discretionary sector.
Investors looking to capitalize on the resurgence of the consumer cyclical sector may find attractive opportunities in the following stocks, which are trading significantly below their fair value estimates, offering attractive investment opportunities.
Two stocks that fit the bill are:
Here’s a closer look at these two undervalued stocks.
Magna International
Analyst: David Whiston, CFA, CPA, CFE
- Fair Value Estimate: C$89.00
- Price/Fair Value: 0.63
- Morningstar Economic Moat Rating: None
- Morningstar Capital Allocation Rating: Standard
- Morningstar Rating: 4 stars
Canadian auto parts maker Magna International produces exteriors, interiors, seating, roof systems, body and chassis, powertrain, vision and electronic systems, and electric vehicle systems, among others. North America accounts for nearly half of Magna's revenue, with Europe contributing 38% and the remainder coming from Asia. GM, Mercedes, and BMW are three of the firm's top six customers and constitute 76% of its revenue.
Factors such as falling interest rates and rising consumer confidence levels are favorable for vehicle sales and, in turn, beneficial for auto and auto parts manufacturers.
“Magna's capabilities are so broad that the firm can nearly design, develop, supply, and assemble vehicles all on its own,” writes Morningstar strategist David Whiston in his analyst report. But Whiston adds that while Magna's Complete Vehicle segment has potential for growth with startup EV makers, the operation is highly capital intensive with limited margin, constraining return on invested capital.
The firm has a clean and robust balance sheet with limited debt liability which provides stability and support during severe economic downturns, such as the coronavirus crisis and the chip shortage, the report adds.
“With limited leverage on the balance sheet, Magna could make a relatively large acquisition if the right opportunity were to present itself,” says Whiston, who recently lowered the stock’s fair value estimate to CAD 89 from CAD 97, to reflect lower revenue and adjusted EBIT margin guidance for 2024 and 2026.
“Despite the bad news in the quarter, we think Magna’s stock remains a good bargain for long-term investors willing to wait out the negative sentiment often surrounding auto suppliers” Whiston says. “We also expect the company to announce a share buyback late this year or in early 2025 that could lift the share price.”
Spin Master
Analyst: Jaime M. Katz, CFA
- Fair Value Estimate: C$43.50
- Price/Fair Value: 0.73
- Morningstar Economic Moat Rating: None
- Morningstar Capital Allocation Rating: Standard
- Morningstar Rating: 4 stars
A leading global children's entertainment company, Spin Master creates, designs, manufactures, and markets entertainment products. Its portfolio comprises products, brands, and entertainment properties across multiple categories including outdoor, wheels and action, preschool and plush, games and puzzles, dolls, and interactive, among others.
The Canadian toymaker, which sells its products across 100 countries, boasts several homegrown brands including Paw Patrol, Hatchimals, Rusty Rivets, and Bakugan. More recently, it has expanded to several adjacent markets through strategic tie-ups.
Spin Master has captured a 2% share in the fragmented, more than $100 billion global toy industry. “Utilizing a multifaceted plan for growth, focusing on innovation in toys and digital games, higher penetration of overseas markets (over 40% of sales), the pursuit of strategic acquisitions, and the development of evergreen global entertainment properties, Spin Master has the ability to grow into nascent product and geographies,” says Morningstar senior analyst Jaime Katz.
These attributes should enable the firm to outperform the global toys and games industry, which Euromonitor forecasts to grow at 4% annually from 2024 through 2027.
Spin Master is projected to amass a free cash flow of around $265 million over the next decade, enabling it to invest in its operations and strategically acquire new assets, says Morningstar Katz, who recently lowered the stock’s fair value to CAD 43.50 from CAD 46 “after digesting first-quarter results.”
In the long term, though, the company can boost sales through product innovation, strategic acquisitions, and growth in emerging markets.
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