For a company that describes itself as the most diversified automotive supplier in the world, it perhaps should come as little surprise that its financial reporting is byzantine. Add on the fact that three of its subsidiaries are public – Decoma, Intier, Tesma – and the remaining (Magna Steyr, Cosma and Magna Donnelly) are wholly-owned subsidiaries and the recipe for complexity is complete.

A cursory glance at Magna’s second quarter and half year results hints at the difficulties. The company’s second quarter sales of $5.11 billion were 39.7% ahead of sales in the same 2003 period, taking the half-year sales advance to 42.8% ($10.22bn). But this overall second quarter sales growth disguised a range of growth at the individual group operations extending from 7.2% to a staggering 187%. Profitability at the group level was left flagging in the wake of this expansion, the EBIT margin falling to 6.7% in the second quarter of 2004, down from 8.1% in the same 2003 period and the half-year margin easing to 6.5% from the previous year’s 7.8%. The second quarter EBIT margin across the individual group companies ranged from 4.4% to 10.3% and the actual EBIT changes when compared with the second quarter of 2003 ranged from +712% to -25.4%. An obvious question is, is Magna indulging in headlong expansion irrespective of the impact on earnings?

Navigating a path through the financial maze to answer this question is not easy, but some general directions seem clear. Unsurprisingly there is good news and bad news. The good news is that, even allowing for some positive currency effects, most of Magna’s operating divisions appear to be succeeding in growing organically in a benign vehicle production environment, especially in North America. Intier’s 24.5% sales growth in the second quarter and Tesma’s 22.2% growth owed much to expansion of average dollar content per vehicle (DCPV) in both North America and Europe. In Europe, Intier’s DCPV rose to $95 from $88 in 2003, some of which resulted from sterling and euro strengthening against the dollar but which was also driven by new business start-ups such as the door panel contract for the new BMW 1 Series and door panels, interior trim, carpet and cargo management system for the new Mercedes-Benz A-Class. Tesma’s North American DCPV increased 22% to $53 in the quarter although the company’s recent acquisition of Davis Industries played a part in this growth.

The bad news is that in some cases, EBIT growth simply couldn’t keep pace with sales expansion. Tesma’s 22.2% sales growth was accompanied by EBIT growth of a much more modest 4.7%, dragging the margin back to a still very creditable 10.3% in the quarter, from 11.1% in 2003. Combined sales growth at Cosma and Magna Donnelly was 7.2% in the second quarter of 2004 but EBIT slipped 3.2%, pulling the margin down one point to 9.6% when compared with the same period in 2003. Conversely, Intier was on a roll. Its 24.5% sales growth was accompanied by EBIT progress of 59.5%, taking the margin up to 4.7%, one point higher than in the second quarter of 2003. A combination of higher sales, lower start-up costs at new facilities and increased operating efficiencies at some divisions compared with the same period in 2003 delivered the margin improvement.

Aside from these general trends, two specific situations, at Decoma and Magna Steyr respectively have to be highlighted. Decoma, Magna’s exterior components and systems operation, continues to face challenges. Put starkly, the division’s sales in the second quarter of 2004 when compared with the same 2003 period, increased 12.6% to $689 million but EBIT fell 25.4% to $44 million, lopping over three points off the margin (6.4% against 9.6%) in the process. This poor second quarter result meant that the six-month sales increase was held back to 18.5% and the EBIT decline was 14.7%. Although the half-year margin was still an acceptable 6.6%, down from 9.2% in the first half of 2003, the recent trend gives cause for some concern, especially as the underlying problems appear to be ongoing. Although Decoma’s North American DCPV slipped by $1 to $94 and its North American production sales fell 1% to $391.8m, it is the company ‘s European operations that lie at the heart of Decoma’s sliding profitability.

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At first glance this appears to be conundrum. Decoma’s average DCPV in Europe in the second quarter of 2004 was $50, a 43% jump from the 2003 level. Production sales in the region amounted to $220.9 million, a 44% hike. Even stripping out obvious currency benefits, which accounted for $2 of the $15 jump in DCPV, some impressive organic growth resulting from increased sales at new European facilities was apparent. Indeed, this added $10 to the DCPV improvement in the quarter. Ramp up of bumper (fascia) and front-end module output for the new VW Golf, supplied from the Belplas and Brussels Sequencing Centre respectively played a major part in this. Sadly, the bright sales picture in Europe contrasts with the darker profit situation. Although second quarter profits in North America fell 20% to $49.8 million, the operating margin was still an impressive 11.8%. In Europe, losses apparent since early 2003 continued. The second quarter 2004 loss of $5.9m was $5.7 million higher than in the same period of 2003. In other words, sales in Europe in the April-June 2004 period were up 44% but losses multiplied almost 30 times. Clearly some special factors were at work. A big problem remains that the new Belplas paint line, which was fired up in the fourth quarter of 2003 to supply the Golf programme, continues to run way below capacity, partly because take-off for the new Golf has been below anticipated volumes. In addition, Decoma has noted that “although improving, first run yields are currently below standard”. In other words, productivity has missed targets and demand is lower than expected, a potent combination that has dented financial performance. Operating losses at Belplas and the related Brussels Sequencing Centre increased $5.3 million in the second quarter of 2004 as compared to the same 2003 period. With front-end module output for the VW T5 Transporter at the Modultec fa cility also being the subject of “lower than anticipated customer production volumes”, Volkswagen is proving a challenging customer for Decoma to service. The only glimmer of hope for the future is that Decoma initiated a Continental Europe Paint Capacity Consolidation Plan at the end of 2003 and this is expected to lift capacity utilization at the Belplas facility significantly, albeit not until 2005. Its also of some comfort that the Q2 2004 loss in Europe was some way shy of the losses of $9 million, $10.4 million and $10.7 million suffered in Q3 2003, Q4 2003 and Q1 2004 respectively.

Magna Steyr, Magna’s Austria-based, wholly-owned subsidiary specialising in complete vehicle engineering and assembly of low-volume models, is also a special case with its own unique complexity. The straightforward details of its 2004 financial performance are little short of spectacular. In Q2 2004, sales rose 187% to $1,484 million, overtaking Intier as Magna’ s largest operation in the process, and EBIT soared by 712% to $65m. Half-year growth rates were 175% and 700% respectively. The reasons for this are equally straightforward. Magna Steyr’s vehicle assembly volumes in Q2 accelerated by 129% to 60,298 units, reflecting the start-up of BMW X3 and Saab 9-3 convertible assembly. These joined existing output of the Mercedes-Benz G-Class and E-class 4MATIC and the Chrysler Voyager and Jeep Grand Cherokee models. Sales at Magna Drivetrain, part of Magna Steyr also rose, partly on the back of the BMW X3 programme and partly from additional business on the X5. This increase in assembly volumes was obviously the prime driver for the much-improved EBIT performance although the relationship between Magna Steyr’s vehicle assembly volumes and its profitability is more complex than first appears.

The terms of Magna Steyr’s assembly contracts differ with regard to the ownership of components and supplies related to the assembly process and method of determining the selling price to the OEM customer. On so-called full-costed contracts, including those for the BMW X3 and Saab 9-3 convertible, Magna Steyr acts as principal and purchased components and systems in the vehicles are included in the supplier’s inventory and cost of sales. These costs are reflected on a full-cost basis in the selling price of the assembled vehicle to the OEM. Other contracts, such as those for the Chrysler and Jeep models, provide that third party components and systems are held on consignment and the selling price to the OEM reflects a value-added assembly fee only. The full-costed/value-added assembly mix has a direct impact on sales and margins but not necessarily overall profitability. A relative increase in full-costed vehicle assembly, as is happening in 2004, can have the effect of increasing the level of total sales but lowering margins, but only if overall assembly volumes are static. This is because purchased components are included in cost of sales. Conversely, a relative increase in value-added vehicle assembly can have the effect of reducing total sales but raising reported margins.

A number of conclusions are apparent, aside from the fact that Magna’s quarterly financial results demand close scrutiny of the details. First, Magna is clearly growing at a phenomenal rate when compared with peer suppliers and a significant portion of this is organic growth based on increasing per vehicle content penetration. The company is looking for 2004 sales in the $19 billion-20 billion range, around 24-31% higher than the 2003 result. Although this clearly implies a slowing in sales growth in the remaining two quarters of the year, it excludes the impact from the final conclusion of the New Venture Gear acquisition from DaimlerChrysler. This should add at least a further $1.5 billion to annualised sales in the future. Second, earnings growth is not keeping pace with this sales expansion, largely because a significant portion of sales growth has occurred in Magna’s lower-margin businesses, most notably Intier and Magna Steyr. This is no cause for real concern although continuing weakness at Decoma is. It remains clear that some businesses continue to drag down Magna’s overall profitability and this must be the subject of continuing improvement efforts. Only through such measures will Magna be able to combine its most diversified supplier title with that of one of the most profitable.