industrial strategy & quantitative strategy; head of...

EQUITY RESEARCH | SPOTLIGHTMonday, April 17, 2017, After Close

For Reg AC Certification and important disclosures see Appendix A of this report. Analysts employed by non-U.S. affiliates arenot registered/qualified as research analysts with FINRA in the U.S.

1

Dissemination: April 17, 2017, 16:30 ET. Production: April 17, 2017, 16:23 ET.

Industrial StrategyCycle Watching: Autos vs. Equipment

OUR TAKE: One of the most frequent questions we get from investors is, “Where arewe in the economic cycle?” Although it is getting late in the current cycle (it has lastedalmost eight years), the tepid U.S. expansion phase and the slow pace of normalizingmonetary policy have, in our view, set the stage for extra innings. For this reason, webelieve U.S. and global economic growth is the most likely scenario for the 2017-2018period. We are closely monitoring end-of-cycle warning signs (e.g., U.S. jobless claimsreverting to above 300,000 and two-year yields trending back down), but we believe it ispremature to write the cycle’s obituary.

We turn our focus to the implications of the economic cycle for two industrial sectors –namely, industrial equipment distributors and vehicle sales and production – and twoplayers in those sectors: Finning International Inc. (FTT) and Magna International Inc.(MGA). We believe the cycle discussion will remain pivotal heading into 2018 as othercentral banks potentially set out on the normalization path started by the U.S. FederalReserve.

Buy FTT for a cyclical upturn and margin turnaround. We believe equipmentexpenditures are currently well below replacement demand in most major markets, andalthough commodity production continues unabated (and has, so far, been largely priceinelastic in most cases), commodity-levered markets have seen the largest purchasedeferrals, with mining equipment expenditures dropping roughly 70% from peak totrough. However, the recent rebound in commodity prices has restored profitability at atime when miners will need to re-invest in fleets as downtime becomes relatively moreexpensive. Therefore, our preferred way to play the equipment space in the anticipationof a cyclical recovery is with FTT. We believe FTT’s story combines a mining-relatedcyclical upturn and a margin turnaround, which supports structurally higher mid-cycleEPS. In fact, despite the move in its share price, we still see roughly 40% upside in thename as we move to mid-cycle.

Buy MGA on an extended cycle (and on valuation), not for further upside to sales.Although we are closely monitoring cycle risks (e.g., declining used-vehicle prices, risingincentives, higher interest rates, etc.), we view “plateauing” auto sales (at levels wellabove replacement demand) as the most likely base-case scenario in the context of 2%to 3% U.S. GDP growth, a robust U.S. job market, and positive global PMI momentum.However, we believe Canadian auto suppliers (including MGA) are pricing in somethingmuch worse (i.e., industry sales volumes declining to levels more consistent withreplacement demand and an overly draconian view on Canada-specific trade risks), withthe Canadian suppliers trading at a discount of approximately 25% to their U.S. peers.

FTT is better positioned for mean reversion, but MGA is unfairly discounted. In thecontext of mean reversion (as well as the consumer-versus-investment cycle), we preferFTT over MGA as commodity-levered equipment markets are positioned for a multi-year recovery, while auto sales should remain resilient in the current environment butwill likely decline as they eventually revert to mean. That being said, multiples for bothsectors (and companies) already partially capture the eventual mean reversion and, inthe case of MGA, a non-cycle-related material discount.

ANALYST TEAM Link to ScotiaView

Vincent Delisle, CFA | Managing Director, Portfolio& Quantitative Strategy; Head of Equity Research,Quebec514-287-3628Scotia Capital Inc. - Canada

Michael Doumet, CFA | Analyst514-350-7778Scotia Capital Inc. - Canada

Mark Neville, CFA | Analyst514-350-7756Scotia Capital Inc. - Canada

COVERAGE SUMMARY

Rating 1-Yr. Target ReturnFTT-T SO C$28.50 20.1%LNR-T* SO C$80.00 45.6%MGA-N* SO US$65.00 65.3%MRE-T* SP C$13.50 45.4%*Companies with pertinent revisions

https://www.scotiaview.com/authors/vdelisle

mailto:[email protected]



Table of Contents

Cycle Watching: Autos vs. Equipment 1

Where We Are in the Cycle 3 U.S. GDP Cycle: Current Expansion Past the Halfway Point, but Fed Policy Lagging 5

ISM and S&P 500 EPS Cycle: Longer Than Average 6

Tracking the Cycle Outside the United States 7

Consumer Spending, Non-residential Construction, and Mining Capex at Different Stages 8

World Manufacturing PMI Forecasts – Scenario Analysis 10

Equipment: Recovery Road 11 Picking Our Horse: Finning International Inc. 13

Scenario Analysis: Recovery Road 14

Risk/Reward Trade-Off: Finning International Inc. (FTT-T) 23

Autos: The Auto Cycle Still Has Legs 24 U.S. Sales to Plateau near Current Levels 25

Still Room to Recover in Europe 27

Expecting More Moderate Rates of Growth in China 27

View Mid-cycle Sales at 15 Million Units 28

What’s Being Reflected Now? 29

Scenario Analysis 30

Buy MGA on an Extended Cycle (and on Valuation), Not on Further Upside to SAAR 32

Risk/Reward Trade-Off: Linamar Corporation (LNR-T) 37

Risk/Reward Trade-Off: Magna International Inc. (MGA-N) 38

Risk/Reward Trade-Off: Martinrea International Inc. 39

Pricing as at April 12, 2017, unless otherwise stated.

Currencies in Canadian dollars unless otherwise stated.


2

Where We Are in the Cycle

From an asset-mix standpoint, assessing where we are in the cycle is always a key question for investors.

Eight years after the last U.S. recession ended and with the Fed raising interest rates for the first time in a

decade, we believe the cycle discussion has become more important. Portfolios should stick with an

equity/cyclicals preference throughout economic expansions and turn outright defensive/raise cash when the

cycle is about to end (i.e., when recession signals emerge). Although the duration of the current U.S.

economic cycle is longer than average (the economy and the S&P 500 both troughed in Q2/09), the tepid

nature of the expansion phase, the Fed’s extended dovish policy, and the slow pace of normalizing rates

argue, in our view, against prematurely writing the cycle’s obituary. Moreover, Q4/16 and Q1/17 have

highlighted the first steps in synchronized global growth since 2009, and our recession radar points to

negligible risks.

Economic cycles usually end with tighter monetary policies, spurred by threatening inflation. We are

definitely not there yet. Moreover, U.S. recessions seldom start with steep yield curves, rising consumer

confidence, rebounding corporate profits, and improving jobless claims. Credit demand (i.e., loan growth)

appears to be the only segment showing signs of fatigue, and we will monitor it very closely. Still, the

probability of a U.S. economic recession (in the next 12 months) appears negligible, based on our U.S.

recession radar (see Exhibit 1).

Globally, momentum in Europe, Japan, and China has picked up since mid-2016. Macroeconomic

momentum outside the United States is supported by pro-growth monetary policies, pent-up consumer and

business spending demand in Europe and Japan, and improving U.S. import demand (U.S. imports are

running at a pace of +4% YOY in Q1/17). Another factor helping the global economy is the YOY recovery in

commodity prices.

Inflation has remained below central bank targets, enabling policy-makers to stick to their dovish biases for

much longer. Trade renegotiations could, however, push prices up and complicate the process of

normalizing monetary policies, and the uncertainty surrounding U.S. trade policy represents a key risk if

Congress adopts counterproductive trade initiatives. Based on President Donald Trump’s failure to repeal

Obamacare, we believe the possibility of a trade-policy misfire that would jeopardize U.S. corporations is

remote. Personal and corporate tax reductions may wind up being easier to implement for the Trump

administration and have positive implications.


3

Warnings signs to monitor. We believe the risk of a U.S. hard landing is low. Jobless claims (see Exhibit

2) and two-year yields (see Exhibit 3) are two indicators that tend to issue warnings of a hard landing to

come. Claims moving up (and passing 300,000) and U.S. short-term yields moving down would, in our view,

be end-of-cycle signals. Both indicators remain in pro-growth territory.

Exhibit 1: U.S. Recession Radar

* On average, the ISM manufacturing has been down five points year over year (last 12 months) when U.S. recessions start.

Source: Scotiabank GBM Portfolio Strategy; Bloomberg; Thomson Financial; NBER; Federal Reserve.

ISM Manufacturing 12M Change in Level +8.0 -5.0

Jobless Claims YoY -9% +11%

Consumer Confidence YoY +18% -10%

Vehicle Sales YoY +1% -6%

Leading Indicators YoY +3% -3%

BBB Spread -84 +17

Yield Curve (10Yr-3M) +2 -27

Real Fed Fund Rate +20 +187

S&P 500 +14% -4%

Dow Transport +13% -4%

Dow Utilities +5% -1%

Trailing P/E 12M Change in Level +1.8 -1.7

Trailing EPS YoY +3% +6%

50D MA to 200D MA Level +6% -1%

NYSE A/D Line YoY YoY +14% -7%Technicals

Equities

Economic

Data

EPS & P/E

12M Change in

Level (bp)Yields

YoY

NowAverage when

Recession starts*Data

Exhibit 2: Jobless Claims (000) and U.S. Economic Cycles

Source: Scotiabank GBM Portfolio Strategy; Bloomberg.

100

200

300

400

500

600

700

100

200

300

400

500

600

700

Jan-6

7

Jan-7

0

Jan-7

3

Jan-7

6

Jan-7

9

Jan-8

2

Jan-8

5

Jan-8

8

Jan-9

1

Jan-9

4

Jan-9

7

Jan-0

0

Jan-0

3

Jan-0

6

Jan-0

9

Jan-1

2

Jan-1

5

Jan-1

8

Recessions tend to happen on average 62 w eeks following the

trough in jobless claims

Exhibit 3: U.S. Two-Year Yields and U.S. Economic Cycles


0

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

Jan-9

7

Jan-9

9

Jan-0

1

Jan-0

3

Jan-0

5

Jan-0

7

Jan-0

9

Jan-1

1

Jan-1

3

Jan-1

5

Jan-1

7

NBER Recessions

U.S. 2-Yr Yields - LHS

200 Day Moving Average

50 Day Moving Average


4

U.S. GDP Cycle: Current Expansion Past the Halfway Point, but Fed Policy Lagging

In terms of duration, the 2009-2017 U.S. economic cycle (approaching eight years) is already well above the

historical average of 5.6 years, based on nine cycles since 1948 (see Exhibit 4). The nine U.S. economic

cycles have been established by the U.S. National Bureau of Economic Research (NBER) and refer to the

trough-to-peak cycles since 1948 (i.e., from the end of one recession to the start of the next). In terms of

growth, however, the current U.S. GDP cycle is well below average, with a tepid 2.1% annualized growth

(which is actually the worst growth rate of all nine economic cycles). Not surprisingly, the pickup in inflation

since the trough in 2H/09 has been subdued (the 14% increase in the core consumer price index [CPI] since

Q3/09 is below average).

We believe that evaluating this cycle from the end of the last U.S. recession can distort the picture. We

prefer to separate the “recovery” from the “expansion” phase. Since the last recession dealt a severe blow to

the U.S. economy, the recovery phase was much longer and U.S. GDP didn’t claw its way back to its 2007

peak until Q3/11. That means the current expansion phase stands at five years, in line with the average U.S.

expansion (see Exhibit 5). Moreover, during longer cycles (i.e., more than five years – in four out of the last

nine economic cycles), the average expansion phase was nearly eight years.

As highlighted in Exhibit 5, the first Fed rate increase generally occurs 15 months after the start of an

expansion. In the current cycle, the first Fed rate hike (in December 2015) came 51 months after the start of the

expansion. A look at how the U.S. yield curve (10-year yield minus three-month yield) evolves during the U.S.

GDP cycle also sheds light on the lag in the current monetary policy. At this stage of the expansion, the U.S.

slope tends to be much flatter (see Exhibit 6). Dovish Fed policy and the slow pace of normalization have kept

the curve relatively steep, which we believe supports extended innings for the U.S. economic cycle.

Exhibit 4: U.S. GDP Cycles Since 1948 – Trough to Peak

Source: Scotiabank GBM Portfolio Strategy; Bloomberg; NBER; U.S. Bureau of Labor Statistics.

Duration (Years) Annualized Real Growth Total Core CPI Increase

Best 9.8 7.6% 48%

Average 5.6 4.6% 22%

Worst 2.0 2.7% 3%

Excludes Current Cycle from Statistics. Best Grow th not necessarily during Best Duration

Current Cycle 7.5 2.1% 14%


5

ISM and S&P 500 EPS Cycle: Longer Than Average

Since 1948, there have been 14 S&P 500 earnings cycles (versus nine recessions). In our view, the higher

frequency of the S&P 500 gyrating in tandem with the Institute for Supply Management (ISM) data is more

important for investors to watch than simply handicapping recession odds (see Exhibit 7). We believe

tracking the ISM (the 12-month average) is one of the best ways to assess S&P 500 corporate profits and

hence the cycle.

Following a flat period in 2015, which was mostly related to oil shock, positive ISM momentum resurfaced in

2H/16 and profit growth resumed. S&P 500 2016 EPS hit US$119, up a modest 0.4% from 2015. We expect

growth to improve to the low double digits by mid-2017 on easier YOY comps and an ISM of 55+. In our

view, favourable U.S. tax adjustments could extend this EPS cycle. Since the start of the current ISM cycle

(8.3 years ago versus the average of 4.6 years), S&P 500 EPS has increased at a 10% CAGR (versus the

average of +14%). P/E expansion has also been above average in terms of duration and change (the trailing

P/E is up 85% from the recession trough).

Exhibit 5: U.S. Recovery and Expansion Cycles – GDP

Source: Scotiabank GBM Portfolio Strategy; Bloomberg; NBER.

95

100

105

110

115

120

125

130

95

100

105

110

115

120

125

130

t -2

7

t -1

8

t -9 t 0

t +9

t +18

t +27

t +36

t +45

t +54

t +63

t +72

t +81

Months

Current Cycle

Average Cycle

ExpansionRecovery

Average First Rate Hike

Fed First Rate Hike

GDP normalized at 100 on expansion

beginning.

Exhibit 6: U.S. Recovery and Expansion Cycle – Yield Curve

Note: Yield curve = U.S. 10-year yield less U.S. three-month yield.


-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

t -2

7

t -1

8

t -9 t 0

t +9

t +18

t +27

t +36

t +45

t +54

t +63

t +72

t +81

t +90

t +99

t +108

Months

Current Cycle

Average Shorter Cycles

Average Medium Cycles

Average Longer Cycles

Recovery Expansion

Exhibit 7: U.S. ISM and S&P 500 EPS Cycles Since 1948

Source: Scotiabank GBM Portfolio Strategy; Bloomberg; Thomson Financial (EPS from 1985 to present); Shiller (EPS from 1948 to 1984); NBER; Federal Reserve; U.S. Bureau of Labor Statistics.

ISM Real Fed Fund Rate

Duration (Yr) Duration (Yr) CAGR Duration (Yr) % Change At End of Cycle

Highest 8.7 6.3 22% 7.4 97% 5.2%

Average 4.6 3.1 14% 3.7 45% 2.1%

Lowest 1.7 0.8 5% 1.5 -6% -4.2%

Excludes Current Cycle from Statistics. Best/Worst Grow th not necessarily during Best/Worse Duration

Current Cycle 8.3 7.4 10% 8.1 85% 1.0%

Trailing EPS P/E Ratio


6

Tracking the Cycle Outside the United States

Although the U.S. economic cycle is a key factor in assessing the state of the broader global

macroeconomic landscape, the world PMI trend also provides valuable insight (see Exhibits 9 and 10). After

stalling in 2015 and early 2016, global growth picked up momentum in the second half of 2016, and the

rebound has been visible in the United States, Europe, Japan, and China. The pace of growth is not as

robust as in the mid-2000s, but the synchronized global growth is a welcome development.

Also supporting our thesis of an extended U.S. and global economic cycle is the fact that most central banks

(other than the Fed) have yet to start normalizing their monetary policies. Since economic cycles usually

come under pressure in tightening conditions, we believe the odds of a global recession are low. Exhibit 10

compares the global PMI survey and global long-term bond yields, with the PMI lagged by 15 months.

Based on this relationship, the global PMI should stay in expansion territory (i.e., above 50) through 2017

before fading in 2018, although we don’t expect global PMIs to take a severe and synchronized dive under

the 50 line.

Exhibit 8: S&P 500 EPS Expansion Cycles and ISM Manufacturing

Source: Scotiabank GBM Portfolio Strategy; Bloomberg; Shiller (EPS from 1948 to 1984); Thomson Financial (EPS from 1985 to present).

30

35

40

45

50

55

60

65

70

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Dec-

48

Dec-

52

Dec-

56

Dec-

60

Dec-

64

Dec-

68

Dec-

72

Dec-

76

Dec-

80

Dec-

84

Dec-

88

Dec-

92

Dec-

96

Dec-

00

Dec-

04

Dec-

08

Dec-

12

Dec-

16

EPS Expansion Period

S&P 500 12M Trailing EPS YoY - LHS

ISM Manufacturing 12M Average - RHS


7

Consumer Spending, Non-residential Construction, and Mining Capex at Different Stages

Some segments of the global economy have recovered as expected throughout the cycle, but other areas

have yet to normalize. Consumer spending and residential investment (i.e., housing) have been an

important growth driver in many countries, while business investment and non-residential construction (e.g.,

infrastructure) have lagged. Mining capital expenditures are down 30% YOY and sit near 10-year lows.

As a percentage of GDP, U.S. consumer spending stood at 69% in Q4/16, above its pre-2008 levels.

Residential construction took more time to rebound, but mean reversion has accelerated in the last few

years, and housing’s share of GDP is closer to its 40-year average. In contrast, business spending and

private investments have recovered to a 16% share of U.S. GDP, still below its long-term average.

Disappointing business investment is surprising, especially in the United States, considering the above-

average earnings recovery since 2009. Non-residential construction has also lagged. If the U.S. and global

economic expansion continues, we believe business investment and non-residential construction will be key

drivers of growth.

Exhibit 9: ISM/PMI Trends: U.S., Europe, China, and Japan

* China PMI: Average of government PMI and Caixin PMI.


38

40

42

44

46

48

50

52

54

56

58

38

40

42

44

46

48

50

52

54

56

58

Dec-

06

Dec-

07

Dec-

08

Dec-

09

Dec-

10

Dec-

11

Dec-

12

Dec-

13

Dec-

14

Dec-

15

Dec-

16

Dec-

17

World

U.S.

Europe

China*

Japan

12-M Moving Average

Exhibit 10: Global PMI Momentum Remains Positive

* Based on the median 10-year bond yields of 11 countries.


-250

-200

-150

-100

-50

0

50

100

150

20042

44

46

48

50

52

54

56

58

60

Dec-

96

Dec-

98

Dec-

00

Dec-

02

Dec-

04

Dec-

06

Dec-

08

Dec-

10

Dec-

12

Dec-

14

Dec-

16

Global 10-Yr Yields* (YoY chg. in bp; Inverted) - RHS

Global PMI (15-m lag) - LHS

Exhibit 11: U.S. Consumer Spending and Residential Construction as a Percentage of GDP


2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

60%

61%

62%

63%

64%

65%

66%

67%

68%

69%

70%

Mar-

80

Mar-

84

Mar-

88

Mar-

92

Mar-

96

Mar-

00

Mar-

04

Mar-

08

Mar-

12

Mar-

16

Mar-

20

Consumer Spending - LHS

Consumer Spending (1980-Present Average) - LHS

Residential Construction - RHS

Exhibit 12: U.S. Private Investments and Non-residential Construction as a Percentage of GDP


2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

12%

13%

14%

15%

16%

17%

18%

19%

20%

21%

Mar-

80

Mar-

84

Mar-

88

Mar-

92

Mar-

96

Mar-

00

Mar-

04

Mar-

08

Mar-

12

Mar-

16

Mar-

20

Private Investments - LHS

Private Investments (1980-Present Average) - LHS

Non-Residential Construction - RHS


8

This dichotomy between the recovery in consumer spending and residential construction and the recovery in

business spending and non-residential construction is reflected in the auto industry and equipment

distributors. U.S. vehicle sales and production have returned to normal in sync with the recovery in

consumer confidence and employment. Some retail sales have suffered throughout the cycle, however, as

consumers shifted to online purchases and prices deflated, but housing (home improvement) and autos

have followed the uptrend in improved consumer confidence.

In contrast, sales for business spending and non-residential proxies (S&P 500 Machinery) are at a five-year

low (Caterpillar Inc. [CAT] is at a six-year low), which is partly echoed in still-weak non-residential

construction. President Trump’s economic plan includes infrastructure spending, which could accelerate the

mean reversion in the non-residential space.

Mining capital expenditures are also

suffering from the post-commodity-super-

cycle hangover, and we estimate that

industry capex was down 30% YOY in

2016. The YOY pickup in commodity

prices and the ensuing improvement in

profitability bode well for 2017-2018. As

illustrated in Exhibit 15, the potential for

mean reversion in equipment distributors

is quite appealing.

Exhibit 13: U.S. Vehicles Sales and Production Growth


-60%

-40%

-20%

0%

20%

40%

60%

-60%

-40%

-20%

0%

20%

40%

60%

Jan-6

8

Jan-7

2

Jan-7

6

Jan-8

0

Jan-8

4

Jan-8

8

Jan-9

2

Jan-9

6

Jan-0

0

Jan-0

4

Jan-0

8

Jan-1

2

Jan-1

6

Jan-2

0

Recessions as Defined by theNBER

US Total Vehicle Sales YoY(smoothed)

US Total Vehicle ProductionYoY (smoothed)

Exhibit 14: U.S. Vehicles Sales and Consumer Confidence


-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

Jan-6

8

Jan-7

2

Jan-7

6

Jan-8

0

Jan-8

4

Jan-8

8

Jan-9

2

Jan-9

6

Jan-0

0

Jan-0

4

Jan-0

8

Jan-1

2

Jan-1

6

Jan-2

0

Recessions as Defined by the NBER

US Total Vehicle Sales YoY (smoothed) - LHS

US Consumer Confidence YoY (smoothed) - RHS

Exhibit 15: Mining Industry – Capex and EPS

* Basket of 178 major mining companies taken from the Bloomberg World Mining Index.

Source: Scotiabank GBM Portfolio Strategy estimates; Bloomberg.

-40%

-20%

0%

20%

40%

60%

80%

100%

-100%

-50%

0%

50%

100%

150%

200%

250%

Dec-

91

Dec-

93

Dec-

95

Dec-

97

Dec-

99

Dec-

01

Dec-

03

Dec-

05

Dec-

07

Dec-

09

Dec-

11

Dec-

13

Dec-

15

Dec-

17

Dec-

19

Dec-

21

CRB Commodity Index YoY (smoothed) - RHS

MSCI AC World Mining 12M Fwd EPS YOY - LHS

Trailing 12m World Mining Capex* YOY - RHS


9

World Manufacturing PMI Forecasts – Scenario Analysis

Scenario Assumptions

SGBM Base Case: PMI Momentum Fades After Q2/17,

and Slow Normalization Sets In

SGBM Bull Case: PMI Momentum Strengthens in 2H/17

SGBM Bear Case: PMI Momentum Peaks in Q2/17

After the United States Fails to Adopt Planned Policies

U.S. ISM declines at a normal speed in

2H/17, and levels remain muted in 2018.

The ratio of new orders to inventories still

points to healthy ISM in Q2/17, but ISM

momentum fades to an average of 53 in

2H/17. The U.S. dollar weakens in 2H/17.

The strength of the PMIs for Europe,

Japan, Canada, and China extends into

Q3/17 (from stronger U.S. import demand

and YOY gains in commodity prices), but

fades in late 2017.

China PMI doesn’t surpass 52-53 (now at

51.8), and momentum slows later in 2017

and in early 2018.

U.S. ISM hovers near 60 through Q3/17

after the Trump administration follows

through on its tax and infrastructure

plans. GDP accelerates in 2H/17, and ISM

peaks later in 2017 at a higher level. The

U.S. dollar remains flat.

The strength of the PMIs for Europe,

Japan, Canada, and China tracks ISM

strength and peaks in early 2018. Central

banks (excluding the Fed) start discussing

normalizing policy.

China is slow to tighten conditions and

lets its PMI overshoot to 53-54.

Commodities also overshoot.

U.S. ISM declines to low 50s by the end

of 2017 on failed economic policy

agreements. U.S. GDP growth stalls, but

hard-landing risks remain tame as the U.S.

dollar slides and the Fed pauses its rate

hikes.

The PMIs for Europe, Japan, Canada, and

China fall, in line with the U.S. ISM, as

global new orders drop. Easing policy is

extended, and global recession risks remain

low.

Bear case reflects our assessment of the

probability of a U.S. and global recession in

the next 12 months.

Exhibit 16: Scotiabank GBM Portfolio Strategy – World Manufacturing PMI* Scenarios

* World PMI calculated by Scotiabank GBM using U.S. ISM manufacturing index instead of U.S. Markit manufacturing PMI.

Source: Scotiabank GBM Portfolio Strategy estimates; Bloomberg.

Q1/17A Q2/17E Q3/17E Q4/17E Q1/18E Q2/18E Q3/18E Q4/18E 2017E 2018E

Bull Case 53.8 57.0 55.0 54.0 53.0 52.5 52.0 52.0 30% 55.0 52.4

Base Case 53.8 54.0 53.0 52.0 52.0 52.0 51.0 50.0 65% 53.2 51.3

Bear Case 53.8 53.0 52.0 51.0 50.0 50.0 49.0 48.0 5% 52.5 49.3

Wgt. Avg. 53.8 54.9 53.6 52.6 52.2 52.1 51.2 50.5 100% 53.7 51.5

SGBM

Probability

Quarterly Averages Yearly Averages

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

1.0%

1.1%

1.2%

1.3%

47

48

49

50

51

52

53

54

55

56

57

Q1/1

2

Q1/1

3

Q1/1

4

Q1/1

5

Q1/1

6

Q1/1

7

Q1/1

8

Q1/1

9

Q1/2

0

World GDP Growth QoQ (Approximated) - RHS

Historical - LHS

Base Case - LHS

Bull Case - LHS

Bear Case - LHS

SGBM Portfolio Strategy Forecasts


10

Exhibit 17: CAT – Longest Losing Streak in History

Source: Company reports; FactSet; Scotiabank GBM.

Exhibit 18: CAT – Mining the More “Obvious” Mean Reversion

Source: Company reports; Scotiabank GBM.

Exhibit 19: CAT – Mining Sales in Negative Territory (Since 2014)

Source: Company reports; Scotiabank GBM estimates.

Equipment: Recovery Road

In our view, global equipment sales are headed for a fifth consecutive year of declines in 2017… but just

barely this time. CAT has suffered its longest losing streak in a century, including during the Great

Depression, marking its 51st consecutive month of retail sales declines in March 2017 (see Exhibit 17).

However, looking ahead, we believe sustained higher commodity prices, increased infrastructure spending,

and an aged installed fleet are supportive of a multi-year heavy-equipment recovery. In fact, signs of

stabilization are already emerging, with green shoots appearing in certain markets and geographies.

While construction equipment sales

should see a rebound from current

levels, we believe the most obvious

recovery will be in mining (see Exhibits

18 and 19). Construction sales are down

from prior peak levels, with the majority

of the weakness felt outside North

America (see Exhibit 20). In fact, certain

construction markets – namely, Latin

America and China – are likely

depressed (i.e., selling below

replacement demand) and setting up for

a (potentially) meaningful recovery.

However, while we expect conditions to

improve in construction-equipment

markets, we believe the majority of the

equipment-cycle upturn will be driven by

a recovery in the mining industry. Despite lower commodity prices (in the last four years), production for

most commodities has been relatively inelastic; the level of equipment wear and tear is high. In our view,

the global economy today is not by any means less equipment intensive than in the past, and,

embedded in our view, is that if mining production remains constant or grows, mining equipment

and product support sales should, at minimum, revert to the mean (i.e., replacement).


11

Exhibit 20: CAT – Construction Poised to Bounce in Commodity-Levered End-Markets


According to Parker Bay Company,

mining-equipment sales increased almost

one-third in Q4/16 compared with Q3/16

(which, in turn, was up 13% from Q2, its

lowest point in 20 years) and as miners

start increasing their equipment spend.

Parker Bay’s Mining Equipment Index

also highlights that, by the end of Q2/16,

mining-equipment sales had fallen more

than 80% from the 2012 peak, but they

are still well below 2009 sales (see

Exhibit 21).

In 2016, CAT indicated that it sold

approximately 100 large mining trucks,

compared with 1,700 in 2012. We

estimate replacement demand for its

mining trucks is approximately 800 per

year; therefore, current mining truck sales

represent roughly 10% of replacement

demand (meanwhile, sales were nearly

200% of replacement demand in 2012).

We believe a portion of the idled

mining fleet, which reached

approximately 20% of the installed base

in mid-2016, is already going back to

work (see Exhibit 22). Since the parked

fleets are in various stages of being

stripped for parts or moved to other

locations, we believe restarting the

parked fleet could generate meaningful

aftermarket business in the near to

medium term.

Equipment cycles tend to be multi-

year, and we appear to be on the cusp

of an upturn (see Exhibit 21). We

believe that if global market conditions

normalize, we will see a meaningful

recovery in equipment and aftermarket

spend. We believe aftermarket and

replacement dynamics alone could be

very favourable in the near to medium

term. While we partially attribute the

current “underspend” to the previous

“overspend” and believe miners could

(potentially) further delay a replacement

cycle, we believe higher commodity

prices should spur miners to focus on

enhancing fleet efficiency as downtime

becomes relatively more expensive.

Exhibit 21: Mining Equipment Off Rock-Bottom Levels

Source: Parker Bay Company.

Exhibit 22: CAT – Fleet Going Back to Work

Source: Company reports.


12

Picking Our Horse: Finning International Inc.

We expect FTT to become the cheapest name (between FTT and Toromont Industries Ltd. [TIH]) on a

P/E basis through the recovery (see Exhibit 23). In the equipment space, we prefer companies that have

commodity exposure rather than construction exposure. Our equipment-dealer thesis is largely based on the

view that commodity-leveraged equipment markets, such as mining and mining-related construction

equipment, are significantly depressed and poised for the largest recovery. For added perspective, CAT

mining sales declined 70% from the peak to the trough; meanwhile, construction sales declined 20% from

their prior peak (see Exhibit 18). As such, while we expect to see some reversion to the mean in

construction-equipment markets, we believe the real opportunity for a recovery is in commodity markets (i.e.,

Western Canada and Chile for FTT).

With FTT and TIH shares trading relatively in line (on our 2017 estimates), we believe FTT shares have

the most upside given our view that the company’s earnings growth should outperform in the upturn.

Recent increases in commodity prices and a related recovery in mining profits make us increasingly

comfortable with the notion that mining spend has bottomed and that the industry is likely positioned for

a multi-year recovery. For FTT, we forecast EPS will grow 30% YOY in 2018 and 78% through mid-cycle

EPS.

While TIH’s revenue growth slowed in 2016 as a result of reduced near-term visibility on federal

infrastructure spending and an influx of inventory and contractors into the more active Ontario market,

we believe overall equipment demand remains relatively healthy (i.e., at or near mid-cycle). However,

given its under-leveraged balance sheet, TIH has sufficient capacity to complete a sizable debt-funded

acquisition. We estimate it can spend roughly $500 million in cash and debt to fund an acquisition

without requiring equity. Rather than account for mid-cycle earnings potential (as we do with FTT; we

believe TIH is already at mid-cycle), we incorporate a $300 million debt-funded acquisition in our post-

acquisition scenario for TIH.

Exhibit 23: Earnings Growth Should Make FTT the Cheaper CAT Dealer (P/E)

Note: Assumes CAT mid-cycle EPS is in line with 2012 earnings (assumed margin improvement a result of cost-reduction efforts). TIH “post-acquisition” earnings assume TIH deploys $300 million to fund an acquisition.

Source: Company reports; FactSet; Scotiabank GBM estimates for FTT and TIH.


13

Exhibit 25: FTT’s Aging Installed Fleet Is Supportive of a Sizable Replacement (and Product Support) Cycle


Exhibit 24: FTT – Higher ROIC Supports Mid-cycle Valuation

Source: Company reports; FactSet; Scotiabank GBM estimates.

FTT attractively combines a margin turnaround with a cyclical recovery story, which supports a

structurally higher mid-cycle EPS. Management’s strategy has shifted the company’s focus to improving

returns on capital (from growth, in our view). Previously, FTT invested heavily in its branch network; now it is

focused on optimizing its existing asset base with selective investments, increased service-platform

efficiency, supply chain improvements, and market share gains. While the company has successfully

advanced operational initiatives, improvements have largely been masked by the current economic

downturn – we believe Canada represents the most significant opportunity to expand margins and returns.

Scenario Analysis: Recovery Road

We view FTT’s earnings recovery as a two-part story: Canada and FINSA (i.e., South America). In our

view, the prospect of a multi-year earnings recovery looks probable, but our near-term expectations are

relatively modest. In 2017, we expect FTT’s Western Canada operations to improve, driven largely by

rightsizing efforts and increased rebuild opportunities (see Exhibits 32 to 35). In 2018 (and beyond), we

expect a meaningful recovery in its depressed FINSA market, potentially driving meaningful earnings growth

(see Exhibits 36 to 39). In the two geographies, we expect replacement demand (and increased product

support) to be a large driver of sales growth (see Exhibits 41 and 42). However, we believe our forecast

horizon captures only a small portion of the likely multi-year cyclical recovery. Long term, we believe the

company can drive consolidated margins higher (and capital intensity lower) to achieve ROIC of close to 15%

(at mid-cycle).

At mid-cycle, we believe FTT could generate EPS of $2.10, which supports a mid-cycle valuation of

approximately $33.50 per share. We use 16.0x P/E as our mid-cycle valuation multiple, reflecting a

modest premium to FTT’s average historical multiple, which we attribute to improved (forecast) capital

returns (see Exhibit 24). As FTT is earning well below its mid-cycle earnings potential (through our forecast

horizon), we anchor our current valuation in FTT’s mid-cycle valuation to reflect the company’s higher

“normalized” earnings potential. Our $28.50 per share one-year target reflects a 15% discount to our mid-

cycle valuation for FTT.

FTT shares trade at 20.6x 2017E P/E and 15.9x 2018E P/E (average 18.3x P/E) – see Exhibit 40. FTT

trades at the upper end of its previous trough earnings multiple; in the previous two commodity upturns

(2005 to 2007 and 2010 to 2011), FTT shares traded in the range of 16.0x P/E to 19.0x P/E (see Exhibit

24).


14

Constructing Our Base Case (Mid-cycle)

For FTT, we forecast relatively flat revenues in 2017, consisting of modest product support growth, offset by

declines in new-equipment sales. However, in 2018, we believe the upturn in Western Canada and Chile

and the opportunity to recapture market share in Argentina will accelerate and could torque up earnings

growth – all of which we expect to be supported by a sizable replacement and product support cycle (see

Exhibit 25).

In Western Canada, we forecast EBIT margins of 6.5% in 2017, up from 5.5% in 2016, and believe

margins will have significantly more upside when conditions normalize further. FTT’s restructuring efforts,

which permanently reduced fixed overhead by more than $150 million, should also provide upside to

margins through enhanced operating leverage in a recovery. At mid-cycle, we believe FTT could achieve

an EBIT margin of 8.3% in Western Canada (see Exhibit 27).

In FINSA, we forecast EBIT margins of 8.4% in 2017, in line with 2016, as a result of increased

expenses related to the implementation of the enterprise resource planning (ERP) system and the recent

appreciation of the Chilean peso (without the associated increase in higher equipment demand). While

purchase behaviour remains cautious given the “questioned” sustainability of higher copper prices, we

believe a sustained copper price at these levels should see equipment purchases accelerate

meaningfully in 2018. At mid-cycle, we believe FTT could achieve an EBIT margin of 9.5% in FINSA (see

Exhibit 27).

In the United Kingdom and Ireland, we forecast EBIT margins of 3.3% in 2017, reflecting a competitive

environment and product support accounting for a smaller portion of the overall business. Management

has restructured the business to re-align the operation with changes in its end-market, which, in our view,

are likely to generate lower margins (versus historically) but should be less capital intensive, such that,

on a net basis, ROIC should expand. At mid-cycle, we believe FTT could achieve an EBIT margin of 5.0%

in the United Kingdom and Ireland (see Exhibit 27).

Exhibit 26: FTT – Assumed Mid-cycle Margins Not a Thing of the Past



15

On a consolidated basis, our mid-cycle estimate assumes a 50% revenue recovery from the previous peak

and a margin contribution of approximately $0.20 per revenue dollar. At mid-cycle, we estimate EBITDA

margins of approximately 11.0% – below TIH’s EBITDA margin of 15.5% in 2016.

In terms of sensitivities, increasing sales

$100 million would add approximately

$0.10 per share; increasing our gross

margin assumption 100 bp would add

approximately $0.30 per share; and

increasing our incremental margin

assumption 100 bp would add

approximately $0.04 per share.

Furthermore, in streamlining its capital

requirements, we believe FTT will benefit

from capital efficiencies such that it

should be able to draw down free cash

flow (FCF) from excess working capital in

2017 and require less working capital

investment in a recovery – we expect

efficiencies to be driven largely by

increased equipment inventory turns.

With excess capital to deploy, we believe FTT would look for accretive opportunities. The company has

already announced that it plans to invest in its digital strategy and repay half its $350 million of term notes

(which mature June 2018), which should be accretive by $0.05 per share in 2019. We would also not rule

out potentially acquiring a CAT dealership given FTT’s strong mining expertise.

Exhibit 27: FTT – Mid-cycle Assumptions


Exhibit 28: Commodities Recovering from Bottom (US$)

Source: FactSet.


16

Potential “Bull” and “Bear” Scenarios

Barring a global economic recession, we believe FTT’s mid-cycle earnings potential is well supported by

supply and demand dynamics of major commodities (oil and copper). Given commodity prices are likely to

be propped up by tighter market conditions, we believe the equipment cycle will eventually normalize.

OPEC supply cuts are providing a tailwind to oil prices. Despite growing U.S. production, the expectation

is for global oil markets to cross into a deficit in 2017 (according to Scotiabank GBM analyst Michael

Loewen; see Exhibit 29). That being said, the majority of FTT’s oil sands mining equipment is operated

in mines with relatively low operating costs (i.e., relatively high upfront costs and low marginal costs),

which ensures a relatively stable level of production. While oil sands customers may temporarily defer

overburden removal and maintenance, a relatively inelastic production rate should result in continued

equipment-related spend.

In our view, copper’s trough years are likely behind us. While it may be premature to anticipate a new

cycle of higher prices in the near to medium term, the current copper market deficit is supportive of

prices in the range of US$2.50/lb to US$2.55/lb (according to Scotiabank GBM analyst Orest Wowkodaw;

see Exhibit 30). In the medium term, we believe a larger net copper market deficit is supportive of higher

copper prices and could stimulate incremental supply.

As such, the variables we examine in our bull and bear scenario analyses reflect varying degrees of what

FTT’s earnings could look like in the context of nearing mid-cycle earnings potential, largely focusing on

varying company-specific margin and execution assumptions (and more modest revenue sensitivities). In

the case of our bull scenario, we assume higher commodity prices, robust economic growth, and, in FTT’s

case, better-than-expected margin execution. Conversely, we apply nearly opposite assumptions to our

bear scenario (see Exhibit 31).

As it relates to the timing of the earnings recovery, FTT’s sales and earnings have historically lagged

commodity price rebounds by 12 to 24 months (see Exhibits 32 to 39). Oil and copper prices bottomed in

Q1/16 (and bounced along the bottom for a few of quarters). However, now, 12 months later, we believe

FTT is nearing a sales and earnings recovery.

Exhibit 29: Global Oil Supply-Demand Forecast (Base Case)

Note: Comprises crude oil, condensates, NGLs, and other sources.

Source: IEA; DOE EIA; JODI; OPEC; Scotiabank GBM estimates

(2.0)

(1.5)

(1.0)

(0.5)

-

0.5

1.0

1.5

2.0

2.5

88

90

92

94

96

98

100

102

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

2013 2014 2015 2016 2017 2018

Net

Ba

lan

ce

(M

Mb

bl/d

)

Su

pp

ly &

De

ma

nd

(M

Mb

bl/d

)

Net Balance Forecasted S/D

Supply Demand

Exhibit 30: Global Refined Copper Net Surplus (Deficit) vs. LME Copper Price, 2000-2020E

Source: Company reports; Bloomberg; Scotiabank GBM estimates.

$-

$0.75

$1.50

$2.25

$3.00

$3.75

$4.50

(1,500)

(1,000)

(500)

0

500

1,000

1,500

2000 2003 2006 2009 2012 2015 2018E

Copper Net Surplus/(Deficit) (kt) Copper Price (USD/lb)


17

Exhibit 31: Inputs for Potential Bull and Bear Scenarios

Source: Scotiabank GBM estimates.

S ce na rios M id-Cycle Bull Be a r

Nam e M id-Cy c le Com m odity B oom E x tended Rec overy

M argin P rofile + O perating Leverage + O perating Leverage Rights iz ing

Return P rofile ~ 15% RO IC > 15% RO IC < 15% RO IC

M ult iple 16.0x 15.0x 18.0x

Drive rs

W TI US $/bbl $60.00 $65.00 $50.00

Copper US $/lb $3.00 $3.50 $2.50

W es tern Canada M argin 8.3% 9.0% 6.5%

FINS A M argin 9.5% 10.0% 8.0%

UK & Ireland M argin 5.0% 6.5% 3.0%

V a lua tion S e nsitivitie s M id-Cycle Bull Be a r

V aluation M ult iple 16.0x 15.0x 18.0x

Ta rge t P rice S e nsitivity

M id-Cy c le E P S $2.10 $2.10 $2.10

W es tern Canada - $0.25 ($0.30)

F INS A - $0.07 ($0.21)

UK & Ireland - $0.08 ($0.08)

Im plied E P S $2.10 $2.50 $1.50

FTT M id-Cycle V a lua tion $33.50 $37.50 $27.00

Discount to M id-Cycle V a lua tion 15% 15% 15%

P ote ntia l O ne -Ye a r Ta rge t $28.50 $32.00 $22.00

Im plied Ups ide / (Downs ide) 20% 34% (7% )


18

Exhibit 36: FINSA – Previous Sales Downturn


Exhibit 37: FINSA – Sales Recovery


Exhibit 34: Canada – Previous EBIT Downturn


Exhibit 35: Canada – Operating Profit Recovery


Exhibit 32: Canada – Previous Sales Downturn


Exhibit 33: Canada – Sales Recovery



19

Exhibit 40: North American Comparables

Note: For companies with FYE other than December 31, we have included their results in the nearest calendar year.

Source: Company reports; FactSet; Scotiabank GBM estimates for FTT, TIH, and WJX.

Exhibit 38: FINSA – Previous EBIT Downturn


Exhibit 39: FINSA – Operating Profit Recovery



20

Exhibit 41: Canada – Aged Fleet Supports Strong Aftermarket and Replacement Cycle


Exhibit 42: FINSA – Aged Fleet Supports Strong Aftermarket and Replacement Cycle



21

Exhibit 43: FTT – Financial Forecast (in C$M, Unless Otherwise Stated)


(Y ear E nding Dec em b er 31) 2014A 2015A 2016A Q 1/17E Q 2/17E Q 3/17E Q 4/17E 2017E 2018E

Consolida te d F ina ncia ls:

Revenue 7,012 6,275 5,628 1,299 1,361 1,359 1,533 5,551 5,970

A djus ted E B ITDA 749 606 465 121 127 135 157 540 623

A djus ted E B IT 533 383 273 74 78 85 102 340 407

Revenue G rowth % 3.8% (10.5% ) (10.3% ) (13.1% ) 3.9% 1.9% 2.8% (1.4% ) 7.5%

E B ITDA Margin % 10.7% 9.7% 8.3% 9.3% 9.3% 9.9% 10.3% 9.7% 10.4%

E B IT Margin % 7.6% 6.1% 4.9% 5.7% 5.8% 6.3% 6.6% 6.1% 6.8%

Adjuste d EP S (fd ) $1.90 $1.29 $0.89 $0.25 $0.27 $0.30 $0.37 $1.18 $1.53

FCF/s hare (after W C) $2.80 $1.90 $2.20 $0.20 $0.59 $0.63 $0.42 $1.84 $1.34

Ca na da

Tota l Re ve nue s 3,633 3,054 2,821 681 696 666 746 2,789 3,008

New E quipm ent Y O Y % 12% (27% ) (20% ) (50% ) 15% 8% 5% (14% ) 12%

P roduc t S upport Y O Y % 10% (8% ) 1% 0% 10% 8% 4% 5% 7%

Total Revenues Y O Y % 8% (16% ) (8% ) (20% ) 10% 8% 4% (1% ) 8%

Adjuste d EBIT 283.3 190.2 154.0 40.9 43.1 44.6 52.2 180.8 214.5

E B IT Margin % 7.8% 6.2% 5.5% 6.0% 6.2% 6.7% 7.0% 6.5% 7.1%

Inves ted Capital Turnover (LTM ) 2.2x 1.7x 1.7x 1.6x 1.6x 1.7x 1.7x 1.7x 1.9x

RO IC(LTM) 17.1% 5.5% 5.2% 6.2% 7.2% 7.7% 11.2% 11.2% 13.6%

S outh Am e rica

Tota l Re ve nue s 2,227 2,060 1,855 431 438 475 547 1,891 2,050

New E quipm ent Y O Y % (30% ) (37% ) (13% ) 15% 10% 5% 0% 5% 14%

P roduc t S upport Y O Y % 4% 7% (10% ) (2% ) 0% 3% 4% 1% 7%

Total Revenues Y O Y % (11% ) (8% ) (10% ) 0% 2% 3% 2% 2% 8%

Adjuste d EBIT 213.9 184.6 155.0 34.5 36.8 40.4 46.5 158.1 184.7

E B IT Margin % 9.6% 9.0% 8.4% 8.0% 8.4% 8.5% 8.5% 8.4% 9.0%


RO IC(LTM) 14.6% (12.9% ) 13.1% 13.3% 13.3% 13.4% 15.4% 15.4% 18.5%

UK & Ire la nd

Tota l Re ve nue s 1,057 1,077 950 186 227 218 240 871 912

New E quipm ent Y O Y % 27% (4% ) (12% ) (10% ) (10% ) (20% ) 0% (10% ) 6%

P roduc t S upport Y O Y % 13% 5% (15% ) (20% ) (8% ) (6% ) 0% (9% ) 3%

Total Revenues Y O Y % 20% 2% (12% ) (12% ) (7% ) (14% ) 0% (8% ) 5%

Adjuste d EBIT 50.0 33.1 16.0 5.8 7.5 7.4 8.2 28.8 36.1

E B IT Margin % 4.7% 3.1% 1.7% 3.1% 3.3% 3.4% 3.4% 3.3% 4.0%


RO IC(LTM) 16.3% (1.2% ) (4.1% ) (0.8% ) 10.9% 9.7% 9.8% 9.8% 12.6%

Le ve ra ge M e trics:

Debt 1,425 1,665 1,489 1,499 1,499 1,499 1,499 1,499 1,149

Net Debt 975 1,190 896 906 839 765 727 727 553

B orrowing Capac ity (35% debt-to-c ap) 112 (56) 83 74 121 174 207 207 387

Net Deb t-to-Capitaliz at ion 31.4% 36.7% 32.0% 32.3% 30.6% 28.5% 27.2% 27.2% 20.6%

Net Debt-to-E B ITDA (LTM ) 1.3x 2.0x 1.9x 1.9x 1.7x 1.5x 1.3x 1.3x 0.9x


22

Risk/Reward Trade-Off: Finning International Inc. (FTT-T; SO; One-Year Target $28.50)

Investment Thesis

In the equipment space, we prefer commodity-levered exposure to construction-levered exposure. Our equipment-dealer thesis is largely based on the

view that commodity-levered equipment markets are significantly depressed and that while construction markets should see a rebound, the most

obvious (meaningful) recovery will be in mining. We believe FTT attractively combines a margin turnaround with a cyclical recovery story, which should

see a structurally higher mid-cycle EPS. At mid-cycle, we would argue FTT could generate EPS of $2.10, which supports a mid-cycle valuation of

$33.50 per share, indicating continued upside in the shares. As such, we believe FTT can transition to the cheapest P/E name (between FTT and

Toromont Industries Ltd. [TIH]) through mid-cycle.

Key Risks What’s Likely Priced In? Key Stock Catalysts Timing

Volatile or lower commodity (primarily WTI and

copper) prices.

Deferred replacement cycle (deferral of

equipment and product support).

Heightened competitive intensity from overseas

players.

Market share loss in aftermarket business.

A negative amendment to CAT’s dealer

strategy.

Partial recovery in end-markets (primarily

Western Canada and Chile); recovery in sales

and gross margin.

Rationalized (fixed) SG&A and lower-than-

expected ramp-up of costs in recovery.

Improved margin (and ROIC) performance from

execution of Operational Excellence Agenda.

Consistent FCF generation (+/-$300 million in

2017) and delivering balance sheet.

Higher crude oil (>US$55/bbl). Ongoing

Sustained copper prices

(~US$2.75/lb).

Ongoing

Ramp-up in sales and gross

margin.

2018 and

Beyond

Enhanced operational leverage

(increasing ROIC).

2018 and

Beyond

Capital deployment scenarios

(i.e., acquisitions).

2018 or

Beyond

Bear Case: $22.00 Base Case: $28.50 Bull Case: $32.00

WTI/bbl and copper/lb below Scotiabank GBM

estimates.

Deferred replacement cycle (deferral of

equipment and product support).

Continued rightsizing efforts for lower activity

levels.

Below Mid-cycle Assumptions

EPS of $1.50, below mid-cycle EPS

Western Canada EBIT margin of 6.5%;

FINSA EBIT margin of 8.0%; U.K. and

Ireland EBIT margin of 3.0%.

Consolidated EBIT and EBITDA margins of

approximately 6.0% and 9.5%, respectively.

ROIC <15%

NYMEX WTI/bbl of US$56 (in 2018) and

copper/lb of US$2.75 (in 2018) – Scotiabank

GBM estimates.

Continued execution of operational excellence

agenda; achieving incremental margins of

~20% per revenue dollar.

Mid-cycle Assumptions

Mid-cycle EPS and valuation of $2.10 and

$33.50 per share, respectively, discounted

to one-year target.






ROIC <15%

WTI/bbl and copper/lb above Scotiabank GBM

estimates.

Acceleration beyond replacement cycle (growth

in installed fleet).

Capturing increased operational leverage

through measured ramp-up of costs.

Above Mid-Cycle Assumptions

EPS of $2.50, above mid-cycle earnings.






Bear Case Valuation Base Case Valuation Bull Case Valuation

$27.00 per share mid-cycle valuation (18.0x P/E mid-cycle); discounted to one-year target.

$33.50 per share mid-cycle valuation (16.0x P/E mid-cycle); discounted to one-year-target.

$37.50 per share mid-cycle valuation (15.0x P/E mid-cycle); discounted to one-year target.

Bear

Case

$22.00

(-7%)

Base

Case

$28.50 (20%)

Bull

Case

$32.00 (34%)

Current

Price

$24.35


23

Autos: The Auto Cycle Still Has Legs

From 2009 through 2016, U.S. auto sales registered seven consecutive years of growth, the longest such

streak since the 1930s. Moreover, we expect sales to be essentially flat in 2017, at levels well above what

we estimate to be mid-cycle (i.e., at replacement demand of 15 million units). That being said, for the first

three or four years of the current up cycle, the U.S. was still in recovery mode (i.e., it was selling below

replacement demand), which would imply that the U.S. is now into its fourth year of selling above

replacement demand. While this may sound like a fairly long stretch, from a (recent) historical perspective, it

is not that uncommon (or long) – see Exhibits 44 and 45.

In fact, while auto sales are highly cyclical, we believe it is important to highlight the fact that (1) over the 10-

year period from 1998 to 2007, U.S. auto sales were above replacement demand versus the current run of

three-plus years (and counting) and (2) on only three occasions over the last 40 years have industry sales

declined by more than 25% from peak to trough, all during fairly deep recessions: in the early 1980s, in the

early 1990s, and in 2009 (see Exhibits 46 and 47). As such, when viewed through another lens, the recent

run of strength in auto sales looks less extended.

Exhibit 44: Industry Has Seen Longer Up Cycles in the Past

Source: Wards Auto; U.S. DOT; Scotiabank GBM estimates

6

8

10

12

14

16

18

20

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Above Replacement US LV Sales (M) - [LHS]

Current up-cycle has only been above replacement for three years.

Exhibit 45: The Expansion Phase of This Up Cycle Is Not That Long

Source: Wards Auto; U.S. DOT; Scotiabank GBM estimates.

0

2

4

6

8

10

12

14

16

18

20

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

US LV Sales (M) - [LHS]

ExpansionRecovery

Exhibit 46: Jobless Claims at Very Healthy Levels

Source: Bloomberg; Scotiabank GBM.

200

250

300

350

400

450

500

550

600

650

700 5.0

8.0

11.0

14.0

17.0

20.0

Jan

-77

Jan

-79

Jan

-81

Jan

-83

Jan

-85

Jan

-87

Jan

-89

Jan

-91

Jan

-93

Jan

-95

Jan

-97

Jan

-99

Jan

-01

Jan

-03

Jan

-05

Jan

-07

Jan

-09

Jan

-11

Jan

-13

Jan

-15

Jan

-17

US Auto Sales (SAAR; million) [LHS]

US Jobless Claims (000s) - Inverted

Exhibit 47: Odds of U.S. Recession Still Low

Source: Bloomberg; Scotiabank GBM Portfolio Strategy; U.S. Federal Reserve; U.S. NBER.


24

U.S. Sales to Plateau near Current Levels

In the context of 2% to 3% GDP growth, broadly positive PMI momentum, a strong job market, improving

housing market, 16-year-high consumer confidence, and still low interest rates in the U.S., our expectation is

for industry volumes to “plateau” at levels well above replacement demand and earnings to remain resilient,

much as they did in the early 2000s (see Exhibit 48).

While U.S. sales were up only modestly in 2016, transaction prices continued to climb on the back of strength

in the truck, sport utility vehicle (SUV), and crossover utility vehicle (CUV) markets, offset by weakness in cars,

pushing expenditures on new vehicles to record highs (see Exhibits 49 and 50). Overall, we remain positive on

the outlook for industry sales in the United States (and the shares of Canadian auto suppliers).

Exhibit 49: U.S. New-Car Expenditures Growing As…

Source: Kelley Blue Book; Wards Auto; Scotiabank GBM.

$300.0

$350.0

$400.0

$450.0

$500.0

$550.0

$600.0

$650.0

$700.0

1/1

/13

4/1

/13

7/1

/13

10

/1/1

3

1/1

/14

4/1

/14

7/1

/14

10

/1/1

4

1/1

/15

4/1

/15

7/1

/15

10

/1/1

5

1/1

/16

4/1

/16

7/1

/16

10

/1/1

6

1/1

/17

US Industry New Car Expenditure (USD millions)

Exhibit 50: … Prices Track at Record Levels

Source: Kelley Blue Book; Scotiabank GBM.

$25,000

$27,000

$29,000

$31,000

$33,000

$35,000

$37,000

$39,000

$41,000

1/1

/13

4/1

/13

7/1

/13

10

/1/1

3

1/1

/14

4/1

/14

7/1

/14

10

/1/1

4

1/1

/15

4/1

/15

7/1

/15

10

/1/1

5

1/1

/16

4/1

/16

7/1

/16

10

/1/1

6

1/1

/17

USD

Industry ATP D3 ATP

Exhibit 48: Canadian Suppliers Grew Earnings Through the Last Plateau

Source: Company reports; Scotiabank GBM.

($300.0)

$200.0

$700.0

$1,200.0

$1,700.0

$2,200.0

$2,700.0

$3,200.0

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

mil

lio

ns

US

D

MGA - EBIT (LTM)

$0.0

$100.0

$200.0

$300.0

$400.0

$500.0

$600.0

$700.0

$800.0

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

mil

lio

ns

C$

LNR - EBIT (LTM)

($50.0)

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

mil

lio

ns

C$

MRE - EBIT (LTM)


25

Exhibit 53: Risk to Used-Car Prices

Source: Bloomberg; Scotiabank GBM.

80

90

100

110

120

130

140

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

20

15

20

17

Manheim Used Vehicle Value Index

That said, there are a number of potential risks worth monitoring:

The surge in leasing as a form of financing in recent years will see a growing number of vehicles coming

off lease in coming years (see Exhibits 51 and 52), likely putting downward pressure on used-vehicle

prices (see Exhibit 53), making them a more attractive alternative (versus new), which could act as a

headwind to new-vehicle sales. This is one of the main factors that underpins our forecast for moderate

industry volume declines (i.e., 1% to 2% annually) through our forecast horizon in North America.

Industry inventory levels heading into February 2017 were running at elevated levels. However, we saw

a notable improvement in recent months on the back of solid sales (despite March 2017 being below

expectations) and the production cuts that have been occurring since the start of the year (particularly in

cars). In fact, OEMs (including GM and Ford) continue to say they intend to match production to meet

demand. We view these initiatives (i.e., production alignments) as a disciplined approach to protect

industry profitability. It should also allow the OEMs to reduce their dependence on incentive spending,

which continues to run at elevated levels (although the incentives are being met by record transaction

prices).

Rising interest rates could have an impact on volumes and mix. We estimate a 100 bp increase in

interest rates would translate into approximately a $30 increase in monthly new-vehicle loan payments.

Exhibit 51: Leasing Becoming More Popular

Source: Experian; Scotiabank GBM.

0%

5%

10%

15%

20%

25%

30%

35%

0

2

4

6

Q1

/10

Q3

/10

Q1

/11

Q3

/11

Q1

/12

Q3

/12

Q1

/13

Q3

/13

Q1

/14

Q3

/14

Q1

/15

Q3

/15

Q1

/16

Q3

/16

New car sales (millions) % of all new vehicles leased

Large number of leases entered in 2015+2016 will come off lease in 2018/2019.

Exhibit 52: Expecting a Significant Number of Vehicles to Come Off Lease in Coming Years

Source: Experian; Scotiabank GBM estimates.

0 1 2 3 4 5 6

2019E

2018E

2017E

2016

2015

2014

2013

Millions of Vehicles Coming Off Lease


26

Still Room to Recover in Europe

Despite improving European

macroeconomic indicators (including

accelerating PMIs across the region) and

sales in the European Union (EU) still

approximately 5% to 10% below pre-

crisis levels (see Exhibit 54), we forecast

only modest growth in the EU through

2017 and 2018 – partially to reflect

certain geopolitical events and risks (i.e.,

Brexit, national elections, referendums,

etc.) that could create some headwinds.

In fact, the European Automobile

Manufacturers’ Association (ACEA),

which released its 2017 EU sales

forecast in February 2017, is calling for

essentially flat sales. That said, the

association has provided fairly conservative guidance in the past (e.g., initial 2016 guidance called for 2%

growth, but the market grew 6.8%). For the first two months of 2017, vehicle registrations are up 6.2%,

according to the ACEA.

Expecting More Moderate Rates of Growth in China

After an exceptionally strong 2016, when

passenger vehicle sales in China were up

approximately 15%, we expect more

moderate rates of growth in 2017 (with

continued pricing pressure at the OEM

level). Our expectation comes on the

back of changes to the government

stimulus program for small vehicles (i.e.,

those with engines of less than 1.6 litres),

which has become less accommodative

(i.e., the tax rate went from 5% to 7.5%;

see Exhibit 55). In fact, in the first two

months of 2017, passenger vehicle sales

were up 6.5%, but the growth moderated

in March (according to the China

Association of Automobile Manufacturers

[CAAM], vehicle sales were up 2% YOY

in March 2017). That said, demand for

SUVs and luxury sedans remains strong,

which, we believe, points to underlying

strength in the market as these sales

don’t receive any benefit from the

government subsidy on small vehicles.

Exhibit 54: Europe Remains Below Pre-crisis Levels

Note: LTM as of February 2017.

Source: ACEA; Scotiabank GBM.

15.4M 15.5M

14.3M 14.1M

13.4M 13.1M

12.1M 11.8M12.5M

13.7M

14.6M 14.8M

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 LTM

EU New Passenger Car Registrations

Exhibit 55: China Momentum Continues Despite Tightening Policy

Source: CAAM; Bloomberg; Scotiabank GBM.

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

0M

5M

10M

15M

20M

25M

30M

Jan

-06

No

v-0

6

Sep

-07

Jul-

08

May

-09

Mar

-10

Jan

-11

No

v-1

1

Sep

-12

Jul-

13

May

-14

Mar

-15

Jan

-16

No

v-1

6

China Sales; LTM [LHS] YoY Monthly Change [RHS]

Government Stimulus


27

View Mid-cycle Sales at 15 Million Units

In the context of mean reversion, we estimate mid-cycle auto sales (i.e., replacement demand) to be in the

range of 15.0 to 15.5 million units, assuming the average useful life of a vehicle is between 15 and 16 years.

For the sake of this exercise, we assume replacement demand at 15 million units. In fact, over the last 40

years, annual U.S. auto sales have averaged 14.7 million units.

Recession Would Mean Lower Volumes

We estimate trough demand in the United States at approximately 13 million units, about 25% below the

current level. While we acknowledge that sales could drop below that, it would be pretty unusual – it has

happened only three times in the last 40 years (in 1980 through 1983, in 1991, and in 2009 and 2010) – and

likely wouldn’t last long.

Assigning Appropriate Multiples to Different Levels of Cyclical Earnings

Going back to 1998, which is as far back as

our data set extends, North American auto

suppliers have generally traded in a range

of 7.5x P/E (NTM) to 15.0x P/E (NTM) – see

Exhibit 56. We highlight a few periods we

deem noteworthy:

Trough multiples on (actual) peak

earnings. While there were a number of

times when the suppliers dipped to 7.5x or

8.0x P/E (NTM), there were two extended

periods: (1) in 2000, when sales peaked

(before plateauing at a level above

replacement demand for seven years –

more on this in the next point), and (2) from

Q3/11 through Q3/12, when the economic

recovery was still in its infancy (and there

were questions about its sustainability and

strength). As such, we view 7.5x P/E to 8.0x

P/E (NTM) as an appropriate trough multiple

(to be applied to peak earnings, ahead of an

actual meaningful contraction) – see Exhibit

57.

Plateau multiples in extended period

of flat-ish sales (at levels above mid-

cycle). While auto sales effectively plateaued

from 1999 to 2007 (again, at a level above

replacement demand), we define the plateau

period as 2001 to 2005 (including 1H/06) as

sales initially peaked in 2000 (before

plateauing) and again in 2006 (before

declining significantly in 2008 and 2009).

Over this period (i.e., 2001 through 1H/06),

the group of North American auto suppliers

traded at an average of 10.5x P/E (NTM).

Exhibit 56: U.S. SAAR vs. North American Auto Suppliers’ P/Es (NTM)


8M

10M

12M

14M

16M

18M

20M

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

16.0x

18.0x

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

20

16

P/E

[N

TM]

Monthly SAAR - Actual [RHS]

P/E [NTM] - N.A. Auto Parts Suppliers [LHS]

Exhibit 57: Multiples in Context


P/E

15.0x: Peak Multiple on Trough Earnings/Volumes

12.5x: Replacement Demand

10.5x: Plateau

7.75x: Trough Multiple on Peak Earnings/Volumes


28

Peak multiples on trough earnings. The suppliers traded at peak multiples from 2H/09 to 1H/10, when

the earnings outlook was essentially at its worst (i.e., at a trough). While multiples traded above 15.0x

P/E (NTM) during this period (at least for part of the time), we view 15.0x P/E (NTM) as an appropriate

peak auto supplier multiple (to be applied to trough earnings).

Putting it all together to value mid-cycle. We value peak demand/earnings at 7.5x to 8.0x P/E (NTM),

plateau demand/earnings at 10.5x, replacement demand/earnings at 12.5x, and trough demand at 15.0x.

Therefore, in our view, the appropriate multiple to represent replacement demand should be somewhere

between 10.5x P/E (NTM) and 15.0x P/E (NTM). As such, we view 12.5x P/E (NTM) as an appropriate

mid-cycle auto supplier multiple.

What’s Being Reflected Now?

On October 27, 2015, we lowered our valuation multiples for the Canadian auto-parts suppliers we cover to

reflect a maturing North American auto cycle. Using 2001 to 2005 as our reference period (i.e., the previous

plateau), we moved our base valuation multiple to 10.5x P/E (see our Daily Edge comment). At that time

(i.e., in October 2015), the group of North American auto suppliers were trading at an average of 10.3x P/E

on 2016 estimates. However, over the following months, multiples compressed quite significantly on

concerns about reaching a peak in North America, slowing growth in China, the prospect of higher interest

rates, etc. – before bottoming in June/July 2016.

Until the end of March 2017, we saw U.S. supplier multiples expand fairly materially as, in our opinion, the

market became more comfortable with plateauing auto sales (and the related profitability), while Canadian

supplier multiples have recovered only modestly (see Exhibits 59 and 60). However, just recently, multiples

gave up some of their gains on the back of weaker-than-expected U.S. March sales performance. In fact,

the Canadian suppliers continue to trade at or near their 20-year low P/Es and at the widest discount to their

U.S. peers in several years, with the U.S. suppliers now trading at 9.4x 2017E P/E (i.e., more closely

reflecting replacement demand/earnings, in our opinion) and Canadian suppliers trading at 7.1x 2017E P/E.

Exhibit 58: MGA Sensitivities to the Cycle


Peak Volumes Plateau Replacement Trough Volumes

12.0

16.0

20.0

24.0

NA

US$

Bill

ion

s

12.0

14.0

16.0

18.0

Europe

US$

Bill

ion

s

Revenue Sensitivities

5.0%

7.0%

9.0%

11.0%

NA

3.5%

3.9%

4.3%

4.7%

Europe

EBIT Margin Sensitivities


29

https://www.scotiaview.com/cs/Satellite/research/1294931645221/Daily-Autos-and-Components-Q3-15-Preview-Lowering-Multiples-as-Cycle-Matures-175620.pdf

We believe the Canadian discount is at least partially attributable to concerns about (perceived) Canada-

specific trade risks. While we acknowledge this potential risk (as well as broader risks concerning the North

American Free Trade Agreement [NAFTA]), we have been encouraged by commentary from political figures

about the trading relationship between the two countries (i.e., Canada and the United States). Since the

Canadian suppliers have smaller relative exposure to Mexico than their U.S. peers, we view the current

trading discount (~30%) as too severe and expect this discount to compress when (if) these risks abate (i.e.,

to levels more consistent with plateau) – for more details on this subject, see our February 15, 2017, Daily

Edge comment. As such, we continue to see meaningful potential upside for Canadian auto suppliers as

multiples catch up with the multiples of their U.S. peers (assuming the trade issues are resolved). For

example, if MGA were trading in line with the U.S. suppliers, we estimate the stock would be trading closer

to US$52.00 per share instead of at US$39.99 per share.

Scenario Analysis

MGA remains our top pick among the auto suppliers. At the risk of oversimplifying, we believe the vast

majority of upside for the Canadian suppliers should come from multiple expansion – as such, our

preference would be for scale and diversification (i.e., MGA). We have chosen to run our scenario analysis

on MGA. Our order of preference in the space after MGA is Linamar Corporation (LNR) and Martinrea

International Inc. (MRE), although we remain constructive on all three names.

In Exhibit 61, we outline our bull case, base case, and bear case for MGA. For the sake of completeness (as

it is certainly not our expectation), we also outline a global recession scenario. We highlight the key

assumptions used in our analysis:

We use our current 2018 estimates as our base case.

We estimate MGA’s incremental/decremental North American EBIT margin at 17.8% (versus its 2016

EBIT margin at 9.9%) and European margin at 8.6% (versus its 2016 EBIT margin at 4.2%) – see

Exhibits 62 to 64.

Our valuation multiple in our base case and our bull case are the same (10.5x P/E) as, in our opinion,

both still (essentially) reflect a plateau (i.e., the bull case assumes plateau with modest growth from

current levels, and the base case assumes plateau with modest declines from current levels).

Exhibit 59: Multiples Should Move Higher Through the Plateau


4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

16.0x

18.0x

P/E

[N

TM]

-N

.A.

Au

to S

up

plie

rs

Historical [NTM] P/E (1998-2005)

Historical [NTM] P/E (2014-current)

Average (2001 to 2005)

10.5x average [NTM] P/E in post-peak period (2001 to 2005)

Exhibit 60: Canadian Suppliers Lagging Their U.S. Peers


5.0x

6.0x

7.0x

8.0x

9.0x

10.0x

11.0x

12.0x

13.0x

Mar

-11

Jul-

11

No

v-1

1

Mar

-12

Jul-

12

No

v-1

2

Mar

-13

Jul-

13

No

v-1

3

Mar

-14

Jul-

14

No

v-1

4

Mar

-15

Jul-

15

No

v-1

5

Mar

-16

Jul-

16

No

v-1

6

Mar

-17

P/E

[N

TM]

US Auto Parts Suppliers Canadian Auto Parts Suppliers


30

https://scotia.bluematrix.com/docs/pdf/e7864c97-f1c5-4f92-a045-9dfe5115ef3c.pdf

https://scotia.bluematrix.com/docs/pdf/e7864c97-f1c5-4f92-a045-9dfe5115ef3c.pdf

In our bear case, we use an 8.0x P/E multiple, which assumes no multiple expansion (from current

levels) despite (1) lower cyclical earnings (our mid-cycle multiple estimate is 12.5x – see Exhibit 57) and

(2) the potential for a resolution of Canada-specific trade risks, which we believe are largely the reason

the Canadian suppliers trade at a 30% discount to their U.S. peers.

Scenario Results

Our base case (i.e., plateau) implies approximately 60% upside to MGA shares from current levels. We

believe the vast majority of this would come from multiple expansion (largely by closing the gap with its

U.S. peers), from the contribution of the GETRAG acquisition, and from share repurchases as we

forecast industry volumes (on a consolidated basis) will be flat to declining, with related (modest) margin

contraction (on a consolidated basis).

Our bull case (i.e., growth plateau) implies approximately 70% upside from current levels. We believe the

vast majority will come from the same sources as in the base case – multiple expansion, GETRAG

contribution, and share repurchases – as well as from continued growth in industry volumes, with related

(modest) margin expansion.

Our bear case (i.e., replacement demand/mean reversion, with no resolution of Canada-specific trade

risks) implies approximately 2.5% downside from current levels.

Exhibit 61: MGA – Scenario Assumptions

Source: Scotiabank GBM estimates.

In USD, unless indicated otherwise.

Scenario Assumptions Base Bull Bear Global Recession

US Cycle Plateau Growth Plateau Mean-Reversion Trough volumes

Trade risk Trade resolution Trade resolution No trade resolution Trade resolution

Valuation multiple

assumptions Unchanged Unchanged

No expansion despite

lower cyclical earnings na

Valuation multiple - P/E 10.5x 10.5x 8.0x na

Margin profile Some pressure No pressure Compression Compression

US SAAR (millions) 17.25 18.25 15.00 13.00

European growth assumptions Modest Faster Declines Trough volumes

China growth assumptions Modest Faster 25% EBIT decline 50% EBIT decline

Value Sensitivities Base Bull Bear Recession

NA SAAR (millions) 17.25 18.25 15.00 13.00

Europe Production (millions) 21.68 22.94 20.66 17.55

Valuation multiple - P/E (NTM) 10.5x 10.5x 8.0x nm

MG Target Price Sensitivity

MG 2018E EPS $6.06 $6.06 $6.06 $6.06

NA sensitivity $0.00 $0.40 ($0.90) ($1.70)

EU sensitivity $0.00 $0.10 ($0.08) ($0.33)

Asia sensitivity $0.00 $0.06 ($0.20) ($0.40)

MG implied 2018E EPS $6.06 $6.62 $4.88 $3.63

Implied MG target price $65.00 $69.00 $39.00 nm

Implied Upside 62.5% 72.5% (2.5%) na


31

Exhibit 64: MGA – EPS Sensitivities to Industry Volumes


2017E EPS $5.55

N.A. Assumptions:LV production (mm units) 17.6EBIT margin 9.8%Estimated decremental margin 17.8%

EPS sensitivity to a one million unit change in volumes $0.40

European Assumptions:LV production (mm units) 21.6EBIT margin 4.2%Estimated decremental margin 8.6%

EPS sensitivity to a one million unit change in volumes $0.08

Exhibit 63: MGA – North American Decremental Margins


(400)

0

400

800

1,200

4,000 8,000 12,000 16,000

EBIT

(U

S$ m

illio

n)

Sales (US$ million)

Est. Decremental Margin: 8.6%2017E EBIT margin: 4.2%

Forecasts

Exhibit 62: MGA – European Decremental Margins


(500)

0

500

1,000

1,500

2,000

2,500

0 5,000 10,000 15,000 20,000 25,000

EBIT

(U

S$ m

illio

n)

Sales (US$ million)

Est. Decremental Margin: 17.8%2017E EBIT margin: 9.8%

Forecasts

Buy MGA on an Extended Cycle (and on Valuation), Not on Further Upside to SAAR

While we are closely monitoring cycle risks (e.g., declining used-vehicle prices, rising incentives, and higher

interest rates), we view auto sales plateauing (at levels well above replacement demand) as the most likely

base-case scenario in the context of 2% to 3% U.S. GDP growth, a robust U.S. job market, and positive

global PMI momentum. However, we believe the Canadian auto suppliers (including MGA) are pricing in

something much worse (i.e., a significant decline in industry sales volumes to levels more consistent with

replacement demand and an overly draconian view of Canada-specific trade risks), which, in our view, is

why they are trading at a discount of approximately 30% to their U.S. peers (see Exhibit 65).


32

Exhibit 65: Autos & Components Comparable Companies

1. Excludes maximum and minimum values.

Source: Company reports; FactSet; Scotiabank GBM estimates for LNR, MGA, MRE, and XTC (covered by Scotiabank GBM analyst Michael Doumet).

Price Market Enterprise P/E EV/EBITDA

Company Name (YE) Ticker Currency 12-Apr-17 Cap (M) Value (M) 2016A 2017E 2018E 2016A 2017E 2018E

Canadian Auto Part Suppliers

Exco Technologies (Sep) XTC C$ $10.88 $465 $509 9.8 x 8.6 x 7.8 x 6.0 x 5.2 x 4.9 x

Linamar Corporation (Dec) LNR C $ $55.27 $3,641 $4,669 7.0 x 7.2 x 7.1 x 4.5 x 4.5 x 4.4 x

Magna International Inc. (Dec) MGA US $ $39.99 $15,396 $20,101 7.6 x 7.2 x 6.6 x 4.8 x 4.7 x 4.4 x

Martinrea International (Dec) MRE C $ $9.37 $810 $1,505 6.2 x 5.4 x 5.1 x 4.5 x 4.0 x 3.8 x

Average 7.7 x 7.1 x 6.6 x 5.0 x 4.6 x 4.4 x

US Auto Part Suppliers

Adient (Sept) ADNT US$ $66.55 $6,235 $9,172 7.3 x 7.2 x 6.6 x 5.9 x 5.5 x 5.2 x

American Axle & Mfg Holdings (Dec) AXL US $ $16.70 $1,852 $2,207 5.1 x 5.0 x 5.5 x 3.6 x 3.4 x 3.6 x

Autoliv (Dec) ALV US $ $97.16 $8,582 $9,155 14.4 x 14.9 x 13.1 x 7.3 x 7.1 x 6.5 x

BorgWarner Inc. (Dec) BWA US $ $38.59 $8,214 $10,169 11.8 x 11.3 x 10.4 x 6.7 x 6.7 x 6.3 x

Dana Holdings Corp. (Dec) DAN US $ $17.72 $2,553 $3,613 9.1 x 10.1 x 8.8 x 5.5 x 5.1 x 4.7 x

Lear Corp. (Dec) LEA US $ $132.83 $9,125 $10,489 9.5 x 8.4 x 8.7 x 6.3 x 5.4 x 5.2 x

Tenneco Inc. (Dec) TEN US $ $57.99 $3,150 $4,427 9.4 x 9.0 x 8.1 x 5.2 x 4.9 x 4.6 x

Average 9.5 x 9.4 x 8.7 x 5.8 x 5.5 x 5.2 x

North American Average1

8.6 x 8.3 x 7.7 x 5.5 x 5.1 x 4.8 x

3-Year CAGR (through 2018E) EBITDA Margin % FCF Yield FCF Yield ROA Net Debt/ Dividend

Company Name Revenue EBITDA EPS 2016A 2017E bp Impr. 2016A 2017E 2017E 2017E EBITDA Yield

Canadian Auto Part Suppliers

Exco Technologies 7.7% 8.4% 11.6% 14.0% 16.0% +208 11.6% 12.6% 12.5% 0.5 x 2.9%

Linamar Corporation 7.9% 7.2% 5.6% 17.2% 16.6% -56 14.9% 9.2% 10.0% 1.0 x 0.7%

Magna International Inc. 7.0% 9.3% 10.4% 11.4% 11.5% +14 7.9% 3.4% 8.3% 1.1 x 2.5%

Martinrea International 0.7% 9.1% 10.4% 8.5% 9.7% +117 2.5% 6.8% 6.7% 1.8 x 1.3%

Average 5.8% 8.5% 9.5% 12.8% 13.5% +71 9.2% 8.0% 9.4% 1.1 x 1.9%

US Auto Part Suppliers

Adient na na na 9.3% 10.6% +136 3.2% 6.2% 6.4% 1.7 x 1.7%

American Axle & Mfg Holdings 1.0% 2.5% 0.2% 15.7% 15.3% -41 15.5% 15.1% 10.1% 1.4 x 0.0%

Autoliv 6.3% 5.3% 3.7% 12.5% 12.8% +35 4.0% 3.9% 8.6% 0.2 x 2.5%

BorgWarner Inc. 5.6% 5.7% 7.2% 16.6% 17.0% +36 6.4% 6.5% 10.5% 1.2 x 1.5%

Dana Holdings Corp. 2.8% 5.3% 4.9% 11.3% 11.6% +23 2.4% 2.8% 7.0% 1.3 x 1.4%

Lear Corp. 3.6% 7.9% 15.7% 10.3% 10.3% -4 11.2% 10.3% 13.1% 0.3 x 1.5%

Tenneco Inc. 4.2% 6.8% 13.7% 9.8% 10.3% +44 6.3% 8.0% 10.8% 1.2 x 1.7%

Average: 3.9% 5.6% 7.6% 12.7% 12.9% +16 7.6% 7.8% 10.0% 0.9 x 1.4%

North American Average 4.7% 6.7% 8.3% 12.4% 12.9% +47 7.8% 7.7% 9.5% 1.1 x 1.6%


33

Exhibit 66: LNR – Financial Summary


FY-Dec 2015 2016 Q1/17E Q2/17E Q3/17E Q4/17E 2017E 2018E

in millions C$, unless otherwise indicated

SegmentedPowertrain / Driveline

North America $2,709 $2,815 $707 $726 $668 $639 $2,741 $2,764

Europe 822 1,354 347 408 341 366 1,462 1,583

Asia Pacific 301 401 113 113 121 140 487 548

Total Auto Sales 3,832 4,569 1,167 1,247 1,131 1,145 4,690 4,895

Other Sales 478 570 135 151 146 138 570 571

Total Powertrain/Driveline Sales 4,310 5,139 1,301 1,399 1,276 1,283 5,260 5,466

Acquisition - - 70 - - - 70 72

Industrial Sales 852 867 197 302 238 149 886 942

Total Sales 5,163 6,006 1,569 1,700 1,514 1,433 6,216 6,480

Industrial

Organic Sales Growth YoY 10.2% (0.2%) 3.0% 3.0% 3.0% 3.0% 3.3% 6.0%

Estimated FX Impact 12.9% 1.8% (6.0%) 1.0% 1.2% 0.3% (1.0%) 0.3%

EBIT Margin %

Powertrain/Driveline 10.2% 10.7% 10.0% 10.5% 10.0% 10.0% 10.1% 9.9%

Industrial 18.3% 16.8% 14.5% 19.0% 17.0% 11.0% 16.1% 17.0%

Income Statement

Revenues $5,162 $6,006 $1,569 $1,700 $1,514 $1,433 $6,216 $6,480

EBITDA 871 1,030 252 293 259 228 1,032 1,072

EBITDA Margin % 16.9% 17.2% 16.1% 17.2% 17.1% 15.9% 16.6% 16.5%

EBIT 597 697 166 204 168 145 683 709

EBIT Margin % 11.6% 11.6% 10.6% 12.0% 11.1% 10.1% 11.0% 10.9%

Net income (loss) 437 522 122 151 123 106 502 514

EPS (fd) $6.63 $7.93 $1.85 $2.29 $1.87 $1.61 $7.63 $7.80

Balance SheetNet debt $209 $1,028 $1,024 $916 $885 $724 $724 $479

Adjusted Net Debt $227 $1,046 $1,042 $934 $903 $742 $742 $497

Net Debt-to-EBITDA [LTM] 0.2x 1.0x 1.0x 0.9x 0.9x 0.7x 0.7x 0.4x

Debt-to-Capitalization 20.3% 36.1% 30.4% 27.4% 26.0% 22.3% 22.3% 15.2%

Cash Flow ItemsCash Flow from Ops $726 $879 $208 $239 $214 $189 $851 $877

Cash Flow from Ops (after WC) $686 $877 $143 $247 $170 $300 $860 $854

CF/Share (before Working Capital) $11.14 $13.48 $3.19 $3.67 $3.28 $2.90 $13.04 $13.44

CF/Share (after Working Capital) $10.52 $13.45 $2.19 $3.79 $2.61 $4.59 $13.19 $13.09

Free Cash Flow (before Working Capital) $392 $544 $77 $108 $83 $58 $326 $302

Free Cash Flow (after Working Capital) $352 $542 $12 $116 $39 $168 $335 $279

FCF/Share (before Working Capital) $6.01 $8.34 $1.18 $1.66 $1.27 $0.89 $4.99 $4.63

FCF/Share (after Working Capital) $5.40 $8.31 $0.18 $1.78 $0.60 $2.58 $5.14 $4.28

Net Capital Expenditures ($334) ($335) ($131) ($131) ($131) ($131) ($525) ($575)

Capital Expenditures/Share ($5.12) ($5.14) ($2.01) ($2.01) ($2.01) ($2.01) ($8.04) ($8.81)

Dividend / Share $0.40 $0.40 $0.12 $0.12 $0.12 $0.12 $0.48 $0.53


34

Exhibit 67: MGA – Financial Summary


(FY-Dec) 2015A 2016A Q1/17E Q2/17E Q3/17E Q4/17E 2017E 2018E

In millions of USD unless indicated.

Segmented Production Sales

North American Prod'n Sales $17,990 $19,381 $4,727 $4,906 $4,951 $4,864 $19,447 $19,577

European Prod'n Sales 7,536 9,140 2,245 2,405 2,151 2,252 9,053 9,463

Rest of World Sales 2,084 2,656 589 608 678 825 2,700 3,153

Asia 1,630 2,217 509 501 559 692 2,261 2,714

Rest of World 454 439 80 107 119 133 439 439

Total Production Sales 27,610 31,177 7,561 7,918 7,781 7,941 31,201 32,193

Complete Vehicle Assembly Sales 2,341 2,190 256 372 602 1,522 2,753 4,987

Total Tooling Sales 2,741 3,078 605 713 700 913 2,931 2,902

Total Sales 32,692 36,445 8,422 9,003 9,083 10,376 36,884 40,082

EBIT %

North America 10.1% 9.9% 9.3% 10.1% 9.8% 10.1% 9.8% 9.6%

Europe 3.9% 4.2% 4.4% 4.9% 3.6% 3.9% 4.2% 4.4%

Rest of World 5.2% 7.9% 8.2% 7.9% 7.7% 7.8% 7.9% 8.9%

Asia 7.7% 9.9% 9.5% 9.5% 9.3% 9.3% 9.4% 10.3%

Rest of World (5.4%) (3.7%) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Adjusted EBIT % 7.8% 8.0% 7.7% 8.2% 7.6% 7.4% 7.7% 7.5%

EBIT % 7.1% 7.3% 7.0% 7.4% 6.8% 6.7% 7.0% 6.6%

Income Statement

Total Revenues $32,692 $36,445 $8,422 $9,003 $9,083 $10,376 $36,884 $40,082

EBITDA 3,145 3,721 876 948 910 1,000 3,734 3,912

EBITDA Margin % 9.6% 10.2% 10.4% 10.5% 10.0% 9.6% 10.1% 9.8%

EBIT 2,332 2,665 588 663 618 700 2,569 2,660

EBIT Margin % 7.1% 7.3% 7.0% 7.4% 6.8% 6.7% 7.0% 6.6%

Adjusted Net Income 1,852 2,057 478 545 511 572 2,106 2,233

EPS (FD Excl Unusual Items) $4.50 $5.23 $1.25 $1.43 $1.35 $1.52 $5.55 $6.06

Balance Sheet

Net Debt ($281) $2,182 $2,445 $2,685 $2,840 $2,572 $2,572 $2,618

Adjusted Net Debt $2,241 $4,880 $5,143 $5,383 $5,539 $5,270 $5,559 $5,605

Adjusted Net Debt-to-EBITDA 0.7x 1.2x 1.3x 1.4x 1.4x 1.3x 1.3x 1.3x

Net Debt / EBITDA (LTM) (0.1x) 0.6x 0.7x 0.7x 0.8x 0.7x 0.7x 0.7x

Net Debt / Capital -3.2% 17.6% 18.9% 19.9% 20.5% 18.4% 18.4% 17.4%

Cash FlowCash Flow from Ops $2,699 $3,305 $752 $817 $789 $858 $3,217 $3,432

Cash Flow from Ops (after WC) $2,346 $3,386 $570 $597 $688 $1,218 $3,073 $3,322



Free Cash Flow (before Working Capital) $930 $1,158 $137 $202 $174 $143 $657 $1,172

Free Cash Flow (after Working Capital) $577 $1,239 ($45) ($18) $73 $503 $513 $1,062


FCF/Share (after Working Capital) $1.42 $3.17 ($0.12) ($0.05) $0.20 $1.34 $1.36 $2.90

Net Capital Expenditures ($1,769) ($2,147) ($615) ($615) ($615) ($715) ($2,560) ($2,260)

Capital Expenditures/Share ($4.29) ($5.46) ($1.60) ($1.62) ($1.63) ($1.90) ($6.74) ($6.13)

ReturnsROIC 18.3% 16.8% 14.5% 15.9% 14.5% 16.2% 15.3% 14.9%

ROA 10.1% 10.2% 8.6% 9.8% 8.9% 9.6% 9.0% 8.9%

ROE 21.0% 22.0% 19.3% 21.4% 19.5% 21.3% 20.4% 19.5%

ROCE 24.9% 22.5% 19.5% 21.4% 19.5% 21.7% 20.5% 20.0%


35

Exhibit 68: MRE – Financial Summary


FY-Dec 2015 2016 Q1/17E Q2/17E Q3/17E Q4/17E 2017E 2018E

In millions of C$, unless otherwise indicated.

Segmented

Light Vehicle Production

N.A. Light Vehicle Production (M) 17.52 18.06 4.40 4.57 4.37 4.28 17.61 17.48

EU Light Vehicle Production (M) 20.68 21.36 5.66 5.86 4.73 5.31 21.56 21.68

Production Sales $3,705 $3,716 $947 $1,006 $894 $886 $3,733 $3,782

North America 2,993 3,010 750 807 705 681 2,943 2,876

Europe 633 596 160 160 146 158 625 694

Rest of World 79 109 36 40 43 46 165 212

EBIT Margin %

North America EBIT% 5.0% 5.1% 5.8% 6.0% 5.5% 5.5% 5.7% 5.8%

Europe EBIT% 4.9% 5.8% 6.0% 7.3% 6.3% 7.0% 6.6% 6.9%

Rest of World EBIT% (10.4%) (3.5%) - 0.5% 1.0% 2.5% 1.1% 2.5%

Income Statement

Revenues $3,867 $3,968 $987 $1,049 $932 $924 $3,892 $3,945

EBITDA 304 337 93 101 90 92 376 395

EBITDA Margin % 7.9% 8.5% 9.4% 9.7% 9.6% 9.9% 9.7% 10.0%

EBIT 177.2 198.1 55.0 62.7 50.4 51.8 219.9 229.8

EBIT Margin % 4.6% 5.0% 5.6% 6.0% 5.4% 5.6% 5.6% 5.8%

Adjusted Net Income 119.0 130.1 37.7 43.6 34.4 35.7 151.4 160.3

Adjusted EPS (fd) $1.38 $1.50 $0.44 $0.50 $0.40 $0.41 $1.75 $1.85

Balance Sheet

Net debt $688 $662 $711 $683 $688 $618 $618 $541

Adjusted Net Debt $721 $695 $743 $713 $717 $646 $646 $566

Net Debt-to-EBITDA [LTM] 2.3x 2.0x 2.1x 1.9x 1.9x 1.6x 1.6x 1.4x

Adjusted Net Debt-to-EBITDA 2.4x 2.1x 2.2x 2.0x 2.0x 1.7x 1.7x 1.4x

Debt-to-Total Capital 47.0% 44.4% 45.1% 43.0% 42.3% 38.9% 38.9% 32.5%

Cash Flow ItemsCash Flow from Ops $231 $276 $80 $87 $77 $80 $324 $344

Cash Flow from Ops (after WC) $193 $260 $11 $89 $71 $145 $317 $339



Free Cash Flow (before Working Capital) $39 $37 $22 $29 $4 $7 $62 $92

Free Cash Flow (after Working Capital) $1 $21 ($47) $31 ($2) $72 $55 $87


FCF/Share (after Working Capital) $0.01 $0.24 ($0.54) $0.36 ($0.03) $0.84 $0.64 $1.01

Net Capital Expenditures ($192) ($239) ($58) ($58) ($73) ($73) ($262) ($252)

Capex per share ($2.24) ($2.77) ($0.67) ($0.67) ($0.84) ($0.84) ($3.03) ($2.92)

ReturnsROIC 9.0% 9.7% 10.5% 11.9% 9.3% 9.8% 10.4% 10.4%

ROA 5.9% 6.1% 6.7% 7.5% 6.0% 6.3% 6.8% 7.0%

ROE 17.6% 16.2% 17.8% 19.7% 14.9% 14.9% 16.8% 15.3%

ROCE 11.9% 12.8% 13.8% 15.6% 12.2% 12.9% 13.7% 13.7%


36

Risk/Reward Trade-Off: Linamar Corporation (LNR-T; SO; One-Year Target $80.00)

Investment Thesis

Since July 2016, we have seen U.S. supplier multiples expand materially, while Canadian multiples have recovered only modestly. In fact, LNR

continues to trade at or near its 20-year low P/E and at the widest discount to its U.S. peers in several years. We believe the discount is at least

partially attributable to concerns about Canada-specific trade risks. Furthermore, at current levels, we believe Skyjack is essentially being assigned an

automotive multiple despite the fact that access equipment companies (i.e., Skyjack’s peers) currently trade at more than 2x the multiple of auto

suppliers.


Change in North American trade environment.

More significant decline in industry sales.

Rapid adoption of zero-emission vehicles.

Slower-than-expected US infrastructure roll-out.

Canada-specific trade risk: Canadian auto

suppliers (including LNR) trading at a discount

of ~25% to their U.S. peers. Industry sales

decline to replacement demand (i.e.,

approximately a 15% decline in U.S. auto sales

and 5% decline in European auto sales).

No incremental value being assigned to

Skyjack.

Resolution of Canada-specific

trade risks.

Uncertain

Continued strength in U.S. auto

sales.

Ongoing

Improving infrastructure spend. Ongoing


U.S. auto sales decline to replacement demand

(LV SAAR = 15 million units).

European volumes decline 5% (in line with our

estimate of replacement demand). Asia-Pacific

volumes decline 5%.

Modest margin compression on lower volumes:

decremental EBIT margin = 14%.

No multiple expansion despite lower cyclical

earnings. Multiple also assumes no resolution

of Canada-specific trade risks.

Modest volume declines (5%) at Skyjack.

U.S. auto sales plateau (LV SAAR = 17.25

million units).

Modest growth (approximately 1%) in Europe

as geopolitical events partially offset continued

recovery.

Modest growth in Asia.

Modest Powertrain/Driveline margin

compression on lower volumes: 2018E EBIT

margin = 9.9% (versus 10.7% in 2016).

Multiple expansion (to levels of U.S. peers) as

Canada-specific trade risks are resolved.

Low- to mid-single-digit organic volume growth

at Skyjack.

U.S. auto sales continue to grow, but still

plateau (LV SAAR = 18.25 million units).

Faster growth (approximately 5%) in Europe.

Faster growth in Asia.

Modest Powertrain/Driveline margin expansion

on higher volumes: incremental margin = 14%.



Valuation multiple the same as our base case

as we view both as being at the plateau stage.

Faster organic volume growth (i.e., 15%) at

Skyjack.


8.0x 2018E P/E 10.5x 2018E P/E 10.5x 2018E P/E

Bear

Case

$54.00

(-2.3%)

Base

Case

$80.00 (44.7%)

Bull

Case

$89.00 (61.0%)

Current

Price

$55.27


37

Risk/Reward Trade-Off: Magna International Inc. (MGA-N; SO; One-Year Target US$65.00)

Investment Thesis

Since July 2016, we have seen U.S. supplier multiples expand materially, while Canadian multiples have recovered only modestly. In fact, MGA


partially attributable to concerns about Canada-specific trade risks. While we acknowledge these risks exist, we have been encouraged by

commentary from politicians about the trading relationship between the two countries. As such, we view the current trading discount (~25%) as too

severe, especially considering our expectations that MGA will outgrow the industry, deliver at least comparable returns, and return significant amounts

of capital to shareholders.




Canada-specific trade risks: Canadian auto

suppliers (including MGA) are trading at a

discount of ~25% to their U.S. peers.

Industry sales decline to replacement demand:

U.S. auto sales down approximately 15%,

European auto sales down 5%, and EBIT in

Asia down 25%.


trade risks.

Uncertain


sales.

Ongoing



(LV SAAR = 15 million units). Significant margin

contraction on lower volumes: decremental

EBIT margin = ~18.0%.


estimate of replacement demand). Modest

margin compression on lower volumes:

decremental EBIT margin = ~8.5%.

A 25% decline in EBIT in Asia (in line with

declines seen in North America).

Dividend (2.7% yield) well covered from FCF:

estimated ~45% payout.



to Canada-specific trade risks.


million units). Modest margin compression on

lower volumes: 2018E EBIT margin = 9.6%

(versus 9.9% in 2016).



recovery. Modest margin expansion on higher

volumes: 2018E EBIT margin = 4.4% (versus

4.2% in 2016).

Modest growth in Asia (with more significant

growth for MGA as business ramps up). Modest

margin expansion on higher volumes and

higher equity earnings: 2018E EBIT margin =

10.3% (versus 9.9% in 2016).






plateau (LV SAAR = 18.25 million units).

Modest margin expansion on higher volumes:

incremental EBIT margin = 18%.


Modest margin expansion on higher volumes:

incremental EBIT margin = 8%.






Valuation multiple the same as our base case

as we view both as being at the plateau stage.


8.0x 2018E P/E 10.5x 2018E P/E 10.5x 2018E P/E

Bear

Case

$39.00

(-2.5%)

Base

Case

$65.00 (62.5%)

Bull

Case

$69.00 (72.5%)

Current

Price

$39.99


38

Risk/Reward Trade-Off: Martinrea International Inc. (MRE-T; SP; One-Year Target: $13.50)

Investment Thesis

Since July 2016, we have seen U.S. supplier multiples expand materially, while Canadian multiples have recovered only modestly. In fact, MRE


partially attributable to concerns about Canada-specific trade risks. While we acknowledge these risks exist, we have been encouraged by

commentary from politicians about the trading relationship between the two countries. In our opinion, MRE offers the most torque in the space, and

with operations trending in the right direction, we continue to see significant upside in MRE shares should management “put it all together.”




Hitting operational targets/milestones.

Canada-specific trade risks: Canadian auto

suppliers (including MRE) trading at a discount

of ~25% to their U.S. peers.

Industry sales decline to replacement demand

(i.e., approximately a 15% decline in U.S. auto

sales and 5% decline in European auto sales).


trade risks.

Uncertain


sales.

Ongoing



(LV SAAR = 15 million units). Modest margin

contraction on lower volumes.


estimate of replacement demand). Modest

margin compression on lower volumes.

Maintain small operating losses in the rest of

the world (ROW).



of Canada-specific trade risks.


million units). Modest margin expansion (given

operational improvements and mix) despite

some contraction in volumes: 2018E EBIT

margin = 5.8% (versus 5.1% in 2016).



recovery. Modest margin expansion on higher

volumes and mix: 2018E EBIT margin = 6.9%

(versus 5.8% in 2016).

Modest growth in ROW (with more significant

growth for MRE as business ramps up). Modest

margin expansion on higher volumes and

higher equity earnings: 2018E EBIT margin =

2.5% (versus slight operating loss in 2016).

Multiple expansion (to levels of U.S. peers,

adjusted for the balance-sheet-related discount

we attribute to MRE) as Canada-specific trade

risks are resolved.


plateau (18.25 million units). Modest margin

expansion on higher volumes.


Modest margin expansion on higher volumes.


Multiple expansion (to levels of U.S. peers

adjusted for the balance-sheet-related discount

we attribute to MRE) as Canada-specific trade

risks are resolved. Valuation multiple the same

as our base case as we view both as being at

the plateau stage.


5.5x 2018E P/E 7.5x 2018E P/E 7.5x 2018E P/E

Bear

Case

$9.00

(--3.9%)

Base

Case

$13.50 (44.1%)

Bull

Case

$15.00 (60.1%)

Current

Price

$9.37


39

Pertinent Data and Revisions Price Rating 1-Yr. Target 1-Yr. Return

FTT-T C$24.35 SO C$28.50 20.1%LNR-T C$55.27 SO C$80.00 45.6%MGA-N US$39.99 SO US$65.00 65.3%MRE-T C$9.37 SP C$13.50 45.4%

Finning International Inc. (FTT-T;C$24.35)

Valuation: 18.5x P/E on our 2018EKey Risks: Industry cyclicality, commodity prices, competition, operational improvements

Linamar Corporation (LNR-T;C$55.27)

Valuation: 10.5x P/E our 2018EKey Risks: Slowing auto demand and unsuccessful roll-out of program launches

New OldKey Data EPS17E: $7.63

EPS18E: $7.80EPS17E: $7.57EPS18E: $7.72

Magna International Inc. (MGA-N;US$39.99)

Valuation: 10.5x P/E on our 2018EKey Risks: Slowing auto demand and realizing margin improvement (Europe and ROW)

New OldKey Data EPS17E: US$5.55

EPS18E: US$6.06EPS17E: US$5.54EPS18E: US$6.04

Martinrea International Inc. (MRE-T;C$9.37)

Valuation: 7.5x P/E our 2018EKey Risks: Slowing auto demand and unsuccessful margin improvement

New OldKey Data Adj EPS17E: $1.75

Adj EPS18E: $1.85Adj EPS17E: $1.72Adj EPS18E: $1.82


40

Appendix A: Important Disclosures

Company Disclosures (see legend below)*

Exco Technologies Limited VS0273, VS0411Finning International Inc. D39Linamar Corporation VS0115, VS0116Magna International Inc. B43, D35, HH, I, VS0113, VS0114Toromont Industries Ltd. I

We, Vincent Delisle, Mark Neville and Michael Doumet, certify that (1) the views expressed in this report in connection with securities orissuers that we analyze accurately reflect our personal views and (2) no part of our compensation was, is, or will be directly or indirectly,related to the specific recommendations or views expressed by us in this report.

This research report was prepared by employees of Scotia Capital Inc. and/or its affiliates who have the title of Analyst.

All pricing of securities in reports is based on the closing price of the securities’ principal marketplace on the night before the publicationdate, unless otherwise explicitly stated.

All Equity Research Analysts report to the Head of Equity Research. The Head of Equity Research reports to the Managing Directorand Co-Head, Global Capital Markets, who is not and does not report to the Head of the Investment Banking Department. Scotiabank,Global Banking and Markets has policies that are reasonably designed to prevent or control the sharing of material non-publicinformation across internal information barriers, such as between Investment Banking and Research.

The compensation of the research analyst who prepared this report is based on several factors, including but not limited to, the overallprofitability of Scotiabank, Global Banking and Markets, and the revenues generated from its various departments, including investmentbanking, trading fees and other types of transactions. Furthermore, the research analyst’s compensation is charged as an expenseto various Scotiabank, Global Banking and Markets departments, including investment banking. Research Analysts may not receivecompensation from the companies they cover.

Non-U.S. analysts may not be associated persons of Scotia Capital (USA) Inc. and therefore may not be subject to FINRA Rule 2241restrictions on communications with subject company, public appearances and trading securities held by the analysts.

For Scotiabank, Global Banking and Markets Research analyst standards and disclosure policies, please visit gbm.scotiabank.com/disclosures.

Scotiabank, Global Banking and Markets Research, 40 King Street West, 33rd Floor, Toronto, Ontario, M5H 1H1.

Time of dissemination: April 17, 2017, 16:30 ET. Time of production: April 17, 2017, 16:23 ET. Note: Time of dissemination is defined asthe time at which the document was disseminated to clients. Time of production is defined as the time at which the Supervisory Analystapproved the document.

*Legend

B43 Dr. Indira V. Samarasekera is a director of Magna International Inc. and is a director of The Bank of Nova Scotia.

D35 Scott B. Bonham, a Director of The Bank of Nova Scotia, is a member of the Board of Directors of Magna International Inc.

D39 L. Scott Thomson, a Director of the Bank of Nova Scotia, is a member of the Board of Directors of Finning International Inc.

HH The Head of Equity Research or a Supervisory Analyst owns securities of this issuer in his or her own account or in a relatedaccount.

I Scotia Capital (USA) Inc. or its affiliates has received compensation for investment banking services in the past 12 months.

VS0113 Research Analyst Mark Neville visited Dortec, a division of Magna Closures, on December 16, 2013. No payment wasreceived from the issuer for the travel-related expenses incurred by the Research Analyst to visit this site.

VS0114 Research Analyst Mark Neville visited Karmax, a division of Cosma, on December 16, 2013. No payment was received fromthe issuer for the travel-related expenses incurred by the Research Analyst to visit this site.

VS0115 Research Analyst Mark Neville visited Comtech Manufacturing, a manufacturer of precision-machined components, onDecember 10, 2013. No payment was received from the issuer for the travel-related expenses incurred by the ResearchAnalyst to visit this site.

VS0116 Research Analyst Mark Neville visited Skyjack, a manufacturer of aerial work platforms, on December 10, 2013. No paymentwas received from the issuer for the travel-related expenses incurred by the Research Analyst to visit this site.

VS0273 Research Analyst Michael Doumet visited Exco Tooling Solutions, an extrusion die shop, on December 10, 2014. No paymentwas received from the issuer for the travel-related expenses incurred by the Research Analyst to visit this site.


41

http://gbm.scotiabank.com/disclosures


VS0411 Research Analyst Michael Doumet visited AFX Industries, Polytech, and Texas Extrusion Tooling, manufacturing facilities,on September 14 and 15, 2016. Partial payment was received from the issuer for the travel-related expenses incurred by theResearch Analyst to visit this site.


42

Rating and Price Target History

Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17

35

30

25

20

15

Pric

e (C

AD

)

Finning International Inc. (FTT-T) as of April 14, 2017 (in CAD)

Ratings Legend: FS=Focus Stock; SO=Sector Outperform; SP=Sector Perform; SU=Sector Underperform; T=Tender; UR=Under Review; CS=Coverage Suspended; DC=Discontinued Coverage*Represents the value(s) that changed.

22-Apr-2014Price: 29.04Rating: FSTarget: 33.50

15-May-2014Price: 30.17Rating: SO*Target: 34.00*

08-Aug-2014Price: 33.15Rating: SOTarget: 35.50*

21-Oct-2014Price: 29.09Rating: SOTarget: 35.00*

14-Nov-2014Price: 27.83Rating: SOTarget: 34.00*

17-Dec-2014Price: 24.20Rating: SOTarget: 29.00*

03-Feb-2015Price: 23.26Rating: SOTarget: 27.50*

07-May-2015Price: 24.95Rating: SOTarget: 29.00*




16-Dec-2015Price: 18.16Rating: SOTarget: 23.00*


26-Apr-2016Price: 21.70Rating: SOTarget: 23.50*


31-Jan-2017Price: 26.34Rating: SOTarget: 29.00*


Powered by: BlueMatrix


90

80

70

60

50

40

Pric

e (C

AD

)

Linamar Corporation (LNR-T) as of April 14, 2017 (in CAD)


24-Apr-2014Price: 56.33Rating: SOTarget: 61.00


11-Jul-2014Price: 63.57Rating: SOTarget: 75.00*


29-Sep-2014Price: 59.48Rating: SOTarget: 78.00*



05-Mar-2015Price: 74.30Rating: SOTarget: 92.00*



28-Jul-2015Price: 73.99Rating: SOTarget: 100.00*





43


60

55

50

45

40

35

30

Pric

e (U

SD

)

Magna International Inc. (MGA-N) as of April 14, 2017 (in USD)


24-Apr-2014Price: 50.30Rating: FSTarget: 125.00

11-Jul-2014Price: 55.03Rating: FSTarget: 150.00*

08-Jan-2015Price: 54.55Rating: FSTarget: 145.00*

15-Jan-2015Price: 45.92Rating: FSTarget: 140.00*

31-Mar-2015Price: 53.66Rating: FSTarget: 70.00*

29-Apr-2015Price: 51.63Rating: SO*Target: 70.00


06-Jan-2016Price: 37.17Rating: SOTarget: 63.00*




16

14

12

10

8

6

Pric

e (C

AD

)

Martinrea International Inc. (MRE-T) as of April 14, 2017 (in CAD)


11-Feb-2015Price: 10.72Rating: SPTarget: 13.00

04-Mar-2015Price: 13.04Rating: SPTarget: 13.50*

23-Mar-2015Price: 13.06Rating: SPTarget: 14.00*

07-May-2015Price: 12.84Rating: SPTarget: 15.00*

06-Nov-2015Price: 11.87Rating: SPTarget: 14.50*

18-Feb-2016Price: 8.65Rating: SPTarget: 14.00*

27-Apr-2016Price: 9.75Rating: SPTarget: 13.00*

04-May-2016Price: 9.14Rating: SPTarget: 13.50*



44

Definition of Scotiabank, Global Banking and Markets Equity Research RatingsWe have a four-tiered rating system, with ratings of Focus Stock, Sector Outperform, Sector Perform, and Sector Underperform. Eachanalyst assigns a rating that is relative to his or her coverage universe or an index identified by the analyst that includes, but is notlimited to, stocks covered by the analyst.

The rating assigned to each security covered in this report is based on the Scotiabank, Global Banking and Markets research analyst’s12-month view on the security. Analysts may sometimes express to traders, salespeople and certain clients their shorter-term viewson these securities that differ from their 12-month view due to several factors, including but not limited to the inherent volatility of themarketplace.Ratings

Focus Stock (FS)The stock represents an analyst’s best idea(s); stocks in thiscategory are expected to significantly outperform the average12-month total return of the analyst’s coverage universe or anindex identified by the analyst that includes, but is not limited to,stocks covered by the analyst.

Sector Outperform (SO)The stock is expected to outperform the average 12-month totalreturn of the analyst’s coverage universe or an index identifiedby the analyst that includes, but is not limited to, stocks coveredby the analyst.

Sector Perform (SP)The stock is expected to perform approximately in line withthe average 12-month total return of the analyst’s coverageuniverse or an index identified by the analyst that includes, butis not limited to, stocks covered by the analyst.

Sector Underperform (SU)The stock is expected to underperform the average 12-monthtotal return of the analyst’s coverage universe or an indexidentified by the analyst that includes, but is not limited to,stocks covered by the analyst.

Other RatingsTender – Investors are guided to tender to the termsof the takeover offer.

Under Review – The rating has been temporarilyplaced under review, until sufficient information hasbeen received and assessed by the analyst.

Risk RankingAs of June 22, 2015, Scotiabank, Global Bankingand Markets discontinued its Low, Medium, and Highrisk rankings. The Speculative risk ranking reflectsexceptionally high financial and/or operational risk,exceptionally low predictability of financial results,and exceptionally high stock volatility. The Directorof Research and the Supervisory Analyst jointlymake the final determination of the Speculative riskranking.

Scotiabank, Global Banking and Markets Equity Research Ratings Distribution*

Distribution by Ratings and Equity and Equity-Related Financings*

47.2% 46.7%

6.1%

20% 18.7% 7.1%Sector Outperform Sector Perform Sector

Underperform

0%

20%

40%

60%

* As of March 31, 2017. Source: Scotiabank GBM.

Percentage of companies covered byScotiabank, Global Banking and Markets EquityResearch within each rating category.

Percentage of companies within each ratingcategory for which Scotiabank, Global Bankingand Markets has undertaken an underwritingliability or has provided advice for a fee withinthe last 12 months.

For the purposes of the ratings distribution disclosure FINRA requires members who use a ratings system with terms differentthan “buy,” “hold/neutral” and “sell,” to equate their own ratings into these categories. Our Focus Stock, Sector Outperform,Sector Perform, and Sector Underperform ratings are based on the criteria above, but for this purpose could be equated tostrong buy, buy, neutral and sell ratings, respectively.


45

General Disclosures

This report has been prepared by analysts who are employed by the Research Department of Scotiabank, Global Banking and Markets.Scotiabank, Global Banking and Markets Research produces research reports under a single marketing identity referred to as “globallybranded research” under U.S. rules. This research is produced on a single global research platform with one set of rules which meetthe most stringent standards set by regulators in the various jurisdictions in which the research reports are produced. In addition, theanalysts who produce the research reports, regardless of location, are subject to one set of policies designed to meet the most stringentrules established by regulators in the various jurisdictions where the research reports are produced.

The frequency of reports is determined by the analyst on a case-by-case basis, driven by external market factors and issuerannouncements. Analysts will endeavour to review and publish such estimates and recommendations as soon as possible after therelease of material information by the issuer or the occurrence of other relevant events. This will typically involve, at a minimum, asummary of quarterly earnings releases.

Scotia Capital Inc. or an affiliate thereof owns or controls an equity interest in TMX Group Limited and in excess of 1% of the issuedand outstanding equity securities thereof. In addition, an affiliate of Scotia Capital Inc. is a lender to TMX Group Limited under its creditfacilities. As such, Scotia Capital Inc. may be considered to have an economic interest in TMX Group Limited.

This report is provided to you for informational purposes only. This report is not, and is not to be construed as, an offer to sell orsolicitation of an offer to buy any securities and/or commodity futures contracts.

The securities mentioned in this report may neither be suitable for all investors nor eligible for sale in some jurisdictions where thereport is distributed.

The information and opinions contained herein have been compiled or arrived at from sources believed reliable, however, Scotiabank,Global Banking and Markets makes no representation or warranty, express or implied, as to their accuracy or completeness.

Scotiabank, Global Banking and Markets has policies designed to make best efforts to ensure that the information contained in thisreport is current as of the date of this report, unless otherwise specified.

Any prices that are stated in this report are for informational purposes only. Scotiabank, Global Banking and Markets makes norepresentation that any transaction may be or could have been effected at those prices.

Any opinions expressed herein are those of the author(s) and are subject to change without notice and may differ or be contrary fromthe opinions expressed by other departments of Scotiabank, Global Banking and Markets or any of its affiliates.

Neither Scotiabank, Global Banking and Markets nor its affiliates accepts any liability whatsoever for any direct or consequential lossarising from any use of this report or its contents.

Equity research reports published by Scotiabank, Global Banking and Markets are available electronically via: Bloomberg, ThomsonFinancial/First Call - Research Direct, Reuters, Capital IQ, and FactSet. Institutional clients with questions regarding distribution ofequity research or who wish to access the proprietary model used to produce this report should contact Scotiabank at 1-800-208-7666.A list of all investment recommendations in any financial instrument or issuer that have been disseminated during the preceding 12months is available at the following location: gbm.scotiabank.com/disclosures

This report and all the information, opinions, and conclusions contained in it are protected by copyright. This report may not bereproduced in whole or in part, or referred to in any manner whatsoever, nor may the information, opinions, and conclusions containedin it be referred to without the prior express consent of Scotiabank, Global Banking and Markets.

Additional Disclosures

Canada: This report is distributed by Scotia Capital Inc., a subsidiary of The Bank of Nova Scotia.

Chile: This report is distributed by Scotia Corredora de Bolsa Chile S.A., a subsidiary of The Bank of Nova Scotia.

Colombia: This report is distributed in Colombia by Banco Colpatria Multibanca Colpatria S.A. as authorized by the SuperintendenciaFinanciera de Colombia to The Bank of Nova Scotia (“Scotiabank”) by Resolution 058 of 2014 and to Scotia Capital Inc. by Resolution0226 of 2015. Said Resolutions authorize Scotiabank and Scotia Capital Inc. to promote and advertise their products and servicesthrough Banco Colpatria Multibanca Colpatria S.A. This report is prepared by analysts employed by The Bank of Nova Scotia andcertain of its affiliates including Scotia Capital Inc.

Hong Kong: This report is distributed by The Bank of Nova Scotia Hong Kong Branch, which is authorized by the Securities and FutureCommission to conduct Type 1, Type 4 and Type 6 regulated activities and regulated by the Hong Kong Monetary Authority.

Mexico: The information contained in this report is for informational purposes only and is not intended to influence the decision of theaddressee in any way whatsoever with respect to an investment in a certain type of security, financial instrument, commodity, futurescontract, issuer, or market, and is not to be construed as an offer to sell or a solicitation of an offer to buy any securities or commoditiesfutures contracts. Scotiabank Inverlat Casa de Bolsa, S.A. de C.V. is not responsible for the outcome of any investment performedbased on the contents of this research report.


46


Peru: This report is distributed by Scotia Sociedad Agente de Bolsa S.A., a subsidiary of The Bank of Nova Scotia.

Singapore: This report is distributed by BNS Asia Limited, a subsidiary of The Bank of Nova Scotia. BNS Asia Limited is authorisedand regulated by the Monetary Authority of Singapore, and exempted under Section 99(1)(a),and (b), (c) and (d) of the Securities andFutures Act to conduct regulated activities.

United Kingdom and the rest of the European Economic Area: Except as otherwise specified herein, this report is distributed byScotiabank Europe plc, a subsidiary of The Bank of Nova Scotia. Scotiabank Europe plc complies with all requirements under the EUMarket Abuse Regulation concerning investment recommendations.

United States: This report is distributed by Scotia Capital (USA) Inc., a subsidiary of Scotia Capital Inc., and a registered U.S. broker-dealer. All transactions by a U.S. investor of securities mentioned in this report must be effected through Scotia Capital (USA) Inc.

Non-U.S. investors wishing to effect a transaction in the securities discussed in this report should contact a Scotiabank, Global Bankingand Markets entity in their local jurisdiction unless governing law permits otherwise.

™ Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with "Global Banking andMarkets," is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank ofNova Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc., Scotia Capital (USA) Inc.,Scotiabanc Inc., Citadel Hill Advisors L.L.C., The Bank of Nova Scotia Trust Company of New York, Scotiabank Europe plc, Scotiabank(Ireland) Designated Activity Company, Scotiabank Inverlat S.A., Institución de Banca Múltiple, Scotia Inverlat Casa de Bolsa S.A. deC.V., Scotia Inverlat Derivados S.A. de C.V. – all members of the Scotiabank Group and authorized users of the mark. The Bank ofNova Scotia is incorporated in Canada with limited liability. Scotia Capital Inc. is a member of the Canadian Investor Protection Fundand regulated by the Investment Industry Regulatory Organization of Canada. Scotia Capital (USA) Inc. is a broker-dealer registeredwith the SEC and is a member of FINRA, NYSE, NFA and SIPC. Scotiabank Europe plc is authorized by the Prudential RegulationAuthority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Scotiabank Inverlat, S.A., ScotiaInverlat Casa de Bolsa, S.A. de C.V., and Scotia Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financialauthorities.

© The Bank of Nova Scotia 2017

This report and all the information, opinions, and conclusions contained in it are protected by copyright. This report may not bereproduced in whole or in part, or referred to in any manner whatsoever, nor may the information, opinions, and conclusions containedin it be referred to without prior express consent.


47

industrial strategy & quantitative strategy; head of...

Documents