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Canada's auto-parts makers are riding high amid NAFTA tension

Shares of Linamar Corporation and Martinrea International Inc. rallied following U.S. President Donald Trump’s announcement of a tentative bilateral agreement with Mexico on Monday. (Motley Fool)

Analysts are voicing cautious optimism about Canada’s auto-parts suppliers despite an uncertain future for the trade-dependent sector.

Shares of Linamar Corporation (LNR.TO) and Martinrea International Inc. (MRE.TO) following U.S. President Donald Trump’s announcement of a tentative bilateral agreement with Mexico on Monday. Magna International (MG.TO) saw a more muted response.

The trio of companies, with plants scattered across North America, are operating in a climate of confusion, lacking a three-party deal to replace the 24-year-old North American Free Trade Agreement. They’re also surly wringing their hands over the looming threat of hefty U.S. tariffs on parts and vehicles from Canada.

The fresh agreement between U.S. officials and their Mexican counterparts mandates up to 45 per cent of auto content from high-wage jurisdictions, and includes a 75 per cent North American content-per-vehicle threshold. Investors have embraced the preliminary pact as good news for Canada’s auto parts industry.

“We believe this is a positive development for Canadian auto parts suppliers since the North American automotive industry will stay intact, and Mexican assembly plants will need to source parts from high-wage jurisdictions such as the U.S. and Canada,” BMO Capital Markets analyst Peter Sklar wrote in a note to clients.

Sklar couched that by noting this is a tentative agreement without reference to Canada. He warned that Canada’s return to the negotiating table may upend the consensus on autos reached by the U.S. and Mexico.

“Talks with Canada potentially could change the terms of this agreement as the U.S., Canada, and Mexico try to achieve a trilateral understanding,” Sklar said.

Foreign Affairs Minister Chrystia Freeland is in Washington for the latest round of negotiations, flanked by senior Canadian officials, including Prime Minister Justin Trudeau and his point-man on U.S. relations, Brian Clow. The U.S. side favours a narrow timeframe for these latest trade talks, pushing for a deal by Friday.

Macquarie Capital Markets analysts Michael Glen is looking past potential headwinds for Canadian auto parts stocks. On Tuesday, he released a return analysis of Linamar, Magna, Martinrea and Exco Technologies shares, looking at where they would trade if the NAFTA situation ended with a “constructive deal conclusion.”

“The name that clearly stands out from a return perspective is Linamar, which has significantly underperformed the TSX year-to-date,” he wrote. “Most of the pressure seen on the stock in 2018 is related to trade uncertainty, and removal of this overhang could trigger a very rapid move higher.”

Glen is calling for the price-to-earnings ratio for shares in the Guelph, Ont.-based company to reach 62 per cent. A high P/E ratio generally indicates that investors expect higher earnings.

“Under the scenario of a constructive trilateral trade conclusion, our order of preference would be Linamar, followed by Martinrea, Magna and Exco,” he said.

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