Shares of BorgWarner (NYSE:BWA) have fallen to fresh 52-week lows as the company has been hit by modest growth and losses at its EV business, a segment which was supposed to become its growth engine with a long runway for growth.
This is highly disappointing as the company still has a long way to go in electrifying its product line-up, and in fact has invested greatly into building up these capabilities in recent years. With a transition continuing for years to come, investors should not automatically be lured into low earnings multiples, as quite some execution, restructuring and transitioning work remains to be done.
A Softer End To 2023
BorgWarner posted a 6% increase in fourth quarter sales to $3.52 billion, as a large raw material component of its products made that gross margins are relatively modest at 18%, as strict cost control made that operating margins came in at a respectable 8% of sales, while adjusted operating profits fell four pennies to $0.90 per share.
These numbers marked a noteworthy deceleration from 12% revenue growth reported for the year, with sales up $14.2 billion, due to slower demand and less of inflationary pressures. Contrary to the fourth quarter, the company grew adjusted earnings in a convincing manner to $3.75 per share, although that GAAP earnings were meaningfully lower at $2.70 per share, as they have consistently come in lower.
Talking about the business, just over half of sales are generated from Air Management, responsible for $7.8 billion, equal to 55% of sales, as the segment posts margins around 15% of sales.
Drivetrain & Battery Systems make up for $4.3 billion in sales, making up 30% of sales, for segment margins of 12% and change. The problem was the ePropulsion business which generated nearly $2.2 billion in sales, equal to around 15% of sales, as segment losses of $90 million are equal to about 4% of sales.
Across segments, products manufactured by BorgWarner include traditional combustion turbochargers, boosters, ignition technology, heating and air treatment, battery packs, inverters, fans, among others, supplied to ICE vehicles, hybrids, and electrical cars.
The Market Is Not Digging It
Despite positive headlines at the top of the press release, including a strategic relationship with FinDreams Battery (which is a BYD subsidiary), the completion of the Eldor acquisition, and new product awards, the upbeat comments are not backed up by the outlook.
For 2024, sales are seen up between $14.4 and $14.9 billion, a 1-5% increase compared to 2023. eProduct sales are seen between $2.5 and $2.8 billion (up from $2.0 billion in 2023). While this is up 25-40% year-over-year, it implies that eProduct sales are still only seen equal to about 18% of total sales this year.
With the Eldor purchase being dilutive to earnings, adjusted earnings are seen flattish between $3.65 and $4.00 per share, marking really no growth on a comparable basis, as shares trade at a high single digit earnings multiple while analysts hoped to see earnings rise towards $4.25 per share. Most of the shortfall seems to be the result of the Eldor business, which is lossmaking, which management claims is not a surprise, but clearly seems to have surprised the market based on the discussions on the conference call.
In fact, 234 million shares outstanding now grant the business just over a $7 billion equity valuation just over $30, although this excludes $2.2 billion in net debt, which is manageable with EBITDA seen around $1.8 billion.
The trouble is that the progress to electrification remains painfully slow, with e-sales only seen making up a high-teens percentage in terms of sales, while hybrid and e-vehicles make up a much larger percentage (roughly double) in new product sales across the globe, as an indication that BorgWarner is not a front-runner in this area.
Moreover, the outlook for e-sales is not so impressive, after the company previously announced ambitions to generate $10 billion from electrical vehicle components in 2027, as that looks rather ambitious now, although the company reiterated a need to pursue about $2 billion in M&A in order to achieve this.
The Painful Transition
While BorgWarner is gradually going electric, this has come after some bold moves. The biggest one of this was a $3.3 billion deal for Delphi back in 2020, through which the company obtained a lot of electrical expertise, followed by another EUR 727 million deal for battery pack designer and manufacturer AKASOL AG. This deal was furthermore followed by another $185 million deal for Rhombus Energy Solutions and an EUR 75 million deal for Eldor, with the combined deal tag of $4.3 billion being very substantial in relation to a current >$9 billion enterprise valuation.
There has been a divestment as well, as the company separated PHINIA (PHIN) through a spin-off last summer. By spinning off the Fuel System and Aftermarket business, the company should furthermore become more resilient to the shift in its business model, although that valued at just $1.3 billion (in terms of equity valuation), BorgWarner would see about $3.5 billion in sales and half a billion in EBITDA leaving the door. At non-demanding valuations, I feared the impact of this spin-off on near term earnings power, as the transition was still in the real early innings.
Given all this, the daunting task ahead, and notoriously cyclicality seen in automotive supplier stocks, I was leaning rather cautious over the summer, as low earnings multiples looked compelling, but were highly adjusted.
A Cautious View
The reality is that the 2024 guidance is rather underwhelming as long term growth is hard to come, the transition is in its early inning, as shares pay a modest 1% and change dividend yield, amidst a flattish share count over the past decade. These have been the reasons for shares to be trading largely stagnant in a $30-$50 range for most of the last decade.
On the one hand, the company is making the right strategic moves and trades at a dirt cheap multiple. The issue is that after adjustments, multiples come in the low-double digits, as much of the adjustments involve cash outflows related to the continued transition of the business. Cash flow generation is a different story, with more M&A predicted to make the transition, and net capital investments remaining elevated here, depressing free cash flow generation.
Add to this that automotive suppliers are never really been awarded premium valuations in the past, and given the cyclical business and slim operating margins, one should not automatically assume a fair market multiple will be awarded to the shares at that point in time when the transition nears completion.
Amidst all this, shares look very cheap and might very well be cheap, but the transition is still in the early innings, making that investors should be more cautious than simply buy a very compelling earnings multiple given the earnings advancement and continued cash flow requirements.
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