In a free market system, companies facing industrial disruption have only two options โ adapt or die. BorgWarner (NYSE:BWA), a century-old automotive supplier with a prized track record of industry-leading innovation and performance, is a business that refuses to simply roll over and wither away. Faced with the threat of electrification eventually rendering its traditional auto parts and technologies obsolete, BorgWarner has embarked on an aggressive yet measured campaign to position itself at the forefront of global EV production. Its EV parts and technologies segment is growing rapidly, with revenue exploding higher and new supply deals being inked with major EV manufacturers.
The companyโs foundational (non-EV) auto parts business continues to thrive simultaneously, acting as a waterfall of cash from which the nascent EV segment is nourished. Despite the ongoing investment and segment-level losses fueled by the companyโs โCharging Forwardโ electrification initiative, BorgWarner has continued to generate hefty profits and cash flows, even allowing the company to reduce its share count while undertaking the transition to electrification. BorgWarnerโs total revenue is expected to explode higher in the coming years as the EV segmentโs growth continues to compound, though in the short term this trend will continue to depress the companyโs margins.
The EV supply segment is wholly unaccounted for in BorgWarnerโs market valuation, giving rise to a unique investment opportunity featuring a healthy blend of profitability and growth at a reasonable price. Even without the electrification initiative that is expected to supercharge the companyโs growth, the stock would still be relatively cheap at current levels. Considering the investments being made in (and the success already being demonstrated by) the fast-growing EV segment, BorgWarnerโs discounted valuation appears to be all the more nonsensical and unsustainable.
About BorgWarner
BorgWarner traces its roots all the way back to the 1880 founding of its forebear the Morse Equalizing Spring Company. Since the merger that birthed BorgWarner in 1928, the company has been consistently at the forefront of auto parts manufacturing and distribution. Since the 1930s, BorgWarner has been a key supplier of parts and technologies to many of the largest global carmakers. Today, BorgWarnerโs customers include Ford, GM, Volkswagen, Stellantis, and (as of this year) BYD subsidiary FinDreams Battery as well as BYDโs competitor XPeng.
As the auto industry lurches toward electrification, BorgWarnerโs EV pivot has been deliberate yet decisive. The company continues to generate a significant majority of its revenue from the sale of traditional gas-powered vehicle parts, tracking the broader auto industry. However, in recent years the company has prioritized the development of its fast-growing eProducts segment, acquiring numerous EV technology companies over the past several years to facilitate its electric transition. Management has steered the company to conservative growth and contained losses in the EV/hybrid segment, while maintaining the generous and stable profits thrown off by the foundational cash cow business.
BorgWarnerโs foundational (gas-powered) propulsion products include AWD systems, boosting technologies, engine timing systems, transmission and ignition technologies, intake and exhaust systems, and valvetrain systems. Its ePropulsion (EV) technologies include battery systems, charging equipment, Drive System Engineering Services, EV transmissions, thermal management technologies, and electric drive motors and modules.
Performance
BorgWarner is consistently profitable and has grown its top line by a CAGR of 7.4% since 2015. In 2023, revenue was $14.2B, up 12.4% YOY. (Organic revenue, excluding the impact of M&A and currency fluctuations, grew 12.5%.) Net income attributable to common shareholders was roughly flat YOY at $632M. FCF came in at $565M for full-year 2023. Non-GAAP EPS was $3.75 โ a significant increase from $3.17 in 2022.
BorgWarner is guiding for net sales of $14.4B to $14.9B this year, an organic YOY increase of 1-5%, based on current industry forecasts. The company expects its 2024 eProduct sales to be $2.5B to $2.8B, up 25-40% from approximately $2B in 2023. Revenue from the foundational business is expected to be flat to -2.5% on the year. While this forecast represents a slowdown in top-line growth, it comes amid a projected decline in total gas-powered vehicle production across BorgWarnerโs operating markets. Per management, the growth trajectory of its foundational segment is outperforming its total addressable market โby about 300 basis points.โ Moreover, GAAP EPS is expected to rise from $2.70 last year to $3.56-$3.88 in 2024, while non-GAAP EPS is expected to be $3.65 to $4.00. FCF is forecast to be in the range of $475M-575M, a slight YOY decrease that reflects the companyโs ongoing investments in electrification.
As noted, many of the Planetโs largest automakers rely on BorgWarner for critical parts and technologies. Throughout many decades of industrial cyclicality and technological advancement, the company has consistently adapted, remained relevant, and maintained its key role within the automotive supply chain. Now faced with the potentially disruptive transition to electric and hybrid vehicles, the company has neither over- nor under-reacted to changing market conditions. Rather, it is steadily developing a growing stable of much-needed EV/hybrid tools and technologies โ in addition to its traditional (internal combustion engine) parts and products, which continue to account for the bulk of its sales.
BorgWarner is thus well-positioned for either an acceleration or deceleration in EV adoption/production growth; the company will simply manufacture whichever parts and technologies its customers want. The company particularly maintains โtotal” flexibility between its EV and hybrid production, per CEO Fred Lissalde:
What’s important to me is that we’ve built a product portfolio that is totally fungible across hybrid and BEV. R&D is the same engineers, power electronics, motors, transmission, thermal, it’s the same thing. For us, it does not matter. We can support our customers to wherever they want to go.
Fundamentals
At todayโs prices, BorgWarner has a (TTM) P/S ratio of 0.56, GAAP P/E of 12.8, P/FCF of 14.16, P/B of 1.37, and P/TBV of 3.55. The large gap between book value ($5.83B) and TBV ($2.25B) is primarily accounted for by $3B in goodwill resulting from numerous acquisitions. In any event, 28% of the companyโs market cap is accounted for by tangible equity.
A valuation of this nature is normally indicative of a company that is no longer growing or faces a drop-off in net earnings, but BorgWarner remains a growing company whose profits are not in jeopardy. As mentioned, top- and bottom-line growth are expected in 2024 despite a stagnant macro environment. Based on the midpoints of the management guidance referenced above, the forward P/S is ~0.55 and the forward GAAP P/E is ~9.3. While management has issued guidance for 2024 only, analysts anticipate continued sales and earnings growth in 2025.
Electric Future
Charging Forward
BorgWarnerโs โCharging Forwardโ initiative, unveiled in March 2021 with the goal of increasing โthe companyโs electric vehicle revenue from less than 3% of total revenues today to approximately 45% in 2030,โ represents the companyโs strategy to participate in the auto industryโs journey to electrification. Last June, the company updated its Charging Forward strategy with the ambitious goal of generating โover $10 billion in [eProducts] revenue by 2027.โ Due to ongoing oversupply and price wars in the EV end-market, quintupling eProducts revenue by 2027 may or may not be as realistic as it was a year ago. That said, the long-term outlook for BorgWarnerโs EV aspirations remains unchanged. Moreover, as a wholesaler of parts and technology, the company is somewhat better insulated from these headwinds than consumer-facing automakers. If anything, a continued supply glut could help BorgWarnerโs EV segment scale more quickly and thus potentially achieve break-even just as fast as (if not faster than) in a constricted supply environment.
The company has thus far delivered solid compound growth from the <3% eProducts revenue share 3 years ago, with eProducts sales accounting for ~14% of revenue in 2023 and forecast to contribute ~17-19% in 2024. In my view, managementโs goal of achieving 45% top-line contribution from this segment by 2030 remains attainable. Inevitably, this would go hand-in-hand with BorgWarnerโs overall revenue soaring dramatically in the years ahead โ though overall margins should be expected to take a hit while the EV segment takes its time growing toward mature profitability.
Acquisition-Driven Strategy
BorgWarner has taken a somewhat controversial approach to developing and scaling its eProducts division, largely turning to acquisitions to fuel the segmentโs growth. In 2022, the company acquired Rhombus Energy Solutions (a charging tech provider) in a $130-185M deal and Santroll Automotive Components (a Chinese eMotor manufacturer) for approximately$160-200M. In 2023, the company acquired Hubei Surpass Sun Electricโs EV Charging, Smart Grid and Smart Energy businesses in a~$38-60M transaction before inking a roughly$80M deal to acquire Italian auto supplier Eldor Corporationโs Electric Hybrid Systems segment, which transaction closed in Q4 2023.
In response to an analyst question on the companyโs Q4 2023 earnings call, CEO Lissalde confirmed that M&A remains an important part of the companyโs eProducts segment strategy moving forward:
I would say that the capital allocation strategy is pretty much unchanged. We are looking at M&A as an important part of strengthening electrification capabilities. We are very disciplined in the way we look at M&A. We are looking at way more companies than we’re actually putting the trigger on. And we think that the current environment could provide some attractive buying opportunities and be rest assured that we will include and consider the near-term impact in the valuation assessment.
Growth by acquisition always garners its fair share of skepticism, but itโs worth noting that BorgWarnerโs (fast-growing) eProduct revenues of $2B+ appear to justify the capital allocated to its recent acquisitions. The Eldor acquisition alone is expected to contribute $250M+ in annual revenue by 2027, more than 3x the purchase price paid. The primary test as to the wisdom of these acquisitions will be the extent to which the revenue acceleration fueled thereby can be converted into bottom-line profit contribution in the coming years.
Considering BorgWarnerโs advantageous position within the supply chain and its robust track record of profitable growth, I am highly optimistic that its EV investments will deliver high returns for shareholders in the future. In the interim, the traditional cash cow business continues to produce copious profits, providing a significant margin of safety in the event that the companyโs EV transition does not go according to plan.
Buybacks and Dividends
BorgWarnerโs financial stability and consistent profitability have allowed the company to return excess capital to shareholders in the form of stock buybacks as well as a small quarterly dividend. As the companyโs share price dipped and its cash flows swelled in Q4 2023, management devoted $177M to share repurchases, retiring >2% of shares outstanding. BorgWarnerโs share count peaked at 240.2M in 2021 following the all-stock acquisition of Delphi Technologies but has since trended downward to 233.6M.
For decades, BorgWarner has consistently paid a quarterly cash dividend, with the distribution amount historically ranging from $0.11 to $0.25 per quarter. Following the spin-off of PHINIA (formerly BorgWarnerโs Fuel Systems and Aftermarket divisions) in 2023, the company cut its quarterly distribution from $0.17 to $0.11. The stock presently yields a modest 1.27%.
Risks
Cyclical Downturn
The auto industry is notoriously cyclical, with events of recent years putting the vagaries of the car market on full display. As an auto supplier, BorgWarner is obviously susceptible to production cuts or decreased demand for new vehicles. Overall auto demand and production have been quite healthy of late, and new car prices have risen significantly in recent years. According to the European Automobile Manufacturersโ Association (ACEA), global new car sales in 2023 โgrew by almost 10% after remaining stable in 2022โ and global production increased 10.2%.
Rapidly increasing demand and production give rise to the possibility that the global auto industry may be closer to a cyclical peak than trough. The industryโs growth is in fact expected to stagnate over the next few years, though the usefulness of this prediction goes no further than the reliability of macro forecasts in general. Whether auto demand grows, stagnates or falls in the years ahead, BorgWarnerโs long track record of consistent profitability is unlikely to be disrupted in any realistic-case scenario. Moreover, the companyโs strong balance sheet would afford it a competitive advantage in the event of an industry downturn.
EV Oversupply
Global electric vehicle production is exploding, and prices have correspondingly dropped as automakers engage in intense price wars in both North America and China (two of BorgWarnerโs key markets) to gain and maintain share within the nascent industry. This situation presents the dual risks that the oversupply dynamic could either (a) reverse itself in the form of production cuts, thus reducing demand for BorgWarnerโs EV products, or (b) continue putting pressure on BorgWarnerโs selling prices, thus delaying the profitability of its EV unit. While this level of cyclicality and unpredictability could be quite foreboding in the case of a pure-play EV company, BorgWarnerโs currently-limited exposure to the EV market and its long-term-focused approach to developing its EV capabilities diminish the significance of these short-term factors.
Gas Car Demand Combustion
BorgWarnerโs foundational internal combustion engine parts business faces much the same long-term risks as oil and gas companies as well as traditional automakers themselves. Whether or not the world has yet reached โPeak Oil,โ the market share of gas vehicles can be reliably expected to continue declining in the decades ahead, eventually arriving at near-zero. This means that the days of BorgWarnerโs cash cow business are numbered, and the companyโs long-term future will largely rest on the success of its Charging Forward initiative. Fortunately, management is taking this long-term eventuality extremely seriously and is investing the companyโs vast resources, experience and expertise into establishing a sustainable EV business model for the long term.
Debt
Unsurprisingly, BorgWarner has accrued a fair bit of debt in the course of its EV acquisition spree. Long-term debt sits at $3.68B, more than double the $1.67B at year-end 2019 but down ~$450M from YE2022. (Net debt of $2.40B is down more dramatically from $3.22B at YE2022.) The reduction of debt in 2023 was facilitated by the cash proceeds of the PHINIA spin-off. While the increase of debt puts the company in a more perilous position in the unlikely event that its profits dissipate, itโs worth noting that (a) BorgWarner has access to an undrawn $2 billion line of credit, (b) the companyโs robust tangible book value further acts as a buffer between hypothetical loss-making and shareholder dilution, and (c) the companyโs annual interest expense in 2023 was $73M, only a minor increase from $59M in 2019. Considering the doubling of BorgWarnerโs debt since 2019 coupled with the rise of interest rates, the fact that interest expenses rose so negligibly underscores the strength of the companyโs financial condition.
Margin Collapse
As BorgWarner has begun its years-long leap toward electrification, the companyโs margins have unavoidably taken a hit. Its gross margins, which averaged ~21% pre-2020, have since declined to ~18-19%. Operating margin has similarly dropped from ~12% in 2018-19 to 8-9% in the last couple years. The companyโs net income has also been quite volatile of late, with net margin declining to 4.4% in 2023 amid significant investment and growth in the EV segment. As this (low-margin) segment continues to grow as a share of total revenues, overall margins can be expected to continue falling in the medium term. Such is the nature of early-stage, high-growth businesses.
The good news is that margin depreciation will go hand-in-hand with continued revenue acceleration, turning to a net positive as soon as the EV segment achieves sustained profitability. Moreover, management has thus far managed the transition quite capably, with net income holding up well in spite of the investments being made in the companyโs electric future. To the extent that revenue from the EV segment fails to grow as quickly as anticipated, the trade-off will be higher margins, as noted by (now-retired) CFO Kevin Nowlan on the companyโs Q3 2023 earnings call:
But if electrification across the industry slows down a little bit, it probably slows the revenue growth, but it probably improves our margin profile. You saw that a little bit maybe here in the full year 2023 guidance that we have, but that’s consistent with our long-term view as well.
I think overall, taking a big step back, we feel like — that’s why we think our portfolio is really resilient from a financial perspective. Because whether EV adoption is accelerating or decelerating, the portfolio is positioned to deliver comparable levels of adjusted operating income over the long term under any of those outcomes.
Conclusion
On the basis of BorgWarnerโs financial and operational performance, its share price would be cheap even if the fast-growing EV segment did not exist. Considering that this segment provides a long runway for growth into the very distant future, the stock is a bargain. If any company can succeed in the EV parts market, itโs BorgWarner, with its storied track record within the auto industry and an existing cash cow business which provides more than enough capital to support the necessary investments. Indeed, such success is no longer theoretical, as BorgWarner already generates $2B annually from its eProducts segment โ a figure that is rising rapidly.
If the transition to EVs slows, BorgWarner will continue to generate generous profits from its foundational operations. If EV adoption intensifies, BorgWarner will be in a prime position to capitalize as a leading EV parts supplier. Either way, the auto industry will be dependent on BorgWarnerโs products for the foreseeable future, to the long-term benefit of its shareholders. With margins of safety baked in on both ends and electric upside in store, BorgWarner appears amply undervalued at current prices.
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