BorgWarner: Long-term potential with short-term headwinds

Investment thesis

On Investor Day 2021, BorgWarner Inc. (NYSE: BWA) outlined its strategy to strengthen its electric vehicle portfolio and increase its revenue mix to approximately 45% from electric vehicles by 2030. The company expects the total addressable market for light electric vehicle (LV) products to more than triple in the next 4 years. In line with the strategy, the company recently acquired AKASOL and eMotor from Santroll to accelerate its electrification process. The company has also incurred R&D expenditures related to EV products. As a result of these efforts, BorgWarner has been selected to supply a high-voltage hairpin eMotor for a major electric vehicle brand in China, which is expected to start production in 2023. In addition, the company will also supply a Chinese OEM of foreground. with a highly efficient dual inverter for high-voltage hybrid vehicle models slated for launch in 2023.

However, the company is in the very early stages of this transformation and electric vehicles currently represent a low single-digit percentage of its revenue. So there is a lot of uncertainty about the company’s potential transition. Additionally, R&D spending to support the business initiative will also impact operating margins in the near term. Additionally, since overseas operations represent the majority of the company’s revenue, the possibility of further strengthening of the US dollar against other currencies is expected to negatively impact revenue. A possible slowdown in demand for vehicles due to rising inflation and rising interest rates is expected to discourage vehicle production, leading to lower demand for automotive components in the future. Given all of these factors, I prefer to stay on the sidelines until these short-term headwinds subside.

1st quarter profits

BorgWarner Inc. reported first quarter results with revenue of approximately $3.87 billion, beating the consensus estimate of approximately $3.71 billion and falling approximately 3.37% in year-on-year, while Adjusted EPS declined approximately 13.2% to $1.05 from the consensus estimate of $0.87. Gross profit margin decreased by 100 basis points to ~19.4%, mainly due to higher raw material costs. Operating income decreased approximately 16.16% to ~$389 million from ~$464 million in Q1 2021. First quarter net income decreased approximately 13% to ~$251 million dollars, compared to ~$288.5 million in the same quarter last year.

Switch to electrification

The company directs its investments towards electrification. By 2030, the company expects to have a revenue mix of around 45% electric vehicles, up from less than 3% currently. It will deploy up to $5.5 billion in capital to complete this change as well as strategic M&A actions. In 2020, the company acquired Delphi Technologies to strengthen its technology leadership in electronics and software to accelerate electric mobility. Recently, the company acquired AKASOL and eMotor from Santroll to further strengthen its vehicle electrification capabilities. The company has incurred R&D expenditure related to electric vehicles to support its electrification strategy or its “CHARGE AHEAD” project.

BorgWarner has been selected to supply a high-voltage hairpin electric motor to a leading brand of electric vehicles in China, which is expected to start production in 2023. In addition, the company will also supply a leading Chinese OEM with a dual inverter highly effective for a voltage-hybrid vehicle model slated for launch in 2023. This reflects the initial success of the company’s efforts to bolster its electric vehicle portfolio and accelerate electrification. However, the company still has a long way to go before it successfully transforms into an EV-focused parts maker. This can take several years and visibility is limited. Moreover, it will involve a lot of investment and R&D expenses are expected to weigh on operating margins in the short term. The company expects the EV portfolio to be roughly breakeven or better by 2024. Beyond that point, even with continued R&D growth, this should boost sales margins. exploitation.

Macroeconomic Headwinds

With inflation at its highest in several years, the Fed is taking proactive steps to fight inflation by raising interest rates. With interest rates rising and prices of goods already higher, consumers are less likely to shift their spending to discretionary products. As vehicles are considered a highly discretionary purchase, interest rate hikes and higher property prices are expected to lower demand for vehicles in the future.

Total vehicle sales in the United States (FRED Economic Data)

As shown in the graph above, after 17.4 million vehicle sales in May 2021, total vehicle sales in the United States fell to 13.12 million in May 2022, a decline of approximately 26% year-on-year. Looking ahead, I believe it will be some time before inflationary pressures subside and vehicle sales begin to pick up again. The company also revised weighted global light and commercial vehicle production market growth to 2.5% to 5% this year, down from the previous assumption of a 6% to 9% increase.

Given the weak demand for vehicles, domestic automobile production is expected to suffer, which would impact the demand for vehicle components. Consequently, revenues are expected to suffer in the short term.

In addition, overseas operations account for the majority of the company’s revenue. While the U.S. dollar strengthened year-over-year, currencies impacted revenue by approximately 3% in the first quarter of 2022 compared to the first quarter of 2021. Rising interest rates in the United States could further strengthen the US dollar against other currencies, which could impact earnings in the near term. term.

Evaluation and conclusion

The stock is trading at around 9.69 times consensus estimates for FY2022, which is not expensive. The long-term strategy also looks interesting, with the company focusing on electrification. Recently, it acquired AKASOL and eMotor from Santroll to bolster its electric vehicle portfolio. It also incurs R&D expenditure in line with its electrification strategy. However, these expenses are expected to squeeze the company’s operating margins and visibility into the success of the company’s EV strategy is limited. Additionally, weak vehicle demand due to rising interest rates is expected to lead to lower vehicle production and lower demand for vehicle-related components. In addition, the possibility of further strengthening of the US dollar will put downward pressure on earnings. Although the company’s stock price is cheap, I think investors should wait for near-term headwinds to subside and for the company’s electric vehicle initiatives to gain traction. Therefore, I have a neutral rating on the stock.

BorgWarner Technical Center.  BorgWarner designs and manufactures transmissions and components for electric vehicles.

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