Recently, BorgWarner (NYSE:BWA) posted Q1 FY15 operating results. On the surface, reported results were disappointing, though much of the blame can be attributed to FX headwinds. Sales fell to $1.98b, down 5% y/y. GAAP earnings were $0.79 per diluted share.
Strong Q1 performance amidst expected forex headwinds
If we adjust for FX impacts, the company actually achieved strong Q1 performance. Excluding FX impacts, along with the Wahler and BERU Diesel acquisitions, sales were actually up 3% y/y. FX also decreased GAAP EPS by 9 cents per diluted share. The key takeaway is this - on the surface, the company seems to have performed poorly. However, this is not entirely true. Much of the company's "poor" performance can be attributed to FX headwinds. Demand for the company's products and services remain strong, evident from constant-currency y/y top-line growth. I expect this to continue going into Q2.
Tailwinds remain intact
In a prior article, I detailed the major tailwinds for BorgWarner - uptick in vehicle miles driven, low auto loan rates globally, and the growth in China's automotive market. These tailwinds remain more or less intact. A prolonged depression of oil prices should ensure that vehicle miles driven continue to increase, which would result in an increase of demand for BorgWarner's products. Global interest rates remain at record-lows, which should lead to further increases in auto sales. WSJ data supports this assertion. Although China's economy has slowed somewhat, there is no denying that income per capita continues to increase at a rapid rate, which should allow consumers to purchase more auto vehicles.
Management has also announced that it has expanded its manufacturing capacity in China. This development should allow the company to better capitalize on the increasing demand for automotive vehicles within the Asian country. As production ramps up, expect APAC to begin contributing more to the top-line. In the longer-term, the company's APAC presence should allow it to sustain higher growth rates relative to the US economy.
FX headwinds will continue
In my earlier article, I also mentioned that investors should expect the company to experience further FX headwinds going into FY15. For the first quarter, forex clearly had a strong adverse effect on the company's operations. As the FOMC continue to reiterate their diverging monetary policy stance compared to its central banking peers around the globe, investors should continue shifting funds into US securities in anticipation of higher yields, resulting in sustained price appreciation for the greenback. Although the FX situation has improved slightly since my earlier article (the DCI fell from 100 in early April to 94 at the time of writing, according to CNBC data), the fact remains that the index is at elevated levels compared to 2014. Therefore, expect FX to continue being a significant drag on BorgWarners' operating results going into the remainder of FY15.
As seen above, I have updated my DCF model from my earlier article. Due to greater than expected FX headwinds, I have adjusted revenue growth rates downward. Initially, I had hopes that the company would be able to achieve a 9% growth rate in both FY15 and FY16, but I clearly underestimated the impact of FX. Therefore, the top-line is expected to be flat for FY15. Beyond FY15, the currency situation should improve gradually, allowing the company to return to single-digit revenue growth. I continue to expect flat EBITDA margins going forward, as I see no significant opportunity for the company to improve profitability. Sure, the company could experience small increases in profitability, but I am of the opinion that sustained margin expansion will remain a tall order. Using a similar multiple and discount rate (10.2x LTM EBITDA, 10% discount rate), the model indicates that BorgWarner is trading around fair value at the moment. My outlook on the company remains neutral, and I continue to recommend that investors wait for a significant pullback before going long the stock.
Disclosure: The author is long SPY.
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