Delphi Technologies: COVID-19 Is Causing Significant Headwinds

Summary

• Delphi Technologies is a global leading supplier of auto components.
• The outbreak of COVID-19 may significantly reduce the demand for its products in 2020 and 2021.
• However, Delphi should continue to benefit from the trend towards lower vehicle emissions in the long term.
• The company is currently trading at an attractive valuation but visibility is limited.

Investment Thesis

Delphi Technologies (NYSE:DLPH) finished its 2019 with a declining top and bottom line. The recent outbreak of COVID-19 is expected to significantly lower the demand for its products in 2020 and 2021. Its merger with BorgWarner (BWA) may need to be renegotiated due to the sharp drop in its market valuation lately. Despite near-term challenges, we think Delphi will continue to benefit from the trend towards lower vehicle emissions. In addition, its power electronics product should continue to do well thanks to increasing electronic content in vehicles. Delphi is currently trading at a significant discount to its peers. However, given the uncertainty caused by COVID-19, investors may want to wait on the sidelines until better visibility is seen.

Data by YCharts

Recent Developments: Q4 2019 Highlights

Delphi finished its 2019 with declining net sales and net income. As can be seen from the chart below, its net sales declined from $4.86 billion in 2018 to $4.36 billion in 2019. This represented a drop of about 10% in revenue primarily due to weak global auto demand. Its net income also declined sharply to only $0.19 per share in 2019. Excluding special items, its net income per share would have been $2.43 per share. This is still much lower than 2018’s $4.03 per share.

Source: 2019 Annual Report

Earnings And Growth Analysis

COVID-19 is creating significant headwinds

The outbreak of COVID-19 has caused a major disruption to the auto sector as demand has been repressed. In fact, IHS Markit forecasts that auto sales will decline by about 22% in 2020 from 2019. This is much more severe than the 2008-2009 recession. As stated by Colin Couchman, executive director of global autos demand forecasting at IHS Markit:

The pandemic remains a clear and present danger to the autos sector, with months of uncertainty expected to cloud hopes for global recovery prospects. The expected cycle of decline, stabilization and recovery for autos varies by market, reflecting variations in containment strategies and policy responsiveness.”

Even Delphi's aftermarket business will feel the impact as there will be fewer cars on the road and this will translate into fewer repairs. Delphi’s business is expected to be negatively impacted by COVID-19.

BorgWarner may renegotiate a deal with Delphi

Back in January 2020, Delphi announced that it would be acquired by BorgWarner in an all-stock deal. BorgWarner will pay 0.4534 shares per 1 Delphi share. However, on March 30, 2020, Delphi drew down on its full $500 million revolving credit facility so that it has enough liquidity in hand to weather the strong headwind caused by the outbreak of COVID-19. Immediately after Delphi did this, BorgWarner issued a statement to Delphi that this has breached the transaction agreement without BorgWarner’s written consent and that BorgWarner has the right to terminate the agreement if nothing is done in the next 30 days. It is now over 30 days since the announcement and we have not seen any press release by both sides. However, a renegotiation of the deal is likely. We think a merger of the two companies still make sense as it will result in economies of scale and has the potential to extract about $125 million in cost synergies by 2023. However, we will have to wait for BorgWarner and Delphi to release more details if there is any change to the deal.

Delphi should thrive after the recession

Despite near-term headwinds, Delphi should continue to thrive after this recession thanks to the trend of increasing power components in vehicles. As can be seen from the chart below, electronic systems as a percentage of total car cost is expected to increase to 50% in 2030. This will be significantly higher than the 35% in 2010. We believe Delphi’s power electronic system is well-positioned to capture this trend. In addition, Delphi’s gasoline direct injection (“GDi”) business should benefit from more stringent government regulations in different parts of the world. Delphi’s 500+ bar fuel pressure component is well-positioned to compete in this space as it will help reduce the number of exhaust gas particulates by 50% versus its previous 350 bar fuel pressure component.

Source: Deloitte Analysis

Valuation Analysis

Delphi is only trading at a price to 2019 adjusted earnings ratio of 3.93x. This is much lower than its peers who trade at a P/E ratio above 6x. As can be seen from the chart below, BorgWarner trades at a P/E ratio of 7.8x while Magna (MGA) trades at a ratio of 6.8x. Other companies such as Lear Corp. (LEA) and Autoliv (ALV) also trade at much higher valuations of 7.5x, and 12.3x respectively. Therefore, Delphi is trading at an attractive valuation.

Data by YCharts

Risks And Challenges

The impact of COVID-19 may continue for an extensive period of time

The biggest risk to the global auto sales is how long it will take for the economy to return to pre-pandemic level. It is still possible that there may be multiple waves of the pandemic if social distancing is not properly done. The best hope is to have a vaccine developed, which might take at least 12 to 18 months from now. In the meantime, people will reduce travel wherever possible. Therefore, demand for cars will continue to be repressed for at least 1-2 years.

Investor Takeaway

Delphi is facing near-term challenges caused by COVID-19 and this may continue for an extensive period of time. In addition, its merger with BorgWarner may need to be renegotiated. Therefore, uncertainty is high in the near term. Although the company trades at an attractive valuation to its historical average, we think conservative investors may want to wait until better visibility is seen.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.