There are two pretty distinct camps where BorgWarner (NYSE:BWA) is concerned. Bears argue that the company will be unable to replicate its dominance in combustion engine powertrains in the coming EV world, and that the company will see OEM in-sourcing limit its opportunities to offset declines in its conventional business.
Bulls argue that, yes, while there will be some in-sourcing, very few OEMs will be able to insource all of their needs, and many of those that try will ultimately run into problems turn to quality suppliers like BorgWarner. And in the meantime, BorgWarner can continue to generate attractive cash flows from legacy combustion powertrains and hybrids. I’ve long been in that second group, and even after a one-third move up in the share price since my last article (a middle-of-the-pack performance), I’m still bullish on these shares. BorgWarner will need to put forth a convincing case at its March 23 Investor Day to swap skeptics, but I believe the valuation here is still attractive relative to the long-term opportunities.
Continuing To Build For The EV Transition
BorgWarner management had previously made it clear that they weren’t done doing deals to build their EV business, including commentary with fourth quarter earnings, and investors didn’t have to wait long to see a significant deal. On February 15 the company announced the acquisition of AKSOL for EUR 754M.
AKSOL is a German provider of EV battery solutions, specifically battery packs for commercial and industrial applications. AKSOL counts commercial vehicle manufacturers like Daimler (DMLRY) and Volvo (OTCPK:VOLVY) among its client base, as well as French train company Alstom (OTCPK:ALSMY), and has several hundred millions of euros worth of orders booked ahead over the next three to five years (70% of ’24 sell-side revenue estimates are in the books).
BorgWarner isn’t getting AKSOL cheap (1.8x ’24 revenue), but it’s also about building for the future. BorgWarner has its joint venture with Romeo, but AKSOL meaningfully expands BorgWarner’s access to the commercial and off-road vehicle markets – something that management has been making clear is an area they want to target.
As with most things related to BorgWarner, there’s something here for bulls and bears. Bears are going to argue, not without some reason, that battery packs are another EV subsystem exposed to OEM in-sourcing risk. That’s probably true on the auto side, but much less true on the commercial/off-road side, where early EV projects have seen a much greater willingness on the part of OEMs to rely on supplier systems.
The Insourcing Debate Won’t Be Settled Anytime Soon
Again, the biggest bear argument on BorgWarner is that the company’s efforts to build out its EV subsystem capabilities will ultimately prove to be fruitless and that the company will face dwindling revenue and profit growth opportunities as its conventional powertrain business fades away.
To some extent, at least, this is valid. BorgWarner is not going to enjoy the sort of market share it does in turbocharging (over 30%), where pretty much no new entrant has tried to compete for some time. Whether its battery packs, power electronics, motors, or e-drives, there are going to be multiple options for OEMs to choose from, and many OEMs are going to try to insource as much as they can.
There are some “but’s” here.
First, just because OEMs are going to try to in-source doesn’t mean they will succeed. Not all motors or e-drives are equal (a reason I still like companies/stocks like Nidec (OTCPK:NJDCY) and Valeo (OTCPK:VLEEY)), and some OEMs are going to find themselves in a position where inadequate in-house subsystems compromise overall performance and market share.
Second, not all components are going to get insourced. Many OEMs are absolutely going to try insourcing e-drives (at least the gearboxes and assembly, if not also the motors), and I’m sure the same will be true for battery packs. But the power electronics? Much less likely in my view; some will, I’m sure, but fewer than on the e-drive or battery pack side.
Last and not least, conventional powertrains aren’t going to disappear for a while. Not only are the large majority of cars produced today still combustion-based, and with more stringent emissions and efficiency regulations that drive sales for BorgWarner, but hybrids still have a combustion powertrain onboard. In other words, I think BorgWarner is looking at a prolonged “sunset” for its legacy business, and one where more stringent regulations can drive even more market share and margin leverage over the next decade.
The Outlook
BorgWarner reported a good fourth quarter, with a revenue beat of 8% and an operating profit beat of 25%. I discount this a bit as it was the first quarter combining BorgWarner and Delphi, and that usually creates more “noise” with analyst estimates. Still, BorgWarner outgrew underlying production by about 250bp, or 460bp on an adjusted basis, and guided revenue such that the low end of the guidance range was still about 1% above the prior sell-side average estimate.
Management also showcased two recent BEV wins – an 800V e-motor for a global commercial vehicle manufacturer that ramps in 2024, and a 400V SiC inverter order with a European car company that ramps in 2022 and appears to offer meaningful volume. I expect BorgWarner to really focus on its BEV opportunities at the upcoming investor event, and really hammer home details like the fact that 45% of forward backlog is BEV-related.
I continue to expect long-term revenue growth from BorgWarner in the neighborhood of 5%, with modestly better profitability (a 110bp improvement in long-term average FCF margin) driving mid-to-high single-digit FCF growth. In the near term, I’m looking for EBITDA margin of around 15% in 2021, improving to close to 16% over the next three years (and likely flattening out some for a few years after that).
The Bottom Line
Between discounted cash flow and margin-driven EV/revenue, I continue to believe that BorgWarner is undervalued and should trade well into the $50’s, with a double-digit long-term annualized total return potential. Yes, there absolutely are risks that the EV opportunity won’t materialize as expected for BorgWarner, but I think bears underestimate the quality of the platform BorgWarner has built and overestimate the self-sufficiency and internal capabilities of auto OEMs. On balance, then, I think the risk/reward continues to favor BorgWarner.
