piranka
BorgWarner (NYSE:BWA) manufactures numerous parts for cars. The company has aggressively moved towards a more EV-based offering trying to take a piece of the growing market – considering the EV market’s inevitable growth, BorgWarner seems to be priced rather conservatively. As the valuation seems to leave upside to investors, I have a buy-rating for the stock.
The Company
BorgWarner manufactures and sells different automobile parts, including turbochargers, eBoosters, emissions systems, thermal systems, gasoline ignition technology, smart remote actuators, battery modules, and other products. The company has manufacturing quite equally in the Americas, Europe, and Asia with around 38300 employees in total, according to the company’s latest investor presentation.
To address the growing share of electric vehicles, BorgWarner switched its strategy towards an EV-based offering in 2021. After the switch, the company has completed multiple acquisitions to accelerate the switch, including the acquisition of the EV battery manufacturer Akasol in 2021 and light vehicle eMotor manufacturer Santroll in 2022. The company also spun off Phinia, a fuel injection system manufacturer, to elevate the share of the EV offering:
Acquisitions After The Published EV Strategy (Q3 2023 Investor Presentation)
Already, BorgWarner’s EV offering seems to be quite wide:
BorgWarner's eProduct Offering (Q3 2023 Investor Presentation)
The market hasn’t appreciated BorgWarner’s EV offering acquisitions, though – the stock price has fallen in the past ten years. Even considering the spin-off and BorgWarner’s small dividend, the ten-year return on the stock has been very poor.
10-Year Stock Chart (Seeking Alpha)
Financials
BorgWarner has achieved a compounded annual growth rate of 9.2% from 2002 to 2022:
Author's Calculation Using TIKR Data
The growth rate seems really good at first glance, but as the company has achieved the mentioned growth mainly through a high amount of cash acquisitions, the growth shouldn’t be attributed to a fantastic organic performance – BorgWarner’s growth is achieved at the expense of a larger dividend.
BorgWarner’s revenues do have potential for organic growth after the company’s strategical switch, though – the EV market should be growing rapidly in the future. For example, the company expects a CAGR of around 20% for the company’s eProduct segment:
Q3 2023 Investor Presentation
For the current year, BorgWarner guides an eProduct revenue of $2.3 billion to $2.4 billion, around 16% of analysts' expectations of the company’s complete revenues for 2023. The company targets for $10 billion in eProduct sales by 2027, which would signify significant growth for the company’s revenues. I believe the target is quite ambitious but could be achieved if the company performs really well.
BorgWarner has had a mostly stable EBIT margin with an average of 9.9% from 2002 to 2022:
Author's Calculation Using TIKR Data
The margin has stayed very near the long-term average in recent years as well as quarters – I don’t see any clear pressures in the company’s margin into either direction. The company is having some efforts regarding restructuring, targeting savings in the tens of millions from starting in 2027, providing a small potential for a better margin.
To finance the company’s recent EV acquisitions, BorgWarner has used a large amount of debt as a financing option. Currently, the company holds around $4.2 billion of long-term debt – in my opinion the amount seems healthy enough although quite high. Compared to the company’s market capitalization of around $9.7 billion, the amount is higher than most companies, but still at a manageable level.
Valuation
Currently, BorgWarner trades at a forward price-to-earnings ratio of 10.5, below the ten-year average of 12.0:
Historical P/E (TIKR)
It seems quite unreasonable that the company’s forward earnings is below the average – compared to the past, BorgWarner has way better growth potential as the EV offering should start to pick up volume in the following years. To further analyse the valuation, I constructed a discounted cash flow model as usual to estimate the fair value of the stock.
In the model, I estimate BorgWarner’s revenues to shrink by 9% in 2023 as the spin-off of Phinia affects revenues. Going forward, I expect high single-digit growth rates organically – the company’s targeting organic growth into revenues of $19 billion in 2027, which I expect in the model. Going further from the target year, I estimate a growth of 5% for a couple of years, after which the growth slows into a perpetual rate of 2% into perpetuity.
As for the margin, I estimate a mostly stable future. For the current year, I have an EBIT margin estimate of 9.4% after the spin-off. Going forward, I estimate the EBIT margin to scale with EV growth and restructuring savings into a margin of 10.6%. These estimates along with a cost of capital of 10.25% craft the following DCF model scenario with a fair value of $47.39, around 18% above the current price:
DCF Model (Author's Calculation)
The used weighed average cost of capital is derived from a capital asset pricing model:
CAPM (Author's Calculation)
In Q2, BorgWarner had $21 million in interest expenses. With the company’s outstanding interest-bearing debt, BorgWarner’s current interest rate comes up to 1.97% - the company seems to have secured a remarkably low interest rate. BorgWarner has historically leveraged a moderately good amount of debt, which is why I estimate a long-term debt-to-equity ratio of 25%.
For the risk-free rate on the cost of equity side, I use the United States’ 10-year bond yield of 4.47%. The estimated equity risk premium of 5.91% is Professor Aswath Damodaran’s approximate. Yahoo Finance estimates BorgWarner’s beta at 1.43, a relatively high figure as demand for automobiles is quite cyclical. Finally, I add a small liquidity premium of 0.25%, crafting a cost of equity of 13.17% and a WACC of 10.25%, used in the DCF model.
Takeaway
At the current price, BorgWarner seems to be a relatively cheap way to get exposure into the growing EV market. My DCF model estimates an upside of 18% - an amount that doesn’t account for further potential acquisitions in the EV market. As the 2021 strategy switch-up should start to show promising growth soon, it could potentially be the time to get in – I have a buy-rating for the stock.
