BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

So hello, everybody, and welcome again to day 2 of the Morgan Stanley 8th Annual Virtual Laguna Conference. I'm Adam Jonas. I head up Morgan Stanley's global auto and shared mobility team. I'm delighted to have joining us for this session the team from BorgWarner: Fred Lissalde, President and CEO; Kevin Nowlan, CFO; and Patrick Nolan, familiar to many of you, Vice President of Investor Relations. I'm just going to quickly read this disclaimer that this webcast is for Morgan Stanley clients and appropriate employees only. It is not for members of the press. And for important disclosures, please go to www.morganstanley.com/researchdisclosures and read them. And if you have any questions, please reach out to your Morgan Stanley sales representative. And so with that, Fred, thanks again for being here. A crazy year, really important time in your industry, not just due to COVID, of course, but just technologically and so many things going on. Wanted to give you an opportunity to review some key messages for investors just to kick off this slot. Thanks again.

Yes. Thanks, Adam. Happy to be here. I'm missing the view of the ocean though, so -- but it is what it is. We are in this world altogether. I just wanted to take a few minutes for those who don't totally know BorgWarner to talk to you a little bit about who we are. You may have electronics handout. On Page 3, we are a technology leader in clean and energy-efficient solutions that propel vehicles, all types of vehicles, from point A to point B. And we're doing that across combustion, hybrid and electric. We try to be very balanced on how we run our business. We're executing a very balanced customer strategy, geographic strategy and also propulsion system strategy. It is absolutely true that we want to be overweight hybrid electric. But we're also very relevant in the combustion world, where we think that we can add value and make that world cleaner and more energy-efficient. We're delivering strong relative performance from a financial standpoint. We certainly believe that financial strength in this environment is a key competitive advantage. And we've proven we're one of the only few people in the world that generated positive free cash flow in Q2. And I think that speaks volumes to our ability to generate cash. We've really done a good job during this pandemic to control costs and cash. We're delivering outgrowth in all segments: in combustion, in hybrid and electric. We are focusing on delivering 500 basis points of outgrowth on a yearly basis. And we've done that for quite some time. And we are absolutely convinced that we have the right portfolio to do that in the foreseeable future. Product leadership remains the driver of our business. Why? Because with our product, we make cars more efficient, and we enable our customers to be able to sell and differentiate themselves from an efficiency standpoint. And in hybrid and electric, efficiency is also very, very important, sometimes even more important than in combustion. We continue to invest in the future in R&D. Organically, we've not slowed down our R&D and also in M&A. And we're certainly going to talk about the Delphi M&A. On Slide 4, I just wanted to show you a little bit where we see the production world. We see the world where from a global production standpoint year-over-year, we're going to be seeing a volume down between 22% to 25% globally. And you see in the second half of the year at the midpoint of our guide, we still see a double-digit decline in the market. Moving to Slide 5. You see that we've outgrew the market in Q2 by 730 basis points this -- and again, I don't want to look at the outgrowth quarter-by-quarter. But this is a good result. We outgrew 2018, 2019. And we are in the path of outgrowing the market between 450 and 600 basis points this year, 28% down conversion, which I think is pretty good in this environment. And very, very proud to have generated positive free cash flow. We want to end the year around $400 million to $500 million of free cash flow generated even in this environment. We've announced -- and that's a milestone, a significant milestone in our business development. We've announced on Page 6, a few weeks ago, the fact that we are working with Ford Motor Company on the launch of their Mach-E, the integrated drive module, which I think showcases our ability to be a system supplier, system integration, varied manufacturing setup and footprint, scalable and modular approach, very, very proud about that. On Page 7, we've also announced 3 key wins in China with electric drive modules with motor and transmission for 3 Chinese OEMs. And in the world of electrification, China is really where most of the music is played right now. And we've announced products with EGR module for an engine with FCA. And the Americans might have an issue figuring out what the 0.99 liter looks like, kind of small. But we make those engines even cleaner, leaner, more efficient with, in this case, EGR cooler for the Fiat 500 and the Panda combustion and also hybrid models. On Page 8, really quick update on the Delphi Technologies acquisition. We are absolutely on track to close in the second half of the year. We've completed the $1.1 billion senior note. The Delphi shareholders have approved with an overwhelming majority the transactions. We're down to one jurisdiction to approve the transaction. It's the European Union. And the integration team continues to work very well, very diligently. We have matched pairs of 150 people on both sides, 14 work streams, very happy with the engagement that exists from both companies. And on Page 9, I just wanted to do a little recap of who we're going to be after the Delphi closing of the transaction. This transaction offers BorgWarner a -- strengthen our ability to play in the field of propulsion system leadership, especially in the electrified propulsion system. We're going to be one of the only ones in the world that has scale in 3 continents, the development, the validation, the engineering, the purchasing and the manufacturing of mechanical, rotating electrics and power electronics. And I think that's going to drive value to our customers and value to our shareholders. It increases our scale in electronics and power electronics and also enhances our market share and technology products in commercial vehicle, in aftermarket businesses, resulting in a good, more balanced business between pass car, commercial vehicle and aftermarket. And we can generate good top line synergies and good bottom line synergies, too. So we're very happy with where we are. We're going to close the transaction soon in the second half of this year and going to have a one-of-a-kind product portfolio that's going to capitalize on the acceleration of the electrification, which we think at BorgWarner is profound. With that, I turn it back over to you, Adam.

Thanks, Fred. That's a really good introduction. Wanted to kind of give you an opportunity to highlight anything a little shorter term in terms of the environment as we progress through the third quarter that you wanted to call out or that you've made previous disclosure on in terms of rate of change or something that might be getting better or worse either by product or region. Just wanted to give you that opportunity before we move on to other topics.

Yes. We see some good sequential improvement as far as volume is concerned, especially in North America and Europe. China, which is an important market for us, especially with 50% of our backlog being there, we see solid pretty much at pre-COVID numbers, our business launch being on track. In the Western world, we still see a lot of volatility especially in Q4 with week-over-week changes. I think our customers are trying to find out a little bit what's the end market looking like and also having -- making sure they have all the supply base being able to ramp up as they do. But pretty much on track with what we've seen, in some areas, a little bit better with still volatility in the last part of the year.

Great. And anything COVID-related up the -- your supply chain that has -- that is -- we need to consider? Or has that been progressing well and not at any threat of any previous outlook that you might have communicated?

We've been able to manage that. And so far, so good. It's not been without a lot of work from the team. But no disruptions, no disruptions so far. We've been able to sustain all the schedules and forecasts that our customers wanted to see us sustaining. By the way, we've also -- and the team has done an awesome job. In Seneca, we had a tornado hit us a few months ago in the middle of COVID and we've not heard anything. We're back on track with an amazing save from the team. So, so far, so good. And certainly having our supply base strong and having the right liquidity in the second half of the year is going to be important for their ability to ramp up, too.

Let's get into the business. And a question I had kind of positioned for later, I want to kind of move it to the top, which is kind of based on GM's announcement this morning that they're going to be kind of insourcing, I would say, large parts of the electric vehicle powertrain, not just the batteries but also the powertrain around it. Now there may or may not be -- I might imagine there would be some opportunities, of course. They're not going to make everything in-house. But that kind of messaging of a bit of insourcing seems to have spooked the market today. A lot of suppliers are down on that. I've been getting bombarded at all morning from investors that want to ask that question. What is your kind of view of OEM potential insourcing of components now that they have a chance to completely rethink the electric vehicle architecture? And how does that -- how does your business adapt to that?

Yes. So first of all, we're not totally surprised by the GM announcement. I think it was, at least for us, obvious that they were taking more of an in-house path. And as you mentioned, it doesn't mean that we can't supply subcomponents. And we've learned that we need to position ourselves and we are positioned to supply systems, like the Mach-E, systems like our eDM that we've announced and I alluded to that earlier, all components. It's not going to be black or white. You're going to have some people doing propulsion in-house, either for battery electric vehicle or for hybrids. You're going to have customers that won't touch it. And you're going to have customers that do both. Right now, when we go around the world, we see that the proxy that we have had since about a year or 1.5 years, about 50% of the market, if you take the electric motor as a proxy, 50% of the market customers are going to go in-house, 50% of the market, they're going to go and buy. And that's the proxy we're working with. We feel comfortable with that. I'll tell you why we feel comfortable with that because we're going to be one of the only ones in the world that is going to be at the table earlier on to talk about system. If a customer wants to do a make or buy, the customer has to have a buy option. And we're going to be one of the only ones in the world having mechanical, motor, motor control and software under one roof, under that one business unit called PowerDrive Systems, where we're going to be an option to buy. And so we're going to be at the table. We're going to be knowing early on what they do. And I've learned over the past 31 years I'm in this business that it's not a good idea to compete with your customers. If they want a system, they'll buy a system and we're going to be positioned as a system. But we don't have to. We can supply motors. We can supply power electronics. We can supply 2 out of 3, 3 out of 3, 1 out of 3, and it's okay. The thing is that we understand systems. We understand now systems even more with Delphi Technologies onboard after the closing of that transaction. And I think that's going to position well for the next-generation electrified propulsion architecture that are going to see daylight by 2025, 2026 that are going to be sourced in the next 12 to 24 months. And I think those technologies under one roof, I think it's going to allow us to be optimizing the system better than anybody else. Because we're going to understand the good, the bad and the ugly of each and every subcomponent. And you need to know that in order to optimize your system. And having 2 companies or 3 companies do that is not easy. Having one company and especially one business that can do that is going to generate, I think, speed and agility and value to our customers.

I want to talk about hybrids because the customer we were just mentioning, General Motors, they, of course, very openly don't do hybrids. Maybe they have the luxury of doing that because they're not in Europe, where the regulatory regime is, of course, a bit more hybrid-friendly for now. But you're quite bullish on the architecture. And not just because of use of hybrid architectures themselves, but also because it helps you build scale into EVs and that the more competency and that kind of incumbency that you protect by that stepping stone, even if it's temporary, puts you in pole position. Is that the way to think about it? And kind of what are the risks that you see more OEMs say, "You know what, hybrids, they're great, but that's super complex. That's like a Patek Philippe mechanism complication married to a Casio digital. We've got to go straight to the digital"? Help us understand that.

Yes. And I think you got it right when you said that it's getting a scale. If I look at the next 10 years and if I look at the opportunity of creating value in the next 10, 15 years with hybrid, where you see 20%, 25% of the market being hybridized, I think this would be a missed opportunity for us to dismiss that. So we're very successful in hybrid. We're not very active in the 48-volt hybrid, the mild hybrid, but we're very active into the high-voltage plug-in hybrids in China and in Europe, where we have announced a few key wins and in all parts of the world. And you're absolutely right. This is getting us -- and by the way, it's also the case in commercial vehicles, too. It is getting a scale. If I look at an electric motor and if I look at what is required from a modular design perspective and from a production perspective, there is -- okay, it's not the same product, but it's the same kind of animal, a motor that drives a hybrid propulsion architecture and a motor in an iDM, it's pretty close. So when we gain scale in hybrids, it's going to help us be strong and competitive into the battery electric world. When I look at the difference between a battery electric vehicle transmission and what we do from a combustion or hybrid perspective with our transfer cases and 4-wheel drive systems, okay, it's not the same -- it's not totally the same thing, but it's very, very close. When I look at the power electronics that we are using or going to use into those high-voltage plug-in hybrids and the ones that are used into battery electric vehicle, same comment, it's going to get a scale. And so we're totally convinced that we're going to generate, first, value in the next decade or more into growing with the hybrid market and not knowing where this market is going to go, preparing us nicely for battery electric vehicle growth. We are convinced that the electrification trend is profound, absolutely profound. You've got different technologies that are competing with each other. I think it's -- we're very happy to be able to hedge our bets into different technology and being agnostic, not tainted when we talk to our customer to have to sell product A only because we don't have the right breadth of product. The relationship with the customer is very open, very transparent because pretty much when you see the product portfolio that we have, and especially after the Delphi transaction, there is no product that we can't supply.

Great. I wanted to talk about your BEV wins. You obviously -- you won the cooling, the integration for the Ford Mustang Mach-E. What else can you call out? And I'm getting a few questions on the webcast if you can call out any exposure to the GM Ultium platform broadly that you could share with us today.

So we've talked about the Mach-E. We've talked about 3 wins in China with the eDMs, so it's motor and transmission. We've talked about heating system for batteries. We've talked about a few other components in BEV. We can't talk about GM. And Delphi has talked about a few wins on 800-volt power electronics and inverters for BEV and 3 wins on power electronics with 3 Chinese OEMs. So I'm pretty happy with where we are. Right after the close of the transaction, we'll be talking to our customers on how we can put the energy together to position ourselves in the next 12 to 24 months well in order to capitalize on the growth past 2025 of those plug-in hybrids and battery electric vehicles. So from a product portfolio, from a competitiveness, from a reach on 3 continents, you don't have a lot of companies like BorgWarner that can compete in this market. And when I look at the level of growth potential and total market availability in those segments and content per vehicle, I am feeling really well with the portfolio that we bring to that market.