BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Hi, everybody. Rod Lache, again from the Wolfe auto team. Welcome back to our next session at the Auto and Auto Tech Conference. Our next company, as you could see, is BorgWarner. BorgWarner is a powertrain supplier with a really long history of innovation and engineering and technology. All their technologies help automakers improve the efficiency of their propulsion systems. And the company has dominated. So many different innovations over the years, whether it's turbochargers or timing systems, advanced transmission technologies, as we saw the evolution of engine technology and then hybrids. And then in the past 5 years, the company has taken some very aggressive steps to position themselves equally well for vehicle electrification. They've built a very strong portfolio in technologies, like clutching and transmission gears and electric motors, both organically and through acquisitions. And they just recently rounded out their portfolio with also a lot of application in electrification. The acquisition of Delphi, which is a leader in power electronics, and then AKASOL, which is a company that makes battery packs for commercial vehicles. In our view, that makes the BorgWarner one of the most technically competent suppliers in this space. But obviously, the transition is accelerating to electric vehicles. I think there's no one on this call that would argue that they expected the magnitude of acceleration that we're seeing right now. And certainly, investors want to understand how BorgWarner is going to transition from the majority of their business being tied to certain internal combustion technologies to the majority eventually becoming electrification technologies. How are their products going to fare competitively? So with that as an introduction, I'm going to introduce the company's CEO, Fred Lissalde; CFO, Kevin Nowlan; Vice President of Investor Relations, Pat Nolan. I do want to remind everybody -- thank you, gentlemen, for joining us. I want to remind everybody, if you do have questions -- I have a few questions that I would like to ask. If you think I'm missing something or I should focus on something else, send me a text through the text box in the go-to webinar. It should be very simple. And that only appears to me, and then I ask those questions anonymously, or I try to weave them in as best as I can.

So let's -- maybe just to kick things off. Let's talk about the growth as the business evolves. So maybe you could just talk a little bit about how the bidding landscape of new contracts, how is that evolving? What does it look like today versus what you saw a year ago or 2 years ago?

Yes. Thanks, Rod. Yes, and good afternoon, everyone. It has accelerated the last 12 months. We've seen acceleration in request for quotation, acceleration in the relationship and the discussion with our customers. The closure of the Delphi transaction was done exactly at the right time. We're ready to -- where we have accelerated with -- seeing a very strong pool for our electronics -- power electronics systems. And we've announced a few days ago that we will be producing just with 3 programs in Europe up to 1.1 million inverters in 2024, if I remember correctly.

'25.

Excuse me?

'25, yes.

'25. '25. And so that's really speaking volume to our technology in power electronics. We are moving a lot of R&D money into the e-products. About 30% of what we spend in R&D in the company are going to be for e-products. And it's because the pool is so big, 40% of our $2.8 billion backlog, 40% is for BEV products. And so we have to support those application programs, and that's why we are upping our game on R&D. And also, what we see is an acceleration in commercial vehicle electrification. We've announced last week a win with an 800-volt drive motor for commercial application in Europe. And the acquisition of AKASOL is also I think a sign that we're committed to commercial vehicles, and we're committed to electrification of commercial vehicle. So all that is moving fast, and we are also accelerating in line with the market acceleration.

So I'm getting questions already coming at me, I guess, on what you said. So Fred, you said 30% of R&D in e-products. Why wouldn't it be 70%? Why wouldn't it be just the overwhelming majority of what you spend in R&D? Can you just explain what the process is for allocating R&D dollars?

Yes. I mean, the backlog that we have is 100% electrification. Out of this backlog, 40% is in BEV, but 60% is in hybrid. And so we're still investing in each of those in GDI. Most of the hybrid, they're going to be turbocharge and GDI. And so we have to carry on investing, supporting our customers. Don't forget that in the next 10 years, about 900 million cars will still be produced with a combustion engine attached to it. We can't let our customers down. That relationship, that reputation, the strong links that we have with all our customers around the world are the assets that we want to nurture that will help us bridging the company efficiently towards the world of electrification.

So the point is, I think that you're making is that a lot of the R&D is actually D, right? A lot of it is actually applications that you've been...

That's correct. That's correct.

Right. So you previously -- when we've spoken before, talked about how the combination that you've put together of motors and gearboxes and power electronics all in one house gives you an advantage versus other players. And I'm hoping that we can maybe revisit that a little bit because as finance people, we have so many companies that we look at in the world that it's such an exciting space. Everyone says they're going to be growing in electric drivelines. So I'm wondering if you could just talk a little bit about, are there signs that you can point to that suggests that, that differentiation is having an impact?

There are many signs that show that this differentiation of having under one roof, without having to rely into joint ventures or purchasing a motor or power electronic or transmission, having mechanical, motor and motor controller under one roof is a differentiation. And we see a lot of discussions with our customers, and we are in those system discussions whether we said it's 3 in 1 or a 2 in 1 or inverters or motors, if customers want to do some in-house, it's absolutely okay. I want to give you a few examples. First, we've been in production on BEVs with transmission and motors for years. And the addition of the inverter is only going to make our life and our customers' life easier in order to have one supplier that can support their needs. But if you see some of the wins that we've announced, it is, I think, a proof in the pudding that this equation works, mechanical, motor plus motor controller. When I see the P3 modules that we are launching, the P2 high-voltage module that we're launching, the 400 volts eTurbo that we're launching, this is the same equation. It's having to deal with mechanical, motor and power electronics software combination, understanding all the puts and takes, all the interfaces and making a product that is more efficient than competition. Efficiency is what drives our technology. It's what drives our application money and R&D money. The efficiency in the BEV is even more important than the fuel efficiency in a combustion-based powertrain. It directly impacts range and battery sales. So this equation works. I don't worry much about competition. I focus on getting the best technology in the market. And I worry and focus on our financial discipline. That's what we're doing for a living.

What percentage of the -- when you're speaking to a company, a potential customer, about supplying motors, what percentage of those discussions are kind of systems where you've got the traction inverter, the motor -- or being in traction inverter, the motor and the gearbox all as a system? Is that a significant proportion? Is there any way to sort of give us a sense of how that looks?

So the -- in the deck -- in the IR deck, you see that what we've seen in the market is that about 70% of what composed an iDM is going to be outsourced. And you see more outsourcing into the power electronics, the electronics software standpoint at about 80%, 85% of outsourcing. For motors, our proxy about 1.5 years, 2 years ago was about 50-50. What we see right now is about 60-40, 60 outsourced, 40 in-sourced. And the transmission when the customer in-sources essentially in-sourced. So we have about 70% of the content that is in-sourced. The relationship that we have with customers that we start talking about systems first. In order for them to make a decision between a make or a buy, they need to have a choice of somebody they can buy from. And so we are that somebody they can buy from. Then, through those discussions, some programs, they're going to go and buy a system; some programs, they're going to make a system, but buy a motor on power electronics, that discussion early, from a system standpoint, being able to talk electronics, control strategy, but also NVH, also mechanical efficiency, transient behavior of a motor puts us in a position that we can talk early to our customers at the different elements of the system level. And once we have that discussion, they don't have to worry about being in the middle of Mr. X has the motor and Mrs. Y has the inverter. We do it all for them.

But do they -- is that typical? Is -- are half of the contracts to get awarded -- I mean, you did talk about all of this, 60% of EV motors, 34% of gearboxes, 82% of power electronics are going to be outsourced. So it sounds like it's a component there and it's a component there and it's something else there. So it doesn't really give you the impression that these are being outsourced as systems. Is that...

We have discussion with customers who want to outsource the system. Don't forget that we can't go to a customer -- we are going together as one BorgWarner to customers since about November, right? Before that, the -- we couldn't go as one BorgWarner, including the Delphi Technologies know-how to a customer and talk about systems. So things take just a little bit of time, but the discussions are very intense.

So as far as the outsourcing strategies that you're seeing, is that something that you think -- when you gave those percentages, is that something that's kind of a long-term expectation? And the reason I'm asking, right, and I've gotten a few investors that have actually, just now, chimed in, because we hear sometimes that companies that are initially talking about outsourcing and then once they get to a certain scale, they bring it in-house. Ford is an example. Yesterday, we had Jim Farley talking about how they're starting to make motors in-house, which on the Mach-E. So do you see sort of the first generation of Mach-E, you make the gearbox and the next-generation you may not? Or how does that kind of play out?

You have examples that go both ways, right? You have customers that start in-sourcing and then outsource. You have customers that make an outsource component, and you have customers that start in-sourcing and outsource some of their programs. So it's not a one size fits all. That's what I can tell you. And it will change over time. I am convinced that at the end of day, the force of physics will apply and somebody that has a better product at a better cost, leveraging scale in different continents are going to win. And that's our focus, right? Technology driving efficiency in our products, financial discipline, having scale in 3 continents around those elements of motors and electronics is certainly going to -- and we show -- we see that in the flow of business that we're booking, certainly something that is going to be very interesting for customers.

Let's just quantify something today and sort of what you talked about earlier in terms of your growth in EV. I think that in 2020, EVs were around 3% of your sales, maybe $450 million. Maybe that's off a little bit. But you did say that you had $1.26 billion of EV business in your backlog and you made an acquisition of AKASOL, which adds another $500 million. So if I just added those things that I'm -- I think I'm coming to a number around $2.2 billion of revenue that you'd build up by 2024 that's in EV, which kind of looks very similar to the 13% that we're forecasting for EVs as a percentage of the market in that time frame. Is that consistent with what you guys have been -- what you've meant when you said we're going to be powertrain-agnostic, even though part of it is through acquisition, is that the sort of the math that we should be thinking about?

Yes. Let me take you through the math conceptually and help explain the walk. I mean, if I start with the market and where we see the market evolving in 2024, just to put a stake in the ground there, I think our outlook on EVs is fairly close to what we see from IHS. Beyond that point, we see significant potential for acceleration of electrification. But as we look through 2024, the volumes are pretty much known at this point. So I think it's fair to say that where we think EV volumes globally are going to be is going to be somewhere in that 11 percentage range. So this will stand right there for '24 for battery electric vehicles. For us, directionally, this year's EV sales, so I use '21 as a jump-off point, your number is not far off. I mean, we're probably in that 3.5%, 4% range of total revenue. So that's probably a better jump-off point. Maybe it's a little bit higher than the $450 million you're assuming, but it's still pretty close to your number. And then as you walk forward to 2024, you mentioned the e-products in our backlog. If I just look at the BEV portion of that, which Fred commented on earlier, it's 40% of our backlog is truly on BEVs. It's about $1.1 billion of content. So $1.1 billion plus something maybe closer to $500 million than $450 million, that's kind of your start point of where we expect EV to be. But the one piece that you're missing in the math that I think you're doing is that remember, when we talk backlog, we're talking about revenue that's above and beyond market growth. So that's if the EV market is also growing from today, where it's maybe half of where it's expected to be in 2024, up in that 10%, 11% range, we also expect that core base of that $450 million that you quoted or maybe it's a little bit higher than that, to be -- if the market is doubling, that's doubling as well. So you have to contemplate that when you're thinking about the base EV revenue base for us. And so I think when you do that math and includes the market element of that, which I think is missing, it shows how our base business without AKASOL is actually tracking that movement in the market, maybe even a little bit higher than the market. And then the acquisition of AKASOL is obviously additive to how we're tracking the market.

Okay. That's really helpful, Kevin. Can we just talk about battery packs and what's the rationale behind this and why does it fit into BorgWarner's strategy? Prior to this, AKASOL, you made a 30% stake -- took a 30% stake in Romeo Power and you have an international joint venture with them. Does AKASOL, first of all, supersede Romeo because you own all of that, like how should we be thinking about these different investments in battery pack technology?

So let me take a step back for a moment. The strategy is to be downstream with the battery, having electronics, motor and mechanical at scale and very successful there, either the systems or performance. The second half of the strategy is to have components [ touches on ] as well. We have charging -- stationary charging. We have onboard charges. We have battery packs. We have battery coolant heaters. We have DC/DC converters. We have battery management systems. And downstream, the battery, it goes into the inverter, the motor and then driving the wheels. So batteries is a strategic element that we have decided upon. And this acquisition of AKASOL, we're very, very happy with. Everything that we've seen is very exciting, it's part of the execution of this strategy.

Okay. Can you explain why you want to have all those things? I mean, it's -- I'm going to come across as cynical, but you don't make fuel tanks, right? You make the driveline components or you make the efficient turbocharger timing system. So there's -- maybe this is very naive question, but why -- what's so proprietary about that for you? What would make this a good business for BorgWarner over time to be in battery management?

Well, you have a lot of IP in battery management, right? You have battery management systems, you have the cooling, you have the heating, you have the software, you have the agnosticism across battery cell types that we make a lot with AKASOL. This business is all about product efficiency. We're not talking about fuel efficiency. But we've been in the business of making powertrain efficient right from the inception of this company. And the efficiency within a component or across component is extremely important in a BEV, being [ DC ] or CV because we need to use as less electrons as possible to improve range, reduce the battery, reduce the cost or use electrons to do other things. That's where we are. That's our core, right? And in the battery pack, there is a lot to be done within that system and a lot to be done across the system. And so when we understand battery coolant heaters, when we understand battery management system, when we understand all the electronics that goes around it, we will find ways and means to create value and efficiency for our customers, either within the component or across components.