BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Good morning. I'm excited to host our next fireside chat with BorgWarner. As many of you know, we recently initiated on board with an overweight rating and ranked it as our top pick. We're particularly bullish on the Delphi acquisition as we see it driving a really strong margin story. In the near term and longer term, we really believe Delphi's EV technology puts Borg in a significantly stronger competitive position. With us today, we have BorgWarner CFO, Kevin Nowlan; as well as Pat Nolan and Eddie Sander from the IR team, which I'm sure you all know pretty well. Thanks, guys, for joining us today.

Thanks for having us, Colin. Good to see you.

[Operator Instructions] With that, let me just kick it off with the first question. Yesterday, you reported a very solid beat in Q1 and actually, raised your full year outlook in really tough environment right now. Your guidance, though, is based on light vehicle production of 10% to 13%. There's been some, obviously, very large automakers with some headline Q2 cuts because of the semi supply chain issue. What gives you confidence that, that production assumption is low enough?

Yes. A couple of things. One, the 10% to 13%, keep in mind, that's a global number based on BorgWarner's weighted volume production. And so if you look at the global market production just weighted by the whole market -- actual market production, it's probably about a point lower than what our BorgWarner weighted production growth is. So just keep that in mind. But obviously, the nature of your question is about the semiconductor issue and how big an impact is that. The issue is still really fluid right now, as you know. Lots of forecasts coming out from lots of different prognosticators, customers still coming out with new news. So lots of things still moving. We try to take our market intelligence, our discussions with customers, news that we see in the marketplace and triangulate all that information to give our estimated update to the outlook. And so what you saw us do yesterday was basically take our global production down about 2%, mainly skewed to North America, which we took down about 500 basis points. And then we took production down about 200 basis points in Europe. China, Asia Pacific, relatively flat on a fully loaded basis. So what that implies for BorgWarner is that we're saying that production is going to be impacted about 1.5 million to 2.5 million vehicles on a net basis over the full year. So that's our outlook, but I wouldn't say we have perfect precision and insight into everything that's going on. We're triangulating different data points just like everybody else is. And so for us, what we see is the largest impact of the semi issue likely going to be in Q2 with spillover into Q3. And then not really clear on whether we'll see any market recovery as we look ahead to Q4. So that's what's underlying our guidance.

Okay. Thanks for the clarification. I guess, you also announced a pretty large iDM win with an undisclosed major agent automaker, not in China. This is my understanding, your traditional e-drive merged with the Delphi inverter capabilities. So you're already -- deal closed in Q4 -- already delivering a win sort of based on the combined integrated technologies of the acquisition. How important do you think is the breadth of EV capabilities in electronics and the e-motor. It just seems that a lot of these subsystems are getting merged together like e-motor and inverter. And how many suppliers do you think actually have the capability to do both as these systems integrate?

Yes. We're definitely excited about the win we announced yesterday, and you're right. I mean it came so quickly on the heels of the acquisition. I think that's pretty encouraging. I think it's just a testament to the technologies we have and the power of bringing these 2 companies together. And you're right. What's underlying that iDM that we announced yesterday is BorgWarner's e-drive. So effectively, our gearing, our motor capability and the power electronics, the inverter, effectively coming from Delphi. So when you look at the question you had about fundamentally the breadth of capabilities, having those system capabilities and just a system understanding, we actually think is a competitive advantage for us. And that's true whether we ultimately pursue a modular system solution with a customer or we just pursue individual components because ultimately, the customers want to speak to suppliers that can talk in terms of system-level capabilities and have those system-level conversations. And so when we bring world-class capabilities and technologies to the table across a spectrum of products in a whole system, it allows us to engage in those discussions with the customers. But ultimately, whether we ultimately supply a system solution or simply components, we're fine either way. But we do think it's an advantage of getting in the door and having those types of discussions -- strategic discussions with the customers. And so you can see the signs of our success. I mean, over the last year, we've announced eDM awards. We've announced iDM awards. We have announced individual motor sales, inverter sales. So we're happy with whether we supply system solutions or, ultimately, component solutions. But we do think it's a competitive advantage. I think the last piece of your question was about other -- alluding to other competition maybe in the space. To be honest, we're a little bit less concerned with how many competitors there are and what their capabilities are. Although I would tell you, they're probably -- when we look around the environment, there aren't many that have the breadth of ePropulsion capability in-house like we have now when you look across our iDM capabilities and what we actually do in-house today. But frankly, we're more focused on how we maintain technology and product leadership, how we maintain those strong interactions with customers and continuing to maintain our financial discipline. That's really where we focus. And if we do those things, we'll continue to be successful and win our fair share in the market.

But there must be a much smaller group that does the electronics. To be honest, a lot of e-motor people chasing that market pretty aggressively. It seems like there's few that could do both sides, right? I mean, it always seems like you're talking -- you count them on maybe one hand.

I think that's fair. I mean, I think you see more competitive dynamics probably in the motor space. I think when you look at power electronics and really power electronics at scale with credible suppliers and then who has the power electronics as well as the mechanical and the rotating electric -- yes, that universe of potential suppliers -- credible suppliers in today's market is pretty limited. And so we're happy to be one of the leaders in the space there.

And then I guess, I was going to say last quarter, but that was yesterday. In Q4, you had indicated, you had 1 point -- wins that would accumulate 1.1 million inverters with just 3 European customers. That seems quite significant. I mean, do you -- how big -- any magnitude of how big that would be relative to your entire win base? Is that the vast majority of them? And based on your EV forecast, what kind of share is that giving you in the inverter segment when you get to 2025?

Yes. That's obviously not the totality of what we're doing in inverters or even the EV space. But we've profiled those because I think we're trying to illustrate the technology leadership and the credibility that we have in the market with our customers. It's difficult to cite specific market share figures at this early stage of the market, but let me try to dimension it a little bit, and how we think about it or how you might want to think about it in terms of share and how we're winning our fair share of the market. If you go back to our Project CHARGING FORWARD, which is about 45 days ago now, we talked about our expectations for the eLV market, the light vehicle market from an electrification perspective. We think it will be about 15% in 2025. So if you think about what that means, if the market is returning to kind of low 90 millions in global production, call it, '16 to '18 type of levels, 2016, 2018 type of levels. That implies globally we're probably in low teens, probably 14 million or so EVs across the globe. And probably, half of those or so are coming in China, which means the other half, the 7 million or so that's left is the rest of the world, predominantly Europe, but the rest of the world. And we're talking about these 3 programs having 1.1 million inverters on what's left there in the EV space. So now some EVs actually have more than 1 inverter. But by and large, the 1.1 million is across -- it's predominantly 1 inverter per vehicle in that space. I think that just gives you a way to think about in dimension how we are an important player and winning our fair share of the marketplace as it relates to inverters in the market.

No. I mean that's very helpful math. I think that helps frame that. You seem to have some pretty sizable share already.

Sizable and it's with premium OEs. I mean, I think we're signaling pretty strong. And when you think of 3 OEs accounting for 1 million inverters, it goes to technology leadership, it goes to the scale, the fact that we're winning in the marketplace, and we think it positions us great for the longer term.

Okay. That makes sense. You do have -- I mean, kind of on the market share side, you have very high market share in most of your internal combustion engine products. I mean, one of the concerns I hear from investors is that it's going to be hard for you to replicate that share in an EV world. Do you think you could get the same share in EVs? And does that even matter? Can you still get double-digit type margins in your EV products that's smaller share?

Yes. I think the actual market share that we ultimately achieve is a little bit less important. Hey, maybe it's a great aspirational goal for us to have and say, boy, could we get our EV share or market participation, we like to call it, to be comparable to the CV side or the ICE side. But at the end of the day, when you take a step back, it's not as critical because the content opportunity in EVs is so much bigger. So if you look at when we look out to 2025, the content opportunity on an EV being a little over $2,600 per vehicle, which is almost 3x what it is for our content on an ICE vehicle. So maybe it would be nice to have an aspirational goal of getting to the same types of participation levels, but again, not critical. One premium inverter sale actually is worth more than the totality of our combustion opportunities across our product portfolio. So achieving that type of participation rate in the market is less critical. It's really about making sure we have product leadership. We capitalize on our fair share of the content opportunity as the market is growing. And as you think about that market growth, I mean, just look at the total addressable market for EVs. Today, we estimate in the products in which we play across light vehicle and commercial, it's probably about $19 billion of EV addressable market opportunity for us today. It's growing by 5x that as you go out over the next decade, a little over $100 billion. So the revenue opportunity, even if we're not achieving the same type of participation rates as that we do in combustion, it's not as critical because there is a huge market opportunity for us. And as we talked about, we're winning our fair share. To the question you asked about margin, as we evolve more towards EVs, we remain committed to achieving and sustaining that top quartile margin profile we have, which is basically, we think, going to be in the double-digit operating margin range. And that's because we'll continue to maintain an intense focus on return on invested capital. That's part of the core of what we do at BorgWarner from a financial discipline perspective. Now the key to remember for us is, ROIC, we look at over the life of a program. And as we're ramping up aggressively in EVs, there's a heavy investment upfront in R&D to get to the ultimate payoff over time. But we're willing to make that trade-off because ultimately, at the end of the day, it allows us to sustain at more of a steady state that double-digit margin profile.

Got it. I think that's a good segue to my next question, talking about ROIC. You've guided to $2 billion to $3 billion by 2025 of EV-related acquisitions. I think with Delphi and AKASOL, you really have quite a large suite of EV capabilities already in-house or I guess, once AKASOL closes this quarter. What kind of technologies are you looking to acquire? And one of the concerns is that the EV is pretty highly sought after today. I mean, how do you acquire them at a reasonable price, given the demand for this technology?

Yes, and you're right. I mean underlying the acquisition strategy, we'll have technology that's going to ultimately be at the core. And you're right, when you talk Delphi Technologies and even the pending acquisition of AKASOL, we have a lot of the key building blocks to really position ourselves for success. But as we look to continue to grow and improve our positioning, I'd say, there is probably a few general areas to think about where you should expect us to be continuing to pursue acquisitions. One, it's looking at opportunities where we can continue to gain scale in our existing product portfolio or where we can improve our overall competitive positioning. So when you look at power electronics or other aspects of the ePropulsion architecture, we're stronger in some components than others. So we'll continue to look at ways to improve scale or competitive positioning. We'll continue to look at ways to improve the diversity of our offering, whether it's from a technology perspective, a geographic perspective or a customer perspective. And there are probably elements that we can look at to improve or maybe look at vertical integration that might improve our product positioning and ultimately, our ultimate ability to deliver on our margin profile and competitiveness over time. So those might be some general areas to think about. So just because we've completed Delphi Technologies and are on the verge of completing AKASOL, doesn't mean there isn't opportunity to improve in those areas of scale, competitive positioning, diversity of technology or geography and things like that. And by the way, when we think about acquisitions, just one thing I want to make sure people realize. You look at Delphi Technologies and AKASOL, very different acquisitions at the end of the day. Both very much technology focused, but obviously, scale of what they do very different. When we look at M&A on a go-forward basis as part of Project CHARGING FORWARD, I think you should expect that these acquisitions are going to tend to be more focused, a lot like an AKASOL versus a Delphi Technologies. We're very happy with the Delphi Technologies acquisition. It's going great. The integration is ongoing. But I think any of the potential acquisitions from here on out, you should expect to be more single product line focused or much more concentrated in the EV space, a lot like the AKASOL deal that we're closing on here shortly, hopefully.

And any color on what kind of EV products are you trying to sort of build up capabilities in? I mean, is it sort of the battery management systems, DC-DC converters at that end? I mean, you seem pretty strong. You've been in e-motors for a while. You have -- inverters seems pretty solid. What part of the portfolio is sort of where you think could use that?

I think those could be some of the areas as well as others. I think as we look going from grid to wheel in places, we assess all aspects of the portfolio we have. Our competitiveness, our ability to bring leading technology to the customer, are we achieving the scale that we need? Do we have the right technology, even though we might have technology in certain respects, there is evolving technologies in each of those different areas even that you mentioned. And so are we maintaining product leadership there and growing with the type of competitiveness and scale that we need. So it could be in those exact product categories you touched on or others across that e-propulsion landscape, in particular, going from grid to wheel.

And how about valuation there? I mean, how should -- how are you thinking about that? I mean, in terms of the timeline to sort of get your return on invested capital, and any color on the number of targets you have in your pipeline? I've got to admit, I can't think of too many like you've concentrated EV plans, but it's such a murky market...

You'd be surprised, there's lot out there, and so we have a pretty deep and active pipeline that we're looking at. The -- and the way we approach it is, we go out and we source deals. We're not waiting for teasers to come in and then saying, oh, yes, let's go after this deal. Let's go after that deal. We target the companies that we think makes sense to be part of the BorgWarner story on a go-forward basis. And you saw that with AKASOL. I mean, I think -- obviously, the deal hasn't closed yet, but AKASOL had been on our radar for a long time. I don't think most people have heard about it or even really thought about who AKASOL was, and then we announced the deal and people say, well, yes, that makes sense. But the -- what other deals might be out there, well, there is an active pipeline that we look at of companies that probably fly under the radar for a lot of people. But knowing the space pretty well and who the players are, we see opportunities out there. So obviously, not going to disclose names, but there is an active pipeline and a lot more of those types of transactions potentially out there. The way we go about it then, just like we did on AKASOL, it's not about paying a multiple, it's about paying a discounted cash flow. And so we look at a return analysis relative to our cost of capital. And if we can't make that work, then we're not going to do the deal. The AKASOL transaction was premised fundamentally on a DCF of our expectations of how this business would grow, both from a revenue and a profitability and cash flow perspective over time. We look at the discounted value of that and ultimately, put a bid on the table based on that. So we'll continue to maintain that discipline going forward. But what that means is, as you're looking at these EV types of investments that have a much longer growth trajectory, they're not already at steady state, it tends to be that the payback on those initiatives, the return on invested capital, takes longer to get there, but that's okay because we're willing to invest over the life of the investment to achieve our return on capital.

And you've guided to divestitures of $3 billion to $4 billion of ICE assets. What kind of interest are you seeing since you made that announcement? Any color -- I mean you gave some rough numbers on the Capital Markets Day, but color of the kinds of valuation you're expecting on these. And would -- in particular, is aftermarket a core business? Or is that something that you'd evaluate and consider divesting?

Okay. So let me just remind -- as I get into that discussion, let's take a step back and just remind you the basic criteria that we're using to assess whether we want to keep a business or a product line or look to dispose of it. Fundamentally, the businesses that we think fit with BorgWarner over time are those places where we have product leadership, where we have clear medium-term growth expectations and where we have a path to a strong margin profile. We need to tick all 3 of those boxes. So if we have a business or product portfolio that doesn't tick all 3 of those things, then we don't think it's a fit with the company longer term. And so that's not to say those are bad businesses, it's just that they don't tick all the boxes of product leadership, long-term profitable growth in the company. And so they're probably owned by -- that are owned by somebody else. So to your question then of, in terms of potential buyer interest, I'd tell you that over the last 7 to 8 months as we were just coming up to the closing of the Delphi transactions, we started to get a number of inbound inquiries from both strategic buyers and potential financial sponsors who are interested in looking at different pieces of our product portfolio and expressing an interest. So there's been inbound inquiry, whether those aligned with the types of products we are looking to sell or not, we have had inbound inquiry from strategics and financials. So we do think there is a market opportunity out here to execute on value-creating transactions as we look to dispose of some of those businesses that don't tick the boxes. In terms of the question about potential proceeds, you saw in our Investor Day, we're talking, like you said, about $3 billion to $4 billion of potential dispositions. And we said that at the end of the day, we think that will net us somewhere around $1.5 billion of divestiture proceeds -- those are net proceeds. And what we mean by that, it's net of potential proceeds from the sale, minus the loss of ongoing cash flow from those businesses through 2025 because these are still cash flow generating businesses. So we have to kind of look at it on a net basis. As you look at the potential proceeds side of that equation, fundamentally, the way we look at it from purely a capital planning perspective. We'll see how it plays out in the market, but from a capital planning perspective, we looked at trading multiples in the supplier space, and we ascribe a discount to those multiples. And that combined with the loss of ongoing cash flow is what netted us about $1.5 billion of that total $7 billion of capital generation over the coming years. And then finally, you asked about the specific business on aftermarket. I'm not going to comment on any specific businesses or product portfolios as it relates to potential disposition. But what I will tell you about aftermarket, since we've acquired that business, we're pleased with what we've seen in the performance. And you saw yesterday, we delivered our second consecutive quarter of double-digit margins. That segment hasn't operated at double-digit margins, but it is now. We have a path to delivering growth over the medium term, and there is really good linkage with many of the OE businesses within the legacy Delphi portfolio. So business is performing very well right now.

Got it. When you announced the Delphi acquisition, I think you said there were $90 million of cost synergies and then $175 million by 2023, like $90 million in 2021. And then Delphi itself had $45 million of cost savings. How is all that tracking? Based on Q1, it sounded like it's on track. And how is the merger transition going relative to your initial plan?

Yes. We're definitely feeling really good about the cost synergy guidance that we initially provided and how it's continuing to progress. And you heard us say yesterday, we're continuing to expect an incremental $70 million to $80 million of synergies in 2021, which is on top of the $15 million we generated in Q4. So that's how it lines up to the $90 million that you cited. And as we look through the balance of 2021, we actually think we're tracking more to the high end of that range than the midpoint or the low end. You referenced also the former Delphi Technologies savings plan, what they call Project Pioneer, I'd say that's also tracking very well. We've got savings in that business coming this year from Project Pioneer, which are helping to mitigate the impact of the continued pressures on the diesel business decline that we've seen, particularly on the fuel injection side, and you can see that in the results. When you look at the results of the fuel injection segment, you see 2 consecutive quarters now of relatively stable margins in the 7% to 8% range. Not where we want it longer term, but a far cry from where that business was operating just a year ago, and so feeling pretty good about the improvements that we've already generated from -- for Project Pioneer as well as the additional improvements that we see coming over the next 18 months as we bring that program to conclusion as well as the ability to capitalize on the growth in their GDI portfolio in the coming years. So from a financial position, acquisition is going really well from a synergy perspective or Pioneer perspective. And then beyond the financials, also going well. The cultural integration is really key to this business because we just approached the business very differently than legacy Delphi Technologies, which was more of a top down, maybe command and control environment versus BorgWarner, which is very much about local accountability, pushing P&Ls down to the lowest level. We're delivering new business wins. You've seen that with the inverter award we announced last quarter. You saw we've had some GDI wins and then, of course, the iDM award yesterday. So overall, very pleased with the way this has progressed.

One of the questions I get from investors is there's going to be a challenge as you wind down your internal combustion engine assets, I guess, the ones that you decide to keep and then ramp up on EV. I mean how much can you leverage your existing facilities? How should we think about managing that transition? I mean, do you have to impair some of these facilities? How is that going to play out?

Yes. We've heard that question as well, and I struggle with it because it doesn't really fit the BorgWarner model, the way we operate our business. So there is a couple of things to keep in mind there. When you look at our combustion business as a start point, we're predominantly an assembly-based business. The IP that we have from a BorgWarner legacy perspective, it's really a product design and the assembly process. So what we do is, we're purchasing value-added components and then we assemble them in our facilities. So very few of our facilities are process based manufacturer, where you bring in raw on one end of the facility and out spits a finished product. That's not the normal BorgWarner business model. And so as we look at EVs, we actually expect much the same business model from a manufacturing perspective, predominantly assembly-based business. IP and product design, IP in the assembly process. So what that means is, our facilities are really largely an assembly-based footprint, and that footprint can be used for ICE-based transmission modules, for example, or for production of an iDM. It's the 4 walls of the building, but it's not like we have massive furnaces and huge machining operations throughout the organization that create this footprint that's hard to redeploy or reutilize. In fact, we actually have a facility in China that assembles DCTs on one side of the plant, and then you go on the other side of the wall, and it's the eDMs, the electric drive modules, on the other. So the biggest thing for us as we think about footprint is, we just need to balance our footprint within our geographic regions where we're winning EV business because ultimately, just like the existing business model we have, we intend to produce in the same regions as our customers are producing. That's the main business model that we pursued, and we think it's worked well for us. So as it gets to the question about impairments, we don't see that. It's just -- it's a very different business model than maybe some of the more vertically integrated suppliers you've seen.

All right. That makes sense. The AKASOL deal gets you into the medium-duty EV market and maybe large, I guess, but it seems like mediums where things are focused on.

[indiscernible].

How is that different than light vehicle? I mean, because I think most of pack-type work is done in-house by automakers. Is there -- it sounds like there is a much greater willingness from the sort of truck maker side to outsource some of these capabilities? And I guess, it's a lot higher dollar content as well.

Yes, absolutely. I mean when you look at the dynamics, if we just talk about the battery systems space, for instance, we do see a higher level of outsourcing battery packs in the commercial vehicle space than we do in the light vehicle. It's part of what's attracted us to AKASOL. It's not in the light vehicle space at all, and that's not really an attractive market for us versus the commercial vehicle, industrial and off-highway space, where we see a lot more opportunity for outsourcing of modules and packs. And so that's partly what we liked about the space. So when you look at where they play, they play in medium duty. They play in some rail. They play in bus in a big way. And they're doing it with large, credible players. Whether you're talking about Daimler truck and bus, you're talking about Volvo truck, Alstom, they have some really important customers there. And so then to the content question you asked -- yes, I mean the content on these types of battery packs is tens of thousands of dollars because a battery pack might be in the $15,000, $20,000 range, and you have multiple battery packs on potentially a bus. So you're talking tens of thousands of dollars of content on each vehicle that you're producing for. So a tremendous opportunity as we look out over the next 5 and 10 years with growing that business.

I think we're almost out of time. Let me just ask one last question. Pretty straightforward. Diesel has been a headwind, particularly in the Borg, but the Delphi business you acquired doesn't seem to show through in Q1. How is that tracking? And when does that drag? Is that still a drag this year? And when does it start turning up? Or does the GDI there sort of offset some of those?

It is still a drag this year, particularly coming from the legacy Delphi portfolio. It's -- the drag in Q1 was far less than what we would have expected, especially when you look at how much diesel penetration came down in the marketplace on a year-over-year basis, 700 basis points or so in the market, but our portfolio seems to be holding up pretty well. We're still expecting about 100 to 200 basis point headwind in the year. That's netted already in our 3 to 5 points of outgrowth, but there is 100 to 200 basis point of headwind this year from light duty diesel in '21, predominantly coming from that legacy Delphi portfolio. But pleased with what we saw in Q1, seem to hold up fairly well.

Okay. I think we're actually out of time. So thank you guys for joining us today. I appreciate it. And thanks, everyone, for being on the call.

Great to see you.