BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Thank you so much for joining us for this session with BorgWarner as part of Deutsche Bank's AutoTech Conference today and tomorrow. My name is Emmanuel Rosner, and I'm the senior U.S. Autos and Auto Technology Analyst here at Deutsche Bank. BorgWarner is a leading global supplier of systems and components, primarily for powertrain and drivetrain applications, but increasingly and successfully with an eye towards electrified applications. And so I'm very pleased to be joined this morning by Harry Husted, who is the CTO of the company; as well as Pat Nolan, who is the VP of Investor Relations, for a discussion and fireside chat around some of the progress made around electrification in particular. The format for this session will be a short introduction and presentation by Harry, followed immediately by a fireside chat with questions from me as well as all of you on the call. So to submit a question, please type it in the dedicated box, and I will try my best to incorporate it into the conversation. So with that, thanks again for being with us. And Harry, over to you.

Sounds good. Well, you can see our slides there. So we're going to start out. We've got a couple of pages of forward-looking statements, and then we'll jump right in here. Earlier in this year, we announced what we call Project CHARGING FORWARD. And what that was is really a declaration by us on our future revenue profile. And as you can see, it's a shift focused on electric vehicles. And 2021 today, we're at about 3% of revenue coming from products going on to electric vehicles. And what we said was we're going to move to 25% in 2025 and then 45% in 2030. And the pillars for that are the 3 circles on the left side. So it's about profitably scaling our electric light vehicle business, building from that both organically and inorganically, expanding into ECV and building there from the product base and technology that we have in light vehicles, but also leveraging the portfolio we already have in commercial vehicles and our capabilities globally. And then we're going to optimize our combustion portfolio and dispose of parts of that portfolio that are lower growth or lower margin. So Pat, let's take a look next here, really, about a story that didn't just start this year. We've really been deliberately growing this portfolio over time. You can look back there, and in 2015, we acquired Remy, which brought traction motors for electric vehicles into the portfolio. In 2017, it was Sevcon with industrial-focused power electronics, a couple more acquisitions there. And then the cornerstone really of building this has been the Delphi Technologies acquisition last year in 2020, which brought in scale in both power electronics, controller electronics and also software. And then this year, we were excited to acquire AKASOL, which is a commercial vehicle battery pack company. And this story has allowed us then on the right-hand side, you see to transition in terms of a CPV opportunity, from being about $399 of vehicle of opportunity back in 2014 to over $2,500 a vehicle today. In terms of the products that we are now offering, it's a pretty diverse and well-positioned portfolio. You can see this circle of products that go around the vehicle. If I start in the upper left, we have inverters now, DC/DC converters, we have battery packs for commercial vehicles, and then we have high-voltage coolant heaters -- I'm sorry, I got the upper left wrong, onboard chargers. And then this corner in the right, really, is a nice constellation. It's traction inverters, it's the gear, eGearDrive, and then it's the electric motor. And if you take that corner, those 3, and combine it, it's what we're calling an Integrated Drive Module. Sometimes that gets called an e-axle or a 3-in-1, but the strength we have in all 3 of those corner products set us up really well to deliver that iDM. And then in the lower left, the other thing you can see is a DC fast charging station. It's a 2-handle station, and that leverages that industrial electronics team that we acquired several years ago and puts them to work on being able to get energy from off the vehicle, from the grid into the battery pack. And so in addition to getting a portfolio of products in place, we've also been winning business. So there's an exciting story on this page, in fact, a collection of exciting stories. One thing I'd like to point out is there, in the bottom row, the second one from the left, the integrated drive module that we're supplying to the Ford Mach-E electric vehicle. So we supply the rear drive unit for that vehicle that's selling very well today. If you look above that in the row, we've got a nice 800-volt electric motor award that we received there, which is a commercial vehicle award, actually. So that's showing us already in the ECV space, moving in, getting product award and getting rolling. And then across the top, you can see several other inverter awards we've got, both at 800 volts and also in 400 volts. And those are also using conventional silicon-based power transistors, but also it shows, for example, in the upper right there, where the market is pulling on a higher efficiency solution called silicon carbide. And so that's targeted to go to production in 2025. We also, earlier this year, in the lower left, announced a really nice award with Hyundai to build an integrated -- build and supply an integrated drive module for them. So that work is in process right now, and that launch is pretty soon from the automotive perspective, launches in 2023. And then another nice integrated drive module there on the lower right for a Chinese luxury vehicle, where we're seeing us getting traction, no pun intended really, in the iDM market there and being able to supply that unit. So how are we doing on CHARGING FORWARD in this organic revenue target or the revenue target that we had for 2025? Well, the answer is we're doing very well. You can see on this chart that in terms of booked EV revenue, we're already at about the $2.3 billion mark. So -- of a target that we had set for ourselves to hit 25%, that target was a $2.5 billion target. You can see we're a bit above 90% already on achieving that target here this year. And in addition to that, it's a nicely balanced set of awards. It's balanced across the 3 major regions, and its components and its systems. So very good. And the other thing I'll point out is the revenue that's going to come from AKASOL, that new commercial vehicle battery pack company that we acquired, is not in this revenue picture today. So we're off to a great start here in terms of achieving that goal. So what I'd like to do now is kind of go a little bit closer to one of the key components and talk a little bit about that. And that component, in this case, is a piece of power electronics called an inverter. And what that inverter does, if you look on the left side of the picture, you've got the driver there with their foot on the pedal and you've got the battery pack that's got the energy. And what the inverter does is it sits in that space between the battery pack and the electric motor, and it controls getting that power and controlling it in a very smooth, linear way according to the driver foot pedal, what they want to have happen. And so the inverter has 3 main pieces inside of it. It's got a computer with software that takes the command from the driver's foot, and then it controls 6 big power transistors. And we have some really nice proprietary technology there that came in from the Delphi acquisition, actually, and it's a power transistor and a diode combination that we package in a very small way. We cool it very well, and it makes the product very compact and very competitive. And then the third major piece is what's called a bulk capacitor. And it sits there and it stores some local energy, so that when those transistors want to take energy and put it into the electric motor, this gives them a start on supplying some transient energy very quickly. But if you look at what's in there, those are the 3 main pieces of an inverter. So if we go to the next page, what does BorgWarner bring in terms of innovation into this space? And I really want to highlight 2 things. First of all, we've got this proprietary power module based on our Viper transistor and diode. The advantage there is we cool the power transistors on both sides. So when we cool them better, what it means in reality is that we have to put less silicon or silicon carbide inside of it, which is very expensive. And that allows us to have a very competitive product, and it also produces a very compact package. So when a customer comes to us and says, "Here's a very limited packaging space. Can you fit the functionality in?" With this type of technology, we're better able to fit in the packaging space and achieve the target that they've given us. On the right-hand side, a great complement to that. This is more on the computer side of the inverter, but it's our ability to design custom integrated circuits. And what a custom IC does is you can see that picture there, that green thing, that's a chunk of circuit board. We will look and strategically pick a section of circuitry that goes together well, and we'll design it and shrink it down onto a very small silicon die. So I put a penny there, I set a silicon die on it, it's really small there, sitting by Lincoln's nose, but that's very typical. We'll have hundreds of thousands of transistors on that where we've shrunk down that circuit board. And the advantage we get there is we save a lot of money when we do that. The product gets smaller, and we add in proprietary functionality that differentiates our product versus the competition. So what are some big drivers of change today? Well, we're seeing a couple of trends in the market, and this is customer poll, right? One is 800 volts, that's an emerging trend for electric vehicles. It does a couple of things at a very high level. Number one, if you're trying to increase the power level of your premium or sport-oriented vehicle, you can double your power in the drivetrain without increasing all your conductor sizes and things like that, so that's very attractive. It also positions the propulsion system to be charged faster with what would be a practical cable size, so reduced charging time is a nice enabled benefit. The other trend we're seeing is silicon carbide, and that's a pretty recent trend. Silicon carbide as a semiconductor for a transistor. It is more expensive, but what it brings is much higher efficiency inside the inverter. So what that means is more of the power from the battery pack makes it to the motor and to the wheels than it would with traditional silicon. So as we look at that, that higher efficiency has become really attractive to car companies that want to maximize the range of their vehicles and just get the best efficiency. So we spent a little time on this inverter product, and part of that is to help build some knowledge and understanding and also explain why we're positioned to be the #1 non-captive inverter producer by 2025. We've gone through some of the features and the innovations we have, and with our bookings, this product continues to book very well with OEMs around the world. And you can see there that our booking profile looks really great. We have secured an additional $1.7 billion of sales in 2025, and we're not done pursuing things for -- even for that year. So that's it. I think that was the quick presentation that I want to go through and just give you a flavor for what we're doing and how we're doing.

That was great. Thanks a lot, Harry, for both the overview as well as the deeper dive inside inverters, which has certainly been an area of good success and good investor interest.

So I guess maybe turning to some of my questions and obviously, to all investors on the line, feel free to type some in the box and I will weave them into the conversation. Maybe starting from some of your successes and awards, which I think you showed in one of the slides. Based on your track record so far in your conversation with OEMs, where would you see you're getting the most traction in electric vehicles? Is it specific components? Is it complete systems? Where do you feel you've essentially been offering most differentiated product and that had the most customer success?

I guess, what I'd say, it's been a pretty balanced level of interest from the customers, right? It's -- we're seeing really nice interest across this EV portfolio in both component level items like inverters. Our high-voltage coolant heater is a product that's really done well in the market, and customers continue to pull us in. First, we're going to production at 400 volts, but now at 800 volts as well. The inverter space is doing really well. And you can see on the one page there, we've got some really nice bookings already on the entire integrated drive module, which -- the way, it saves the customer a lot of work. They're not having to piece something together and make it harmoniously work. BorgWarner does that system level work and integration work together. So I would say the bookings are pretty well balanced. I'd say to date, we've got more bookings in the passenger car market. But as you look at that ECB market, that's going to -- that's earlier, and it's going to build over time. And you can see that electric motor, the one that we highlighted there, that we've already booked and are going to supply.

Great. Then a question I had, which is being asked by an investor on the line, so we may just jump to it now. Basically, some of the major automakers that you worked with have announced plans to in-source electric motors, potentially inverters, although I would love your view on this. How do you see this as a trend? Or how do you work with this? How does it impact your business?

Yes. Well, it's -- we work pretty flexibly with it, and different automakers have a different approach to this. Every OEM has their own DNA and how they approach the market and what they want to do. And a lot of that's because of the situations they have with factories and things like that. What I would say is we continue to have strong demand. For example, the product -- the inverter is -- it's a high content product, but it's also a very difficult product to design and validate and produce. And that's because of this combination of high-precision computing you have to do inside the box with the computer. Then you've got high power. You're pushing hundreds of amps through this unit and controlling it precisely to the motor. And then you have to liquid cool that, and you have to get it all in a very small package, and in a combination that has, really, leading cost profile. And doing that is not easy, and so that's why our customers come to us. We have the experience in doing that. We've been doing automotive power electronics for 30 years. They realize that, and we have the ability to validate that product through some very rigorous automotive-grade tests to make sure that the product is going to survive and perform out in the field. So it's really a combination of a lot of things that allow us to be a really strong inverter supplier and have a lot of automakers looking and going "Let's just have BorgWarner do that versus trying to build up a huge design team and a very complex set of capabilities to do that."

And Emmanuel, you can look at the volumes that we've disclosed of the 1.9 million units that are EV inverters. You can run some math. Our assumption is that it's about 15% of that market in 2025, we believe it's going to be EV. So you can see we're already a healthy way there in terms of the inverter market share that we're going to have just on what's already booked by 2025, and we're still planning to book additional volumes over the next several quarters.

And the other thing, Pat, I'll just add, and Emmanuel, there's a lot of transition that all the carmakers are doing in this space to get volume and scale. And sometimes they look at that and it helps them to go outside to a supplier like BorgWarner who can bring scale so that the automaker doesn't have to capitalize it all themselves.

That's great. And so, in terms of the willingness or, I guess, desire or plans to in-source by some of the automakers, I think you're seeing different trends for different components. And I think in previous sets of slides, we've highlighted expectations for some components to be more or less in-sourced. Can you maybe talk a little bit about this? Is our inverters the area where we see the most -- the largest proportion of -- or the best likelihood of automakers relying on suppliers like you to proceed? Is it different when you move to the other parts of the electric powertrain?

Actually, that's a great one for Pat.

Yes. So maybe I'll just give you some numbers and assumptions. So on the inverters and other power electronics, we see that predominantly being outsourced, over 80% outsourced in both of those -- in both categories. On motors, it's a bit more mixed. We think about 50-50, but by our numbers, it's slightly more than 50% outsourced by 2025. And then on iDMs and transmissions, we think about 1/3 outsourced. So it does vary by component. As Harry kind of alluded to, it's really driven by the technology and the needs by our customers as well as, frankly, some of our customers need to absorb some of their own fixed costs and some of the more labor-intensive components.

Understood. Okay. And then I guess maybe just focusing then on the inverter side. So I mean, as you know well, Pat, maybe -- you announced recently sort of these strong awards on the -- I think, the largest award to date on the inverter side and -- which we view as extremely encouraging in terms of global automakers relying on you for this. And I think some of the investor feedback at that time was like, well, yes, great, but could some of these global automakers very focused on EV essentially be using BorgWarner or other suppliers to build something that they have essentially designed. And so I guess, what would you say to this? Like is there -- how much of it is sort of like your technology versus -- versus automakers' technology, and having you sort of build it? Yes, I guess let's start with this, and then we'd love to speak about your relationship with the silicon carbide partners.

Yes, it's not build-to-print-work to be -- just to summarize, right? When we do an inverter, it's BorgWarner technology through and through, and we really are a leader in this space, so -- and we see that lead is going to continue to be there because we continue to innovate. It's a very specialized field, and we supply across a wide group of automakers. So we're continuing to develop very innovative technology there. And so we see ourselves maintaining that lead in terms of cost competitiveness, compactness, performance, efficiency, those types of things. So those existing bookings you got are not the print bookings.

You can also look at, Emmanuel, look at our average transaction price. We've given you volume and we've given you revenue. You're going to see that implies our average per inverter revenue is about $675 when you run the math. That implies a fairly healthy mix of what we're actually selling. So that means if your 400-volt silicon inverter is about $400 and your 800-volt silicon carbide inverter is $800-plus, if our average is $675, that gives you a good feel for what our mix is looking like. And just by that number, you could see these are not commoditized build-to-print inverters.

Yes. Yes, absolutely. So I guess let's focus a little bit on this -- the silicon carbide technology. Can you update us on some of your silicon carbide partnerships? The -- what it left with us is -- it provides your power electronics business compared to, I guess, alternatives and peers. And when we read from the outside, some of these automakers building direct partnership with some of these silicon carbide providers such as Wolfspeed, I think GM had announced a sort of like a direct partnership. Is that -- is there a threat of them working directly there? Or is there something that works well with your business model?

I think when you look at the supply issues we've had, it's really natural to have OEMs want to work to have security of supply, right? And we care about those very same things. So when we're working with partners, for example, we've been very public about our partnership with Wolfspeed. That gains us access to work with them and they're putting a lot of capacity in place so that we can -- we and our customers can be assured that parts are going to be available at the scale that are required to move forward. So that's -- I don't think that's -- I'm not seeing that as a big threat, really. The other thing I would just say is that partnership is a good one, and we work with them on advanced technology as well. So through that, we're gaining access to the next generation of technology. We're working that, and we have that in our road map rollout to bring product that continues to be more efficient and more cost-effective as we move forward. So that one is a really nice example of a partnership that works well for both parties.

And so I guess, which semiconductor overall companies do you work with for your main inverters? Which do you see as most advanced and best positioned for the next few years with their technology and your technology and product road map?

Yes. We work with multiple companies. We don't typically publicly go through a list of who we work with and who we think is best and things like that. But just to say, we work with names that everyone on the phone would recognize in the industry, right? There's some very, very good players out there that we've worked with for many years, right? And so we work with multiple suppliers, and it depends on the technology, really, and what they bring to the table at that time. What are their capitalization plans, what are their cost profiles and things like that, so that we can bring the most competitive solution to the table when we're quoting to win business.

Understood. Another question from an investor. What is the pace of silicon carbide adoption? Will there be an inflection point of silicon carbide inverters in 2024, or is this beyond that? And also, how are you thinking about the price inflationary curve for silicon carbide components?

Yes. Really good questions. I would say the pace of adoption has accelerated in the past 2 or 3 years. I was working right in the middle of that group, and I remember where we were in the 2018, early 2019 time frame. And since that time, the uptake in the turn from silicon to silicon carbide has accelerated in our customer base because people are really, I think, getting a hold of the efficiency benefit and then they're looking at range and battery pack sizes and costs and things like that and where they're positioned, and they're realizing choosing silicon carbide is -- makes sense for them. So that's been accelerating. And because of that, right, volumes are going up significantly in the silicon carbide supplier base. So that has a number of great things, right? Scale, health. So silicon carbide prices are coming down in the out years. And as that market grows now and if people come in, we also have additional semiconductor companies now moving into that space and innovating and adding capacity. So it's looking pretty virtuous there, but it -- it's definitely increasing.

Perfect. So since there's 2 more themes that I would love to touch upon, so we're just going to -- I'll ask you a few near-term questions maybe for Pat, and then we'd love to come back and discuss some of the recent awards and how much detail you're able to share there. First, a quick point of clarification. The $2.5 billion revenue target from electrification, does that include components and system on hybrid vehicles? Or was that strictly battery electric vehicle?

So I was going to say, the way I -- and Pat can answer, right? The way I answer that question is there is no X in front of the EV, right? A lot of times we put XEV to mean HEV, plug EV, battery EV, there's no X in this case. It's pure EV.

Okay. Great. And then, Pat, so how has the production environment -- supply chain environment progressed as of late? Are you seeing any notable improvement from the third quarter? And then how do you think about -- same question for -- going into next year?

Yes. So I would say fourth quarter more or less playing out as we expected from an industry standpoint. I can't comment on our -- we're too kind of far along in the process to comment directly on BorgWarner. But we were expecting a modest increase in industry production on a run rate basis as we move into Q4 versus Q3. And I'd say we're seeing that. We're still seeing some volatility in production schedules, but I'd say the level of that volatility has come down somewhat. However, we still are seeing constraints on the semiconductor side. And as we look out to next year, we do expect the industry to still be dealing with the supply constraints as we move into 2022. So we're -- short of it is, we are seeing a sequential improvement versus Q3, but we are still expecting continued headwinds as we move into 2022.

Perfect. Very clear. So then I guess, maybe I'll spend the last few minutes discussing some of the recent awards, which you had summarized nicely in one of the slides. Can you give us some color on the recent inverter win that you announced in the third quarter earnings call. I think this was the largest award to date. And anything you can tell us in terms of volume, content per vehicle, customer relationship or even sort of like based on what technology do you feel like you won this award?

Harry, do you want me to take that one or you want to start off?

Well, I think there's some good questions -- things there for you to talk to, Pat. I'll add any comments I want to or can regarding technology after that.

Yes. I mean, unfortunately, Emmanuel, we can't go into the customer name or the size of the program or which platform it is, but it's a program that we're really excited about. It is our largest high-voltage silicon award to date. It's also our largest inverter program to date. It's with a global OEM for the north -- launching in the North American market. It's going to launch in 2024. It's going to be across multiple EV platforms, and that includes passenger cars and trucks. Can't -- unfortunately, I can't go into much more detail than that.

Yes. And the only other thing I would say is it continues to leverage our design set and our proprietary swap power switch technology, right, which -- that the customer has found very attractive. So it's a nice win.

And I would add, just in general, we're seeing a lot of those awards. We're not winning on price per se, we're winning on our technology being one of the differentiating factors, and you consistently see that in the awards that we're booking.

And anything to read into the -- you've been qualified as high voltage rather than 800 volts or 400 volts?

It's one of those disclosures that unfortunately we're unable to share.

Okay. Then I guess, can you just tell us a bit more about your recent iDM wins for your complete systems with Hyundai and the other Chinese OEM. What are potential content per vehicle there and volumes?

So I'll start with Hyundai. Hyundai is a great award for us. It's our first complete iDM that we secured. It's our motor, it's our inverter, it's our transmission components. We also have some thermal components for it. It's for Hyundai's A segment e-vehicle -- electric vehicle, so obviously, you're talking about a 400-volt system. So you can kind of run the math of where that would fall. Obviously, that's on the lower end of content because it is a smaller vehicle at 400 volts for an iDM, but it's a good award for us. And it's an important customer, and we hope to see more there. In addition, we announced an inverter award with a Chinese NEV manufacturer. Now that is another award. Again, it's our motor, our transmission, our power electronics, and it's a leading NEV brand in China and another good success for us. I think you're going to see more iDMs to come.

And so with about 90% of your 2025 EV revenue targets essentially already secured, what has played out better than, I guess, expected when the -- some of the targets were laid out? Is it more volume for some of those platforms? Is it more wins than previously expected? And then is there, therefore, some upside potential from -- pull forward of some of these programs or just, generally speaking, upside potential to the targets?

Harry, do you want me to take that one, too?

Yes, go ahead. Yes.

Yes. So I mean, we feel really good that we're a little bit more than 6 months removed from unveiling Project CHARGING FORWARD, and we're already at 90% booked rates. I can tell you we've been pleasantly surprised by the -- just the amount of bookings that we've had this year and the pace of those bookings. Inverters, as you can see, is about a little under 60% of the mix there. And I think, clearly, that's one area where we've demonstrated very clear product leadership, and you could see that reflected in the share leadership that we now have there. We're pleased by what we saw in the iDM market, that's another significant win for us, but that's a market that's going to be about 1/3 outsourced. So in that context, we're relatively pleased by what we're seeing there. But also, really, call out some of the other products like our e-heaters that don't get a lot of headlines. That's another meaningful portion of that wins for 2025. As it relates to whether or not that target could go higher, I think our CEO would tell you, let's get to the 2.5 and then we'll reassess. We still have a number of quarters of opportunity to come here, and we're really relatively confident in our ability to get to that target.

Okay. Great. Maybe if I can squeeze 2 more quickly. One of them, so obviously your -- you think you're on track to become the #1 non-captive inverter producer already by 2025. We sort of like look at essentially awards that have happened so far, but also decisions brought more broadly by automakers. Are you seeing also -- have you seen so far automakers make -- choose to make their own inverters for large EV programs going forward? I guess, how has been the track record so far versus your in-sourcing expectations there?

I think some do and some don't. There are some OEMs that go down that path of engineering and inverter in-house. I've sat across the table from some that also have done it. And they used a phrase roughly like this is the Generation X inverter we're awarding you. We did x minus 1 ourselves in-house, and we learned how difficult it is, and we'd like you to do the next generation. And they also said we're going to be essentially a better customer because we understand exactly what you have to do when you have to design and validate that product. So it is mixed, and we'll -- but we're seeing, like we said, you can look at the bookings. There are some OEMs that have done it in-house, but they're constantly going to look at that and reevaluate, and we are not standing still from a technology standpoint. So at some point, they're going to have to evaluate what does it cost them to do it in-house versus what is a global supplier able to supply to them for.

And then maybe very finally, just turning to the M&A piece of your plan. I guess you have a fairly large budget available for EV M&A and on the acquisition side, and then also some goals to divest commercial engine assets. Can you just maybe give us an update on how are you thinking about what you would like to add to your portfolio here as part of this acquisition strategy, and potentially an update on how the divestitures are going?

Yes. So as you said, we have roughly about $5.5 billion of available capital for M&A through 2025. Now we're already underway in that plan. So AKASOL is part of our acquisition plan. They're about 20% to 25% of our targeted acquisition-related revenue to EV, so we're already underway. And I can tell you that there are a number of targets that we're in active discussions with, and we feel relatively optimistic that you're going to see additional M&A from us over the next year or so. I can tell you, it's 3 areas that we're focused on. It's opportunities to gain scale, it's opportunities to gain diversity, and that could be technology diversity, that could be geographic diversity, that could be customer diversity. And we also see some areas that have possible vertical integration within some of our components of the EV side. On the disposition side, also underway with that process. We're targeting our first $1 billion in divestitures by the end of next year. And I can tell you that we're already underway with a number of transactions, one of which actually qualified as held for sale, and you can see that in our latest Q.

Great. Well, I really appreciate this conversation and a deeper dive into some of those products and technologies. So thank you so much for all this color. Thank you for your time. Thank you, everyone, for being on the line and submitting your questions. I look forward to seeing you on all the rest of the sessions for the next couple of days. So thanks again. Operator, this is the end of the session. Thank you.

Thank you.