BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Next fireside chat, which is with BorgWarner. As everybody here knows, BorgWarner has long been viewed as a leader in technologies, that drive efficiency in vehicles, starting out in internal combustion. And in March of 2021, the company laid out a plan call charging forward. And essentially, the objective was to leverage the company's existing competencies, and expand much more aggressively into the EV market. The opportunity is really big. When you look at the content per vehicle, for BorgWarner's EV driveline technologies, power electronics, electric motors, gearboxes, battery heaters. It could be over $2,600 per vehicle. And when you think about the equivalent in internal combustion, it's around $900 per vehicle. So for the company, the plan was to increase EV exposure from 3% of sales, $350 million in 2021 to 25% of sales or $4.5 billion by 2025, and then 45% of sales by 2030. That $4.5 billion target included $2.5 billion from organic growth, at the time and $2 billion from acquisitions. So far, the company has line of sight on $3 billion from organic. So better than expected, $500 million better than expected, and they have made $1.3 billion from acquisitions. So essentially on target maybe ahead. They expect to achieve operating margins for the overall company in excess of 11% in their future state. Obviously, the state is changing a little bit with the new configuration of the business. And that's even while making investments in growth. And additionally, the shift in mix will also be helped by $3 billion to $4 billion of dispositions, and we just saw BorgWarner announced a $3.3 billion or spin-off of their fuel systems and light vehicle commercial fuel systems, plus aftermarket business. So with that as an introduction, we're really pleased to welcome Kevin Nowlan, BorgWarner CFO; and Pat Nolan, Head of Investor Relations. So I'd like to -- I'll sit over here, just make some room. Maybe just to talk a little bit first about the momentum that you're seeing because something changed, at least from my perspective, looking at the company and CHARGING FORWARD, you laid out a plan to have $4 billion of higher revenue from organic growth between 2021 and 2025, $2.5 billion from the electric vehicles and implied growth of about 4%, growth over market. In 2021, you did 8.5%, not 4%. In 2022, you did 10%, that it did include about 4 points from pricing, but even ex-pricing, better than that 4%. And then in 2023, we're looking at a number that implies at least 8% growth over market. Again, not 4%. So what's happening? So if our math is right, are you going to hit your 2025 targets early? Is -- did something change versus your initial expectations for growth over market?

Yes. I don't think anything has changed in our planning. I mean we're pleased with the fact that we are demonstrating and delivering growth over market. But at the end of the day, growth over market really isn't the underlying objective for the company. It is really about positioning us to be overweight significantly in electrification, as we get from where we were, a couple of years ago to 2025. And so for us, the real mile marker is getting to that $4.5 billion of battery electric vehicle. Now by virtue of the fact that, that positions us to be overweight the electric vehicle market, which is the fastest-growing portion of the market. Naturally, that should contribute to outgrowth above market. And I think, what you're seeing now as we come off of, like you said, the 2021 numbers, we were less than $350 million of battery electric vehicle as we progress toward that $4.5 billion, you're starting to see the acceleration. And you really see it this year, with $1.5 billion to $1.8 billion in battery electric vehicle revenue, progressing toward what we already have line of sight to, as you mentioned, $4.3 billion in 2 years. So a lot of growth that's coming, and it's coming through effectively as growth above market. But I also want to make sure, I mentioned that, embedded in that growth above market too, is the fact that our combustion portfolio is actually performing really well as well. 2/3 of this year's growth is coming from the electrification portfolio. But even if you strip that out, we're still outgrowing the market on the combustion side, as well by a few hundred basis points.

Yes. I want to ask about that, because so like you said, 8% growth this year, 2/3 of that is coming from EVs, let's say, at 6 points. It implies that you're internal combustion business is growing as well. Also implies that your EV business is like doubling this year, reaching something like $1.8 billion. So it's going to already be a double-digit percentage of the company's revenue. And if it's going to get to a little over $4 billion by 2025, that means you've got another $2.5 billion of EV growth over the next 2 years, which alone implies 700 basis points, of growth over market. So pretty good. I'm sort of slow but deducing that the 400 basis point of growth over market is stale. What's happening here that's driving this internal combustion business, to continue growing because the conventional thinking has always been that it's going to cannibalize, at some point. And the industry is going to shift to rely more on EV to achieve CO2 targets and things like that.

Yes. I mean. I think the strength of the combustion portfolio, we've obviously delivered growth above market for a long time, even before we got into the world of electrification. But if you look at the combustion-based product portfolio, it's really focused on making engines more efficient. And when people think of combustion vehicles, they think of a pure combustion vehicle, but they don't think of the advanced hybrids as well. Which requires more fuel-efficient engines, and those need things like turbos and VCT and GDi and all the products, that we bring to market. And so we're seeing pretty broad-based growth across that portfolio still, as we look at this wave of not just combustion continuum, but of the hybrid vehicles ramping up as well.

So it's not that the automakers are sort of foregoing further improvement in internal combustion and just focusing on EV. They actually have to improve internal combustion as well in order to hit those targets?

For the hybrid vehicles they do. In order to have an effective hybrid, you really have to downsize the engine. Otherwise, there's no point in having an advanced hybrid vehicle. And so how do you do that? You do that with some of the technologies, that we bring to market.

Okay. I'd like to ask you about the EV acquisitions that you've made. I think we all understand the rationale behind power electronics, electric motors, gearboxes, really good fit with what we've known to be the competencies of BorgWarner in the past, in driveline. Even battery cooling looks like there are some competencies that BorgWarner had before. What about battery packs and electric vehicle chargers, so how big are those going to be for you? And what are the competitive moats in those businesses? What makes you feel like those are good businesses that fit really well in BorgWarner?

Yes. I'll start that. Maybe I'll start with the AKASOL side. So AKASOL is related to our e-business in the sites of their customers that we already work with or merge with. Remember, we are already in the CV and off-highway business today. And that's really where AKASOL is going to play. You see the -- when you think about where the market opportunity is in the battery pack business for the supply base, we think it's more in the CV and off-highway side versus light vehicle. And when we think about the technology they bring, really interesting power density, really interesting the fact that they can do all the different form factors in terms of battery packs. And you can see that in the quality of the customer base they have. Daimler trucks, Volvo, we've announced a couple of other acquisitions. Now you see that business within the $4.3 billion that you referenced earlier, AKASOL is about $1 billion in revenue by 2025, versus when we initially announced the acquisition, we thought that would be closer to 2030. So we're seeing increased demand for that product. And I think it speaks to the technology and the pull that we're seeing from our customers. On the charging side, I would say that fits with our strategy when we -- Fred often -- our CEO, Fred will often refer to managing the flow of electrons for electric vehicles. And we view the stationary charging as a natural extension of that. We already had a small business in the charging business that came along with the Sevcon acquisition that we executed, I think, back in 2017. And then we decided to build on to that business. So SSE is pending. We had Rhombus earlier this year -- earlier last year, excuse me. And we think that's a significant market opportunity. I think just the hardware side is about $18 billion market opportunity for the company. And those products effectively need to get, more automotive grade for lack of a better phrase. That needs to be more functional. They need to work more percent of the time. We think there's significant overlap with hardware expertise, that we already have. The inverters are big component and a charger. The thermal management capabilities. We already have that and the controls capabilities that we have with BorgWarner, all of those can be applied to those charging technologies.

Okay. So it's power electronics, that then makes sense for you to apply that know-how into the charging infrastructure. What's the competitive landscape like in that business? And what are the competitive moats like in that business?

So it's early days for us. It's a small part of that M&A revenue, but we think there's an opportunity to really differentiate the product going forward, from a quality standpoint and a performance standpoint. I think it's the inverter, I think it's the thermal controls capabilities and the overall ECU and computer controls that we can leverage their existing portfolio.

Just given the growth that we're seeing in electric vehicles for you, I feel like the 25% target is a stale number. You might even hit that number in 2024. So have you sort of thought about what the new trajectory will be, what your latest objectives are in light of the spend in light of the better growth that you're seeing there?

And I think we're still very much focused on, hey, get to that $4.5 billion in 2025, and we still have a long way to go to get there. I mean, a $1.5 billion to $1.8 billion this year, and we've still got to launch a lot of product between now and 2025. So that is our focus before we start talking about what's next. But clearly, we have line of sight to getting to that level. Now we're as part of getting to $4.5 billion, what we are really focused on is making sure that we're overweight EV. So where we stack up relative to that 25%. I'm not sure if we're ahead of schedule necessarily, so much as, hey, getting to that $4.5 billion, we think, positions us there. I would say one of the headwinds, I think, that we're managing and monitoring as we go toward that 25% is our combustion business has actually performed really well. So when you do just math of our overweight position. It's the combination of how the EV business is doing, but it's also how your combustion business is doing as well. So ultimately, we are expecting to get to $4.5 billion. But I think just, as importantly for us is getting to that 25%, but there is a little bit of a headwind that we've had, because of the combustion business. Not saying that we're not going to hit that number because we feel good about delivering on the 25%, but just something to keep in mind. .

Okay. Are you working on any additional dispositions at this point? Or is this essentially, you're done with what the plan was through 2025?

For what we wanted to accomplish through 2025, I think with the execution of the Water Valley disposition from a little over a year ago, plus the spinoff that we announced with PHINIA here for later this year, we'll have accomplished that objective. That, I think, covers our objectives of what we wanted to do through 2025, but portfolio management is a living breathing process. So we'll continue to go through that and assess the right portfolio composition for the company over the long term. But nothing else at the moment that I think we need to do in the next couple of years, but we'll continue to monitor that.

Okay. I want to transition to margins a little bit. So Adjusting for the way you're presenting margins, now you had a 12.5% margin in 2019, a little bit over 10% in 2020, 10.9% 2021, around 10% last year. First half of the year was weaker than the back half, obviously. Can you talk a little bit about the puts and takes as we look out to 2023 now? Your guidance implies kind of flat margins versus the second half run rate, I'm talking about. And it looked like in the short term, your operating leverage is being offset a bit by EV investment. But what was also interesting was that you're the only supplier that didn't really say, boy, we've got a lot of -- like another tranche of inflation, that we've got to deal with. So can you maybe just talk us through, what some of the headwinds and tailwinds are and why inflationary pressure is not affecting?

You want me to focus just on '23 or did you want me to go through any of that?

Well, if you -- if it provides some context for 2022, that would be helpful.

Maybe the brief history going from '19 to '22 and then walk into '23, I mean your numbers are right. I mean, walk into 2020, we obviously had COVID. And COVID had a big headwind on everybody's business. I mean, Q2, I think we were a breakeven margin, so it wasn't even about being double digit. It was 0. And so we recovered from COVID as we were exiting 2020, but it was a big headwind for the full year. We also acquired Delphi in the back half of the year, and we knew net of synergies, Delphi was going to be about a point of headwind in margin just based on the composition of that business. So as we went into 2021, we started to get the full year effect of Delphi, and business was recovering. We were delivering on synergies, and we started to see the margin improvement. We were also getting the benefit of some of the restructuring initiatives that we had announced, back in 2020. So you saw 2021 margin ramp-up to the 10% 9%-ish level. In 2022, you saw a step back of 80 basis points, [ 10.9% dropping to 10.1% ]. And fundamentally, you have 2 headwinds that hit us last year. One was the inflationary environment, which material costs from our suppliers, net of recoveries from customers was about an $80 million headwind. I think it was, so about 50 to 60 basis points of margin. The second headwind was we made the intentional decision to lean forward on investing in our e-products related R&D. So we added $150 million, a 58% increase in 2022 to our e-products related to R&D. So that's about 1 point of margin. So ex those 2 things, we would have been in the 11.5% range. But we had the hit from inflation is real. The other was a conscious decision to invest for the future. Now as you jump into 2023, what's effectively underlying our guide is pretty simple. It's that hey, we're generating a lot of incremental revenue this year. We expect to convert on that in the mid-teens before the incremental R&D investments we want to make on the electrification side this year, which is another $60 million to $70 million. That's why our margin guidance is about 10% to 10.4%. Now to your other question on why aren't we talking a lot about inflation this year. Embedded in our guide is that the way we exited last year is the way that we'll be operating this year, both from the supplier cost side and the customer side. Remember, as we negotiated agreements with our customers last year, the agreements, whether we cut them in Q2, Q3 or Q4, provided is pricing coverage to offset the inflationary environment for the full year. Except for that $80 million headwind that we absorbed in our P&L, which means as we head into 2023, we expect that we're going to be operating at roughly the same levels of where we were exiting last year. So we're not expecting a material difference full year over full year between the supplier cost and customer recoveries because we think we're exiting the year where we're entering the new year.

The incremental spending that you've got this year, obviously mitigating on R&D, mitigating some of the upside, does that business actually become more accretive to margins, as we look out to 2024 and 2025? In other words that, the uptick -- most of the uptick in R&D is in the rearview mirror?

I think that's right. I mean I think we've hit the inflection point of the electrification business from a profitability perspective, as we exit '22 and into the beginning of '23. Because we accelerated all that e-product-related R&D into 2022, $150 million of additional R&D 58% increase. But as you look to '23, the pace of the growth is slowing in the e-products R&D. And why is that? It's not because the opportunities aren't there. It's because we're starting to be able to leverage the existing base of our R&D, to support future programs. So as engineer A rolls off a program 1 that's launching next year, engineer A, can now support the next program. We don't have to hire a new engineer. So we're starting to get this -- see some of that scale benefit come into the P&L, as we look ahead. So pace of growth in ER&D is slowing, pace of revenue ramp-up is accelerating right now. So EV is going to be $1.5 billion to $1.8 billion this year and growing to $4.3 million in the next 2 years, a lot of growth still coming with ER&D growth slowing to the point that we start -- it becomes accretive to our margin profile. And I think, you'll start to see that when you see as we've talked about in the past and continue to expect, as we exit '23 into the beginning of '24, we expect electrification to be breakeven.

In the electrification business, one of the really -- you've become a real dominant player in power electronics. You talked about doing 2.3 million inverters by 2025. 2 million electric motors. Who's using your power electronics? And who's using these motors and gearboxes and what kind of market share and competitive landscape are you expecting for that business?

So the $2.3 billion, it's actually 2.4% now on the pure EV side. But remember, when you factor in the hybrid inverters, which substantially they're the same product. If you're talking about a dual inverter for hybrid, very similar price point, very similar technology deployment. So 3.1 million inverters, 2 million motors. On the inverter side, we think we're actually the #1 noncaptive inverter supplier by 2025. And the customer base is really diverse. Since we announced the acquisition of Delphi, we've disclosed, I think, 13 inverter programs over the -- on our earnings calls each quarter. And if you look at that, what are those programs break down, it's pretty evenly diverse, almost 1/3, 1/3, 1/3, North America, Europe and Asia. So it's a pretty diverse customer base, and that's not all of them. So pretty wide swath of customers. And you kind of run the math when you have that volume, pick your assumption for what you think the EV market is going to be in that period of time, you can see it's a pretty strong position.

Is your -- you made a number of assumptions for outsourcing and in-sourcing back. And when you laid out the charging forward plan, 2/3 of gearboxes, I think you thought would be in-house, 40% of motors and 20% of inverters and obviously, I mean 80% of inverters would be outsourced. Just considering the pressure on OEMs to lower costs, and other pressures that they're seeing with labor, is there any changes to the way you're sort of projecting things would play out versus the way that things are playing out in any of those areas?

Yes. I mean, I would say the in-sourcing versus the outsourcing discussion is something that we're not really talking about, a lot internally anymore. When you think about the amount of business that we've secured, right now, our focus is really on executing and delivering that revenue. If you were to ask us near term, where we're going to fall in that 1.5% to 1.8% in guidance this year. If we can get the components, that's the biggest complicating factor. Same thing when you think about that AKASOL revenue for 2025, it's really can we get the capacity up and running. So I know, there's a lot of discussion about in-sourcing versus outsourcing. But given the book of business we have, we're really focused on actually delivering that revenue. It's not a big focus for us setting more, to be honest.

We have a mic. You just got to get mic over to you.

I don't know if it was in this meeting or the sideline meeting. But Jim Farley said, I would love to do inverters, so can carbide inverters. What's the -- what would be your cost advantage given your scale, doing millions of inverters relative to someone like 4 trying to do it themselves? How much can you save them?

I mean I think you can -- not only do we have the history that we do in inverters, the fact that by 2025, we're going to be selling more than 3 million of them. The scale benefits we have in that are significant. The technology benefits we have by working with multiple OEMs around different parts of the world that we're not just doing one type of inverter. We're not doing just silicon carbide, we're doing 400 volt silicon all the way up to 800 volt silicon carbide and mix of products in between. So I think there's a scale benefit, and I also think there's a technology benefit by the fact of being exposed, to all these different programs. And then the history that we have for the Delphi acquisition there.

But like order of magnitude, thinking about how much of it is just is material -- is it -- can you say 20%? Is it 40%? Like what's the ballpark?

Yes. I don't think in this forum, we want to kind of get into that kind of percentage..

Okay. I want to ask a bit about the SpinCo because obviously, if somebody owns BorgWarner today, they own PHINIA, they own both. So the revenue of PHINIA would be just under $3.5 billion this year. EBIT of about $450 million EBITDA, maybe around $600 million before corporate costs. Can we see a scenario in which obviously, there are corporate costs that are going to come in. Is there a scenario here where the organic growth, as we look out to 2024, it provides enough leverage to sort offset that incremental corporate costs? We're just trying to think about what kind of profitability we should be thinking about that business, number one. And number two, maybe more importantly, do you have any concerns about where that business will trade. Just thinking about -- there aren't really many peers but we could throw out Tenneco before they were acquired by Apollo trading at 3.5, 4x EBITDA, and an aftermarket business. Other businesses there and nothing is apples and apples. But how did you sort of think about what that actually means as an independent company from a trading perspective and valuation and how the market will kind of treat that?

And I'll preface my remarks by say we're planning on having Investor Days for both companies as we approach the spin-off date. And at that point, we'll give a lot more detail on the financial profile of the businesses. I think when you look at PHINIA, what it is, I mean it's a double-digit margin business today. It's a business that we expect to be moderately leveraged, just as we would expect to have BorgWarner moderately leveraged on a go-forward basis. And it's a business that has a very different exposure than a lot of automotives. I mean it's got a big commercial vehicle exposure. It's got a big aftermarket exposure. It has the opportunity to play in hydrogen combustion and based on some of the -- this week's announcements out of the EU. That's pretty interesting, in terms of what that could mean on looking in Europe. So I think there's a lot of interesting opportunities for that business on a go-forward basis, as a company that's already financially strong. So I think we're pretty excited about the prospects for how that business will be treated as an independent stand-alone company and one that's not constrained by me or others in BorgWarner, trying to execute its own strategies. I mean, we are very much focused on electrification and making investments in electrification, the fuel systems and aftermarket business, PHINIA has aspirations to do other things, which don't align with that. So I feel like we're going to constrain their ability to go execute on their strategies. And the ability to let them go operate as an independent publicly traded company, pursuing those strategies, as an already financially strong company. I think it's a good business, a good place for them to be. And a good thing as a public company.

Is there a growth over market for that business, just at a high level?

I think we'll have to see as we go forward, but we see there's opportunities for them in aftermarket, in the commercial vehicle space and hydrogen combustion, maybe consolidation opportunities. There's different things that, that business could be. But I think, the new CEO there, Brady Ericson, who was just announced earlier this week, I'm sure he'll talk a lot more about the outlook for that business, when we get to the Investor Day.

Any other questions from the audience? So I guess maybe another question. I guess if you were to put your portfolio manager hat on, do you think that PHINIA, is an independent public company 5 years from now? And does it look similar to what it is today? Or do you think that, they get consolidated or they consolidate and it looks very different in 5 years than it does today?

I don't know what it will look like in 5 years. I think the prospects for that business as a stand-alone public company are really good, because they have some interesting opportunities out there, given the strength of the financial profile they'll have on day one Both from an income statement and balance sheet perspective and given the diversity of their exposure, globally commercial vehicle aftermarket, in particular, I think there's some interesting opportunities out there for them. And then you've got the hydrogen combustion aspect for them as well, which really syncs up nicely with their gas direct injection portfolio.

But most likely, we're not for where the capital markets. Were you had been having these discussions about a divestiture you had been -- you said before with private equity of various sources. It might have wound up, as sort of a different outcome and it may again wind up as a different outcome. I guess you'd acknowledge that, right, just based on where -- what happened proceeding to that decision to spin off the company?

I mean it's always possible. We're always going to look for a value-maximizing transaction for the company, and the shareholders. But I would tell you, we feel really good about the fact that we're headed down the spin path in giving this company the ability to be a separate stand-alone publicly traded company.

And then from the BorgWarner standpoint, keep in mind, now is the right time for us too. You're starting to really see that inflection point, as Kevin talked about, in the EV profitability path. Now is the time to affect this to allow, not only PHINIA to pursue it's strategies, but allow us now as the EV business approaches breakeven and then into profitability. That now allows us to focus more on that growth path in EV, to be in a profitable line.

Can you share anything about the capital structure that we should be anticipating for the 2 new entities? How should we maybe bracket the right level of leverage?

Not yet. We'll talk about that more, at the Investor Day, but I think we've been trying to signal with the use of the term moderately leverage, what we're really signaling about the path for both companies. This isn't a situation like you've seen in other spin-offs in this industry or other industries where you take a company, you saddle it up with a bunch of liabilities and you spin it off. This is truly about creating 2 separate stand-alone businesses that have the balance sheet and the income statements to pursue their own respective strategies and be successful doing it.

Well, you've been pretty disciplined as far as leverage for the companies. I wouldn't expect you to do something extreme. But which business -- how do you think about the appropriate level of leverage at each? And which one merits more or less relative to one another?

There's a lot of things that go into that. We'll detail that more at Investor Day. I'm going to give much more detail than that other than, I think other than leverage.

Yes. Thanks a lot for squeezing me in. Just on the air management business, and just margins on that. What's kind of the outlook? What are the puts and takes on margins kind of a high-margin business, but just how should we think about that in the next few years?

Not really guiding on the margins of the business, but that business has done a good job sustaining its strong margin profile. I think it ended last year 15-ish%. So it's been a good margin business for us. And with a good chunk of that, that segment coming in the combustion space. Its focus is really on margin management. So I think we'll continue to watch for that business to manage a strong margin profile going forward.

I guess just to put it another way in the past, it's actually pushed past 16%. Are there -- is there a reason why it couldn't do that? Not necessarily looking for it now or tomorrow, but is there a reason why it wouldn't? Is there some kind of price pressure? Or structurally materials issues or anything like that?

And we're definitely focused on managing the margin profile of that business, particularly on the combustion side. But there's also electrification investments that go on in that segment. Our charging business, our DC fast charging business is in that segment. Our high-voltage cooling heaters are in that segment. Our eFan businesses in that segment. The battery cooling technology award, we announced last week is in that segment. So there's a lot of EV awards already in business underlying that segment, that we're growing and investing in that are part of that 15% margin. So when we talk about that e-products related R&D, the 150 step up last year, the 60% to 70% this year. A piece of it is happening in that segment.

Great. I think we're out of time. Kevin, Pat, I've really appreciated, you guys spending your time with us. This is great.

Thank you so much.