BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

We're going to kick off the next fireside chat with BorgWarner. So just to give you a little bit of an introduction. So BorgWarner is a $14 billion revenue company, historically driven by technologies that deliver greater efficiency in internal combustion, hybrid and electric vehicles. At a high level, about $2 billion of the company's $14 billion of revenue last year, around 15% was derived from EVs and Hybrids. That was expected to grow to about $2.7 billion this year, and potentially as much as $4.5 billion next year. So a huge amount of growth, and because BorgWarner has higher content on a hybrid or an EV versus internal combustion, the company will actually achieve net growth as the industry continues to shift towards electrification. Joining us today, I'm very pleased to welcome the company's CEO, Fred Lissalde. CFO, Craig Aaron, is in the audience, Pat Nolan, who runs Investor Relations, is with me on the podium.

So I think, first of all, I'd like to just start with a high-level question about the shift in driveline technology. So look, the market, there's a lot of debate, obviously, right now on what is the magnitude, the shift to EV. What are you actually hearing right now from your customers?

Thanks for having us, and good morning, everyone. So what we see from a launch and booking perspective on BEV, it's pretty much launching as we speak. We're launching a lot of programs in BEV right now. And I would say that even if we see maybe a few months of delays in sourcing of next-generation BEV's, it's launching as we're planning now. The take rate is what makes it very difficult once the product is launched. For hybrids, the activity has been very, very high in China and in Europe. In North America, it's -- people start talking about hybrids, but out of the $1.9 billion of eProducts that we have for both BEV and hybrid. 40% of those $1.9 billion is for hybrid powertrain and 60% is for BEV. What's important for us is that our eProduct, what we call the eProduct, which is BEV product plus the electric side and hybrid, they're the same. The same motors, the same inverters. This is the same power electronics, this is the same cybersecurity software, the same transmission, the same thermal management. So we use the same R&D centers, the same engineers pretty much also a lot of the same equipment and plants. So for us, mid- to long-term, we're convinced that electrification is here to happen because regulation is pushing for it. For us, we're pretty much agnostic whether we go in EV or in hybrids.

Last year, EVs were 11% of the global auto industry. just around 10 million vehicles, 5 million of those were in China, 2 million were in Europe. So what are your expectations for EV penetration in the light vehicle market in the next couple of years? And are there brackets that you can kind of put around the low end and the high end of those expectations based on what you're hearing from your customers and regulatory of course?

So we feel that electric vehicles and hybrids are going to grow 20% year-over-year, 23% to 24%, which is going to put the EV penetration rate globally at around 15%. And the hybrid penetration rate globally around 24%, 25%.

Okay. And that's going to be 15% EV penetration in this year?

In this year.

In 2024?

In 2024.

Okay. And is this something that you think gets to 30%, 40% beyond that?

And that's what's difficult to forecast, right? If you have the answer, just tell us, it's tough to forecast. What we think we know is that electrification overall is growing. Will you have a third EV, a third hybrid and combustion or a bit more EV or less. It's difficult to forecast for us. What's really important what we are very proud of is that we've created a portfolio that's resilient no matter what. We can't control the volume, but we can control about the steps that we're taking to take -- to create a very resilient portfolio that has higher product efficiency than competition. And more importantly, what we can control is converting mid-teens all in. And so we've done that last year. We're guiding for that this year. And so wherever the volume goes with the ups and downs and the sentiment and stuff for us, when we convert mid-teens and when that market grows anyhow, we're going to create earnings growth.

Is it fair to say that the, really the markets that we need to focus on are primarily the European and the Chinese market? The U.S. business is really not that meaningful at this point?

For our side, maybe you chime in. For us, out of the $1.9 billion of light vehicle eProducts this year, about 45% is China and rest of the world. China and a little bit of Korea, as you know, supplying the IDM for Hyundai. And 15% is North America.

Okay. So North America is relatively small?

Relatively small. Do you want...

The only part that's larger in North America is the battery systems business. That's $700 million to $800 million of revenue that is from the battery side. All CV battery packs. That's about 60% North America, 40% in Europe. But when you look at eProducts ex battery packs at North American portion is about 15%, relatively small. Growing over time but small.

The growth rate that you talked about on your Q4 earnings call,$2.7 billion and growing to $4.5 billion to $5 billion. Just seems like a really big number, growth wise. Certainly well in excess of what we're seeing broadly in the industry. Can you give us a little bit of more insight into what, what gives you confidence in that magnitude of growth? Is there some specific platforms or things that you can point to that are driving that?

So here is what I would say. We've booked the business that is building to $4.5 billion. We're launching those products on time. And 60% of all the 39, I think it's 39 bookings that we've been able to disclose 60% of those bookings have launched end of last year launching this year. It's all going to be around volume take rate. And if customer volume do happen the way they think it's going to happen. We have a past there. But it's very difficult to predict. That's why I'm not going to answer 2025. We focus on '24. We're growing 65% year-over-year on battery packs, which is not a demand issue, it's a supply issue. So when we put capacity in place, those products are going to see [ delight ] in the marketplace. And so we're laser focused on launching our products and converting, and that's what we can control. How those ramp up and the take rate will happen in the next 12 to 18 months, I think we'll have a clearer picture in 6 to 9 months from now.

Is it a similar mix where it's 40% hybrid and 60% BEV when we think about that growth? Or is it really going to shift the company's portfolio more towards BEV?

In '25?

On '24 or '25, that inflection going from $2.7 billion to $4.5 billion?

If you ex out the battery pack business, right? I think you're going to see growth over both sides of that portfolio. I think how it depends versus the 60-40 will also may come down to the individual programs and how they perform. I think you should expect growth on both sides of that budget.

Of the $4.5 billion, how much of that is commercial?

What we disclosed this year is that, that revenue is $700 million to $800 million.

Of the $2.7 billion?

Of the $2.7 billion to $2.8 billion, and that should be growing next year. I mean, we previously said that, that business could be a $1.3 billion business by 2027. But clearly, the trajectory of that business is dictated by our ability to produce. If we could produce the $800 million this year, we'd sell it. If we could produce more than $800 million, we could probably sell it too.

Most of what we are asked, and I'm sure most of what you're being asked is on the light vehicle side, but it sounds like this commercial vehicle business is actually pretty important for you. Could you talk about -- it's mostly battery packs right? So what's compelling about the battery pack business? How big could this ultimately become?

So right now, we're literally the only independent battery pack supplier for commercial vehicles. And the $750 million of revenue at the midpoint this year and the growth in the next 2 years is going to be linked to NMC technology, which is nickel-based technology, very high power density. And not as competitive as some other technology. That's why we're now creating an alliance with BYD. And I'm very excited about it because I like the simplicity, right? BYD is a key leader in LFP battery manufacturing. And for commercial vehicle, we're going to get the LFP technology, the licensing and we'll be the manufacturing and customer intimacy arms outside of China for commercial vehicle. So very rapidly, we'll be not only the only battery pack maker on NMC outside of in-house production. But NMC and LFP and LFP brings cost competitiveness versus LMC, pretty excited about this alliance and pretty excited about the simplicity of the setup.

So this is BYD will be making their LFP batteries in China, you have the exclusive right in the commercial vehicle market outside of China to put those into your battery packs?

We'll manufacture all Western customers outside of China.

The pack they will supply the cells?

From [indiscernible] the battery, which is a subsidiary of BYD doing the batteries. It's limited for commercial vehicles.

So as of today, most of that $700 million or $800 million business, most of it is NMC technology?

All of it is NMC.

Okay. Interesting. So this is going to reduce the cost of the cells probably by 20%, something like that, I would imagine?

I won't quote your number, but it's certainly more cost efficient.

What's the penetration likely to be? I mean, just getting back to how big this business could eventually become you're an enormous player in that market. It doesn't sound like any of the major truck -- commercial truck makers really are focusing on this?

I can't give you a number on how big that market can be, but the content per vehicle is very big.

Like how -- what is the content for?

Content for an electric bus. If you're talking about the battery pack per vehicle can be $100,000 per vehicle? So you very quickly can see how relatively low volume from an OEM basis translates into pretty significant revenue dollars for BorgWarner. I would say as you look forward today, we are trying to keep up with demand. So I think our customers are also trying to get the vehicles out there, both from a city bus perspective, school bus perspective and other medium-duty trucks. And I think as you look forward into the future, clearly, as they grow the business beyond that, we'll start focusing on ways to improve the cost base, which NMC is -- LFP is a big driver of that cost.

Interesting.

You see that bus in [indiscernible] trucks and medium size trucks are going to be electric right? The regulators cannot put pressure on people like you and I buy electric car or electric bike. You still have those big fuming buses in the middle of the city. So we think that it's going to be electrified, and we have a very compelling product offer for that.

We're hearing a lot about hybrids now, much more so from the OEMs, Ford is talking about bringing that and making that more prominent in their portfolio. GM is now saying that they're going to be bringing plug-in technology back from China, and it's kind of a reflection of what is the pace of adoption in the consumer to Pure BEV. Could you just remind us again what your content is on an ICE, a BEV and a Hybrid? I know that in addition to the electric component, there's a lot of mechanical things that you do in a Hybrid that I would imagine would be very positive for BorgWarner?

So simply put, hybrids or BEV I have 5x the content, the content opportunity vehicle that we have in cost. About $500 in combustion. Should we sell the products in engine transmission versus $2,500 for Hybrids or BEV. This is excluding the commercial vehicle because it's all the numbers. It's only 8 [indiscernible] and again, we're leveraging engineering validation, tech centers, production, supply chain, supply power, it's the same product that goes into a BEV versus a hybrid. It's -- sometimes it's the same product physically. Sometimes we announce motors in China that are being SOP 9 months after we get the nomination. It's because the product is existing. All the machine is flexible enough so that we can tweak the product and put it into the marketplace. So for us, I'm back to that product resiliency, right? We've settled that product portfolio that works no matter what, at a very high level, the faster the electrification, the higher the top line, slightly lower bottom line. The slower the electrification, the lower the top line, the higher bottom line -- the higher margin.

Is the, but the hybrid side, that $2,500 includes the mechanical side well inside? This is the combustion side, which is a pretty high-margin business, and it's leveraging things that you already have?

Correct.

Okay. So to the extent that hybrid is -- let's say, you gain a point of revenue from hybrid at the expense of BEV, is that net positive for BorgWarner?

From a margin standpoint or a revenue standpoint?

It sounds like from a revenue standpoint, it's the same. From a margin standpoint, wouldn't that be a better outcome?

I think it will be, come out of the details. But at the end of the day, if it's an incremental program. We're pricing the programs with the same return on capital hurdle right? But it's a Hybrid program or E-program. So on that standpoint, if it's a new program, it should be about similar. Now, the only partial caveat, if you're using some programs on the combustion side that are already existing, maybe you get a slightly higher incremental on that. But in general, that should come out in the wash. We're pricing the business that we achieved that same mid- to high teens incremental kind of irregardless of where the growth comes from.

Okay. In some cases, OEMs are kind of making last-minute decisions and bringing things back because they've miscalculated. Farley acknowledge that this morning. The signals that they were getting in 2021 and 2022 on what the demand trajectory would be turn out to be wrong. So now I would imagine that there are a lot of companies that are scrambling. Do you have off-the-shelf technologies in hybrid that you can actually sell and bring to those companies today to actually help them get things off the ground quicker?

I think so, we're not starting the discussion because I think those announcements really recent. But with the scale that we have in combustion in the clutch mechanism between combustion, propulsion and electric propulsion. The scales that we've created with inverter motor and I think we're going to help some of those being passed in the marketplace. And you see that in some of the product wins. Hybrid. I mean this inflection point in hybrid is very American. Outside of North America, it's always been, and we've always said that our portfolio was fungible across those 2 types of powertrain architecture. In China, the NEV market, which is pretty much 35%, 37% of the market, right now, 40% is hybrid and 60% is BEV. It's already that ratio, right? So this native around reinvigorating hybrid is very American.

Let's talk about the pricing environment because it just comes up a lot just given the pressure that these companies are under I'm sure it's the same everywhere. I mean, GM has got negative contribution margins on their EVs. I've estimated they're losing $4 billion on their EVs. Ford actually discloses that they lose $5 billion to $5.5 billion. Solana somehow is making money in this. But there's certainly a lot of pressure, financial pressure on these companies. Typically, that winds up affecting suppliers. We're hearing a little bit about that in China as well with the massive price deflation that's occurring there. So ultimately, it comes down to what are your competitive moats and how defendable your pricing is. So can you talk a little bit about the product portfolio? And what are the technologies that you think are just very difficult for anyone to replicate. It allows you to defend your pricing?

We have several eProduct portfolio, but let me take maybe 1 of the most prominent, which is the inverter, right? The inverter is the computer and the nervous system that controls the muscles, which is the motor, right? And the motor drives the wheel through transmission. It is a very, very complex [indiscernible] average price we disclosed about $750. You've got a computer, you've got thermal management, you've got power electronics, you've got power modules, you've got software, you got cybersecurity software. And a few years ago, I was being asked a lot of question about newcomers in this field, right? Well, there's no newcomers in this field in a meaningful way. You're back to the high-volume electronics Tier 1 suppliers that you know 4 or 5 people in the world can do that. And the more you get scale, the more difficult it is for somebody else to come in, not counting patents and trade secret that exists around those products. So that's the competitive moat. Is there pricing pressure? There's always been pricing pressure in this industry. In Powertrain...

And the inverter is what percentage of the overall business. So when you get to $4.5 billion?

We haven't broken it out by 2025. But when you think about that addressable market that we disclosed about $2,500 the inverter, if one inverter is, averages anywhere from $450 to $800 per vehicle, you're going to have, on average, 1.2, 1.3 per vehicle. But and we skew probably heavier to that than our addressable content because we're stronger in inverter.

So it's going to be a significant chunk of that?

A big part of our driver.

And then the other technologies that you have, the battery cooling and heating and orders and things?

Yes, it's, in this field, the, in powertrain, product efficiency, which is a direct outcome of technology mastering has always been in the forefront of everything we do. We're not talking about fuel efficiency anymore, there's technically no fuel into BEV. There is a little bit into hybrid. That's why you need all the turbos and EGRs and timing systems into hybrid because you need an efficient engine. In the east side, we're talking about [ electrons efficiency ]. And I would say electrons efficiency, I'm always simplifying it's not electrons efficiency, but it's even more important than fuel efficiency because when you add a car combustion cars still have some combustion cars you would overcome the lack of efficiency by fueling and building up your tank. Well, BEV's and hybrid you have efficiency of using electrons to propel the vehicle as an immediate impact on battery pack size range. So it has an immediate impact on our direct customer. And also, it has an immediate impact to how many electrons you can do to do the infotainment, the ADAS and things. So we are in the business of efficiency, and that's BorgWarner's DNA. We're looking every time in that 1%, 2% a year of additional efficiency. That's how we keep competitive moat.

Let's talk about the financial implications of these scenarios. So you alluded to this before, higher EV as you get out to 2027, 2030, means higher revenue, slightly lower margin more ICE would be the opposite, lower revenue, slightly higher margin. But this is kind of the same EBIT.

And I would say and I would not say, excuse me, in the higher EV, I would say higher electrified powertrain.

Right. Hybrid. So hybrid or EV anything in that. Can you help us think about what does that mean in the next year or 2? So to the extent that there's variability, it's not exactly the same, right, as you think about '24, 2025. How can we kind of walk through the financial implications of higher or lower?

Two things I'd point to. I'd point to, #1, you can look at how we performed last year. So we provided a guidance coming out of the -- ahead of this spin-off of PHINIA mid-June of last year. We look where we tracked versus that revenue where we ended the year. Our eProducts business came in about $400 million light versus that initial guide. We didn't make it up dollar for dollar in terms of what we picked up in the foundational side, but we picked up about $300 million of that revenue. The margin, though, actually came in above the midpoint of our guidance, actually get closer to the high end of that guidance. So when you look at the midpoint to the midpoint of EBIT guidance, we pretty much came in line with that, if not slightly better. So we did better on the margin side, better on overall operating profit dollars. How we think we have to manage the business very near-term here, given the volatility that we're seeing in volumes is managing the business on an all-in incremental basis. No caveats, no excluding various cost items given the volatility that we're going to see in volumes, a 15% to 17% or mid- to high teens incremental kind of irregardless of how that revenue growth comes is how we need to manage the business. If E comes faster, continue to increment that. If E comes slower, well then we have to manage our costs and take advantage of the foundational side of the business that we're delivering that incremental kind of irregardless of where that driver of revenue.

Okay. So are you saying that let's say, it would still be enormous growth. But let's say, the eProducts business comes in at $3.5 billion to $4 billion instead of $4.5 billion next year, up from the $2.7 million this year. It's a little bit short. If there's some upside to the ICE business. You sort of manage that and we should be thinking about your normal incrementals on whatever the rest...

That kind of mid- to high teens that 15% to 17%.

So there isn't like a lot of cost that you're absorbing just to ramp up to a certain size, you can manage that up or down?

Even within that 15% to 17% incremental that we have this year, we have costs for our eProducts business going up. Our eR&D is up based on our guidance $40 million to $50 million year-over-year. And then in part of that 15% to 17% incremental. We have to manage it on an all-in basis is really the message.

Another question I wanted to ask you, and I think that you may actually be better positioned than people realize. A big theme that we're talking about is just shift in mix amongst OEMs. In the industry. And from 2019 until last year, there was 900 basis points of market share loss for the western OEMs, Europeans and Americans versus the Chinese primarily, but also Tesla to a certain extent. So as you think about that, I'm sure you've made that observation yourselves. Maybe it wasn't as meaningful in the past couple of years because the market went from $72 million to $89 million. But now in a flatter market, it's going to matter. So how do you think BorgWarner is positioned vis-a-vis some of the shifts that you're seeing?

So I'll give you 2 or 3 points of color. First, and your question is essentially on electrification, right?

I'm talking about just broadly -- broadly for BorgWarner.

So broadly I start with electrification. We work with 7 out of 10 largest OEMs from an electrification powertrain. And as I mentioned before, the $1.9 billion of this year's revenue, about half of it is in China, 95% of that half of $1.9 billion is with Chinese OEM. We've listed the BYD's, the [ GDs ], the [ Changan ] but it is them and all of the above. And it's normal because that's where the music has been playing for the past years, and it's normal that we are overweight China, absolutely normal. Will the overall company do you want to comment?

Overall, I mean, it's interesting when you look at the difference of that mix of eProduct business, if you look at our business today, it's about 20% China, 35% Europe, and 30% in North America with the balance being rest of world. If you were to x out the battery pack business, you'll see China, again, is 45%, North America is 15% and then Europe is the balance. So clearly, we're making a lot of progress with the OEMs as they grow. But I think at the end of the day, this comes down to not tying yourselves to 1 or 2 horses, right? I mean really having the diversity in the customer base is what's going to help us manage through any volatility on one program to the next or one OEM is ultimately successful versus the other?

You said 95% of your China business is with domestic OEMs?

Right in the E.

In the E-side. So when they expand into Europe, are they taking you with them?

So traditionally, when Chinese OEM export cars, we tend to use more western content [indiscernible] components.

So that meaning, Yes?

And they localized manufacturing, I think we are in a pretty good shape to be their partners, too, once they want to localize manufacturing. There, the BYD CV battery pack example is a good example of that dynamic.

So the BYD export business would likely be, it'd be yours. As they're expanding more and more into Europe?

Could be ours.

One last 1 for me. Your sub 2x gross leverage, 1x net leverage. You're going to generate $475 million to $575 million of free cash flow. Could you just talk a little bit about uses of cash? Should we be expecting more acquisitions or are we sure we'd be thinking about more capital deployment to shareholders?

So I think the, I think you started right with the right thing. And I think first and foremost, when we think about cash generation and how we're going to deploy that, we want to make sure that we're in a good position from both a liquidity standpoint and a balance sheet standpoint. And I think as we look at where we ended 2023, both of those are checkmarks, right? We want to be 2x or below on a gross leverage basis, and we want to have ample liquidity to basically manage through any potential economic downturn. Beyond that, what are, how are we looking to deploy our free cash flow? Well; I think we will continue to look at inorganic investments that can continue to fund our future profitable growth, particularly on the eProduct side. I think you'll look at when you see our portfolio, it's going to be expanding that portfolio adding capabilities. After those inorganic investments, the excess cash, you can look at our history, we've deployed that cash to shareholders. Since we closed the Delphi transaction, we've repurchased $633 million of stock. Over the past 4 years, we've done just under $600 million in dividends, and we did a tax-free spend to our shareholder base of PHINIA, which has roughly a $1.4 billion equity market cap there. So I think the message you should take away in terms of our capital allocation going forward, it's going to be the same balanced approach that we've had over the past.

Are there significant M&A compelling M&A opportunities for BorgWarner today?

We always look at M&A. We always look at it looking at [ product efficiency ] technology. We're not buying companies that are [indiscernible]. We own it into a few and then we place a phone call. Usually it takes a long time to create that relationship and create the common goals. So we -- are a few things, difficult to time very disciplined. We're going to take that to term volatility in account when we price those businesses. I also think that the current environment is making M&A maybe it is more affordable.

Valuations has...

Valuations has come down. And also let's take Eldor as a proxy. It was difficult for Eldor to book significant high-volume business on onboard charger and AC/DC convert and looking at their balance sheet and the final sprint. And we strongly believe that we're going to unlock value when this business is under the BorgWarner umbrella. Like we did with AKASOL. Our growth is much faster now than we thought it would be when we close on AKASOL, like we did with Delphi. Delphi balance sheet was suboptimal and under the BorgWarner umbrella, we have leveraged our balance sheet and our customer intimacy to grow that business inverter is one example and create a lot of profitable growth.

So despite where your valuation is now and you think about buying back your stock or acquisitions, you're still seeing opportunities out there that ultimately are more compelling, you think, for shareholders?

We're going to have a balanced approach and look at both.

I think we're out of time. And thank you very much. Fred, and Pat, good to see you.

Appreciate it.