BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thank you so much for joining us for this session with BorgWarner as part of Deutsche Bank's Global Automotive Conference. My name is Emmanuel Rosner, and I'm the lead U.S. autos and auto technology analyst here at Deutsche Bank. BorgWarner is a leading supplier of engineering system -- engineered systems and components primarily for powertrain applications. The company is executing on its Charging Forward strategy. And just a year ago, conducted a spin-off of PHINIA. Today, BorgWarner is looking to drive eProduct growth and profitability, and also maximize the value of its foundational combustion engine business. And I'm extremely pleased to be joined this morning by the entire A-Team: Fred Lissalde, who's President and CEO; Craig Aaron, who is EVP and CFO; and Pat Nolan, who is the Vice President of Investor Relations and an ex-colleague at Deutsche Bank. Thank you so much. The format for this session will be a short presentation by Fred to kick things off, and then followed by a fireside chat around some of my questions. So with that, Fred and the team, thank you so much for being with us, and over to you.

Thank you. Thank you, Emmanuel, for the opportunity, and good morning, everyone. Just a couple of slides, I just wanted to ground ourselves on who's BorgWarner and what we do and where we are in the journey of Charging Forward. Our vision of clean energy-efficient world hasn't changed for many years. We're in the business of moving vehicles as efficiently as possible. Whether it's fuel efficient or electronic efficiency, we have to drive sustainable mobility solutions. As Emmanuel alluded to, we are in the strategy of executing Charging Forward, which I would say is Charging Forward 2.0. First pillar is grow our eProducts. We guided for about $2.65 billion of eProducts this year. Second pillar is to do that profitably. And we've shown over the past quarters that we can convert on the eProduct additional sales. And the third pillar, which is a very important pillar, 80% of our revenue is made of foundational, i.e., combustion products, just to maximize the value of those products for our shareholders. Let's have a little look at the product portfolio the way we've laid it out. Originally, BorgWarner is a combustion powertrain company driving for fuel efficiency, downsize engines, with the different products that you see on that page where we are #1 and #2 in the world. Over the past few years, we created what we call the eProducts that are relevant for battery electric vehicles that are very important for what I would call electron efficiency so that we can extend the range or reduce the size of the battery. And those 2 products, the ticks on the blue and the ticks on the green, are going one to one on hybrids. If you look at the eProducts on the right-hand side, an inverter for hybrid is the same. The motor for hybrid is the same as on a BEV. So for us, we've put the company in a position that wherever the additional revenue comes from, first, we have product answers to support our customers, and we're in a position to convert mid to high teens on any additional sales whether it comes from combustion, hybrid or BEV. And that's pretty much the goals that we're implementing for 2024. For me, the overall umbrella is we're back to the BorgWarner basics, which is we outgrow our market. Despite the volatility of BEV and hybrids, we outgrow those markets, combustion, hybrid and BEV. We're driving incremental of mid to high teens on those incremental sales, and we generate strong operating cash flow, and I'm sure we'll come back to that. That's just what I wanted to say as an opening to your question, Emmanuel.

Thank you so much. So let's dive into it. Let's talk maybe with global industry conditions, how are things playing out so far? You announced plans to restructure and spend about $130 million to $150 million over the next 4 years or so to achieve savings of $80 million to $90 million by 2027. What do some of these restructuring plans look like? And where are you now on those efforts?

Sure. So that $130 million to $150 million restructuring program that we announced in 2023, that's focused on the foundational side of the portfolio. So we're taking actions accordingly over the next several years as that revenue declines, and we're expecting it to decline around $800 million-ish by the time we get to 2027. By the time we get out there, it's important that we remove cost from that portfolio to make sure that we're decrementing in the mid-teens. That's what that restructuring program is focused on. As you mentioned, about $80 million of savings as we look out to 2027, about $60 million as we look out to 2025, and it's a little bit more weighted towards 2025. So we're on our journey on a number of actions across all of our business units, and we're on plan. That's how I would think about restructuring Borg.

And any savings this year from it?

Yes. It's -- so we said $10 million to $20 million in 2023, around $60 million in 2025, and we're on that journey. It's a little bit more weighted to '25.

Got it. Now let's talk about your eProducts growth and margin outlook in the Charging Forward plan. You have a target to grow eProduct revenue to $2.5 billion to $2.8 billion this year. It seems like a good portion of that is from China. Can you talk about the growth drivers in that market? What is your customer mix in China? Are you positioned to win market share?

So at the midpoint, exactly what you said, $2.65 billion of eProducts. At the midpoint, about $750 million of battery packs for commercial vehicles. We're one of the only pretty much independent supplier of battery packs for commercial vehicle in the Western world. So that leaves you $1.9 billion of BEV vehicle eProducts. About half of it, 45% exactly, is China and a little bit of Hyundai. In that market in China, 95% of our customers are Chinese, especially the big names like the BYDs, the ChangAn, the Great Wall, Geely, Chery, you name it. So that's 45%. 15% of that $1.9 billion, the eProducts light vehicle is North America and the rest is Europe. So it represents really where the music is playing. We're bigger in China because that's where the music is played, right? And the music is played by the Chinese so 95% of our business is with the Chinese. And the last lever is North America because it's going to take a little bit more time for North America to get ready on the electrification of powertrain.

And can you talk about the -- I guess, same ideas in terms of Europe and North America market share dynamics? What -- where are you positioned to -- how are you positioned to win there?

From an eProduct standpoint?

eProduct.

Yes. So if you look at the growth of eProducts, going to 6 million inverters in 2027. Should the volume pan out that way, we're going to be top 1 or 2 in the inverter business, top 2 or 3 in the motor business. When the customers choose to outsource iDMs, we're certainly one of the supplier they go to because we're making inverters, we're making motors, and we've made transmissions for about 120 years so we kind of know how to do it. So we're positioning ourselves similarly over time to be #1, 2 or 3 in the eProducts. Battery packs is a good example. #1 in the world, in the Western world in battery packs for commercial vehicle with NMC. We signed an agreement with BYD for LFP technologies, which can only reinforce our position on battery packs. We -- that's what we are positioning the company for.

If I look a little bit beyond this year and you've had this eProduct revenue target for 2025, $4.5 billion to $5 billion, what is the risk of delayed EV launches to this target? I think you had stated that all of your 2025 eProduct sales are booked, and the vast majority of the '27 targets, which is, I think, $10 billion, is also booked. Given that you're still a few years out from 2027, how much conservatism are you baking in on that target? So I guess, well, long question. I'm trying to figure out the 2025 and '27 targets, to what extent these are at risk or not from what's going on the EV side.

It's very difficult to forecast. Everybody's scratching their heads on how to forecast EV. And so that's why we've stopped trying to forecast. We're focusing on where we can control and what can we control. We can control positioning the portfolio to win, booking and winning the programs that we want to win. And that is happening. Now will the volume pan out the way the customers want it to pan out? We don't know. And the second thing that we can do is position the company to convert on those additional sales. And that's what we're doing, both on the e side and on the combustion side. So that's what we can control, that's what we're focusing on, and we'll tell you more about '25 closer to '25.

Let's talk about your battery systems business. You have capacity expansion this year in your Seneca factory in the U.S. as well as in Germany. How is the production ramp going?

Good. The production ramp is going good. So we are about 2 gigawatt hour of capacity in 2023. By the end of this year, we're going to have 6 gigawatt hours. So times 3 in pretty much 18 months. Seneca is a great story of transitioning a combustion footprint into first [ Zebra ] plant, which has battery packs and also transfer cases. It works very, very well. And that example is multiply or multiplied all across the globe, not only for battery packs, but including eProducts and transitioning our current locations from [ C to H to E, ] that works very well. I would say that we certainly have product leadership in this area. We are one of the only ones left independent. And with the combination of NMC, nickel-based, and LFP, lithium-based, with the alliance with BYD, I think we're well positioned. We're guiding at the midpoint for $750 million of battery pack revenue, which is way higher than what we underwrote when we acquired AKASOL a few years ago. And so we're very happy with where we are from a battery pack standpoint, and again, focusing on the conversion on those additional revenue.

Let's move to the margins in eProduct. Using the ePropulsion segment as a proxy, we saw a dip in Q1 margin. How should we think about near-term trajectory on this and exiting this theme?

Sure. So when we finished our first quarter, the decremental conversion of that segment was about 30%, excluding Eldor. And we're not happy with that performance. We mentioned that on the call. So we're looking at various cost measures to get that short-term performance in line. That's kind of our first goal. But just as importantly is we need to set up this business for long term. You've heard us multiple times talk about conversion on an all-in basis. We need to make sure that we get that cost structure right. So as that business grows, because it's a significant portion of our growth going forward, and we're going to convert on an all-in basis in the mid-teens, and that's really our focus this year and into the future.

So despite the first quarter starts, you're still targeting this on a full year basis?

Yes. When you think about -- [ Pam ] mentioned it. When you think about our growth this year, over 100% of our growth is on eProduct, and we're going to convert it to the mid-teens. That's 100%.

Are you still targeting 7% adjusted operating margin in 2027? And do any of the recent developments with the EV changed the way you think about this outlook for '27?

[indiscernible] we've put out that target, this is, at that time, there's improvement in the trajectory of our [indiscernible] technology [indiscernible]. As Fred kind of outlined, [indiscernible] largely [indiscernible]. We can't control that. But what we can control and what we're really focused on is [ out of that business growth, ] whatever that growth rate is, it has that mid-teens conversion. And that's slightly different [ than in the second quarter ] is now we're saying [ we're going to make ] [indiscernible] [ some arbitrary product ] [indiscernible].

A couple of questions on capital allocation, and this should leave some time for any questions in the room as well. So on capital allocation, the part of the strategy in growing eProducts business had been through M&A. Is this still a priority in the current EV slowdown, which obviously is in some geographies? If so, what are you looking to expand on, perhaps in scale or product portfolio? Is there anything on the near-term horizon?

Do you want to start with capital allocation?

Sure. As it relates to M&A, I think that's your question.

Yes.

M&A is still an important part of Charging Forward. And when we think about what are our priorities for M&A, it first starts with industrial logic. Does the asset have industrial logic? Does it have product leadership? The second aspect that we're looking at is what's the short-term impact of that acquisition on our earnings. The third is what's the long-term trajectory. And we're going to have to run a lot of different scenarios with EV adoption because it's very uncertain. We need to make sure that we pay the right value for that asset. So it's really focused on those 3 areas when we're looking at assets right now in the...

In terms of focus on, so I understand the strategy, but is it more EV or less EV than it would have been before?

On M&A?

Yes.

I think if you should need to think about M&A for BorgWarner, it has to be EV. It has to be technology that enhances efficiency on the ePowertrain standpoint. That has strong industrial logic and that has also a strong financial profile.

You repurchased $100 million of shares in the first quarter, I think close to $200 million in the fourth quarter. Are you accelerating your allocation to share buybacks? And if so, how much of the $500 million to $600 million of free cash flow guided for this year would be used towards it?

Yes. Fair question. So again, let's take a step back, and you mentioned it. Q4 of last year, we repurchased $177 million worth of company's stock. In the first quarter, another $100 million. And we got approval from our Board in the first quarter for another $0.5 billion of authorization. So our total repurchase program is up to a little over [ $760 million. ] So just a big step back. As we think about capital allocation, it really comes down to priorities. Our first priority is liquidity, make sure that we have the right liquidity to navigate a very negative downturn. The second is leverage. We target gross leverage around 2x. After that, we're going to hold cash or any M&A activity. And we have a fixed dividend. That's a fixed obligation for us, and we're going to pay that in any type of environment. And when you think about share repurchases, we're going to continue to repurchase opportunistically. That's how to think about it. I'd say we are really happy with our repurchases both in the fourth quarter of last year and the first quarter of this year. That's how we think about it.

Great. Let's open it up for questions in the room. [Operator Instructions] Christoph?

[ Christoph ] of Deutsche Bank as well. I have a question on the competition in eProducts or systems essentially. We see that volumes are far below the budget, especially in Europe, for example, and competitors in Europe are struggling to fill their industrial capacity. Is this leading in basically the RFQs that you see to more fierce competition, which makes it more difficult on price? Or is it actually that you're seeing a couple of competitors dropping out so that your environment is improving from a bit of a slowdown and the OEM is partnering with the bigger players like you are?

Two things. First, the competition intensity from an eProduct standpoint -- and the devil is in the detail, right, on the different product segments. If you take an inverter as a proxy, right, we're competing with a big electronic, Tier 1 electronic, electronic suppliers. So the competition intensity is not more important than what we've seen on the combustion side. The same people doing engine control unit or transmission control units. Two, as far as we're concerned, one portion of your answer is very simple. We're never going to quote anything below 50% return on invested capital, and we're not going to chase businesses. So the discipline that we have in quoting whatever business is the 15% return on invested capital, but we aren't going to chase anyone.

And a follow-up just on how you approach when taking on the order and the base assumptions that you put in for volumes for the programs that you're winning. Talking to other suppliers, they have changed after the EV slowdown in Q3 last year. Essentially, the haircut they applied to the volumes, the OEM communicates with them as they have seen quite a lot of programs being below those targets. Did you introduce any change as well? Or have you been quite conservative before in approaching that anyway so there's no need for you to change?

Yes, we apply cuts to what OEM tell us at the time of quoting, at the time of capital allocation requests, too. We have been around long enough to know that the cuts that OEM 1 is the cuts on what OEM 1 is telling us can be different than the cuts on what OEM 5 is telling us. But again, you can't control that. So what we can control is flexible manufacturing, having motors that goes for customer 1, 2, 3, 4 on the same production line. And it's the case, having inverters that use the same guts through modular design and modular products and techniques so that we limit the risk of being attached to one customer and one program. And we are, on eProducts as well as on all our businesses, naturally hedged across the 3 continents. Pretty much 30, 30, 30 or 1/3, 1/3, 1/3. We have no customers that is more than 10% or 11% of our revenue. Two customers are close to 10%. And we also are pretty much agnostic to where the electrification -- electrification accelerates our growth, no matter what our content opportunity vehicle of advanced hybrid is the same as they want on BEV. So that's how we think about those things. It's important to have scale not to be attached to customer A and program B.

It's important to have a volume clause in our quotes. So if that volume doesn't materialize, it means we need to come back to the table and either get a price increase moving forward or recovery of the capital. So that's really important that with all this volatility that we have protection and some of that is the volume clause as well as flexible manufacturing.

[ Jim ] [indiscernible] Capital. Just a quick follow-up on that question. Your lead time on contract wins, when we think about the new Chinese players, they tend to be doing things on a much faster scale, like maybe Mercedes is at 3 or 4 years and BYD's at 18 months. I'm just making those numbers up. But directionally, so when you think about the contracts that you're winning today and the price productivity sharing that's built into those contracts, is it stable, kind of expectations, 2% to 3% productivity sharing price downs, old terminology? Or is it getting a little bit tougher or better? What's built into your 2-, 3-year assumptions in terms of your margin targets, in terms of the pricing dynamics of sharing productivity with your customers? You already commented on the competitive landscape and the importance of scale. So how is that changing at the margin?

So first, on lead times, you're absolutely right. China is about half of the rest of the world. And the reason is that they have the culture to use what exists. And it's one of the reasons why we're very relevant in China because we've been there for a long, long time. Even 10 years ago, we were already producing eDM motors and transmission for the Chinese market. And so the more scale you have, the more product portfolio you have ready to go, for which we own most of the toolings, which helps our spreading our portfolio faster, it is absolutely important. And the speed to market from China is very, very impressive. So that's the reason. Two, pricing dynamics, pricing intensity, cost reduction on the eProducts. We don't see any changes from what we've seen in combustion back in the days. It's the same competitive dynamics, same pressure, same way of quoting. Maybe some of the time, we tend to get paid for a [ D&D, ] which is not the case on the combustion side, and that works well. Volume close, very important. And what you need to also think about is on the other side of the ledger, on the combustion side, the longer the combustion tail is, the smaller the [ AIS ] are or the price reductions are because they are running out. So you're getting eProducts with some price reduction, which are contractual. But at the end of the day, on combustion, the price reduction are contractually more, right? So this is the pricing dynamic that we see on both sides of the ledger, E and F, right?

Awesome. I think we're out of time. So thank you so much.

Thank you very much.

Thank you for being here. Thanks, everyone, for your questions.