BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Yes. I guess I'll kick it off. Thank you, everyone, for joining us for the next fireside chat with BorgWarner. As you all probably know, Borg is my topic. It's been my topic for a while now. I think if you're looking at the Auto sector, I think suppliers are in a tough spot in general, but I think Borg checks a lot of the boxes people probably are looking for a good balance sheet with the potential to do buybacks. You have a positive trend, I think, from the shift in sentiment toward, I think, from BEV to PHEV, I think there's a good offset that most suppliers don't really have in terms of content that's pretty strong on PHEV. Very strong position in China that I don't think people fully appreciate, given the strong local presence in China with the domestics that have been taking all the growth. And then from my perspective, obviously, in my opinion, but I think the guidance is probably one of the more conservative in the group right now, particularly not banking on sort of a huge second half recovery. So pretty well positioned on all the fronts that I think people should be looking at from the supplier side. So I think, Fred, you're going to kick it off with supplier side and then we'll -- I'll do some Q&A, and we can open up to the...

Thank you. I just have a few slides to ground ourselves on who we are and what we're doing. So first, our vision is clean energy-efficient world. We're moving vehicles from point A to point B as efficiently as possible. So we're talking about fuel efficiency when there is fuel, and we're talking about electrons efficiency when there is electrons. And we're talking about fewer electrons on the hybrid. We are implementing a strategical charging forward, which calls for growth in eProducts. Our eProducts are applicable for the eDrive of hybrids and for BEV, profitable growth and growing these eProducts profitably. I will talk about the fact that we're now in a position to convert mid- to high teens no matter where the additional revenue comes from. And last but certainly not least, 80% of our business is with combustion products, and we are #1 or #2 in the world, in anything we do in combustion, and we want to maximize that value for our shareholders on this business segment. Just wanted to take just a few seconds to remind you what we do from a product standpoint. So you know Borg for many, many decades, being one of the world leader in combustion, making mobility as lean and as clean as possible, driving fuel efficiency and engine downsizing. Over the past x number of years, 5 to 7 years, we've created a pretty robust portfolio from inverters to power electronics, to motors, to thermal management systems to also very tactful commercial vehicles that are very instrumental in efficient mobility of BEVs. And hybrid is right at the intersection of having a lean combustion engine and having an eDrive for hybrid, which is no more, no less than a BEV drive. What you get into hybrid is you get 1/3 of the necessary battery pack. And so the products on the left are fully fungible between combustion and hybrid. And the products on the right are fully fungible between BEV and hybrid. And we most probably will talk more about that, too. So our goals for 2024 is, deliver our growth in each and every market segment, combustion, hybrid and BEV, convert mid-teens incremental margin on those additional sales and generate strong operating cash flow, that's what we're known for. I would say if you see this, and you -- if you look at what we've done over the past decade, this is back to the BorgWarner basics, convert mid- to teens on additional revenue wherever those revenue comes from and generate cash. Back to you Colin?

And just to remind everybody, I think the guidance had previously been up until this year when you converted was -- you excluded the R&D investments -- you're kind of at scale on the EV product?

That's right. So we're guiding $2.5 billion to $2.8 billion of eProducts, BEV and hybrids, right, the eSide of hybrid, which I consider being at scale, I mean, at $2.65 billion at the midpoint, this is the size of a Tier 1 or a Tier 2 supplier taken in isolation. So combined with our $12 billion of Combustion business, we now consider that we're back to the Borg on the basics of incrementing without any caveat of year-over-year eR&D increase that's behind us, converting mid- to high teens all in.

Got it. Besides to touch on hybrid, which obviously I mentioned in my comments as well. I mean any color on -- remind us what the content per vehicle is for a full hybrid PHEV? And are you seeing any shift to PHEV yet? I mean I think the EPA rules in May, I guess, for the last update, seems very pro PHEV. I'm not sure how quickly the OEMs can respond to that. Are you seeing business start picking up on some of those stuff yet? Or is it just too early?

So let me give you some color on your question, Colin. So first, this massive change from combustion to BEV and now to hybrid is very American. Outside of the U.S., the world already moved pretty much 50-50 BEV and hybrid. Actually, the real number is 40% hybrid, 60% BEV. In China, under the new energy vehicle umbrella, it's 40% hybrid, 60% BEV. We all talk about BYD. BYD is 50% hybrid, 50% BEV. In Europe, it's pretty much the same. And actually, if you look at the IR website, on our guide for eProducts for light vehicle, we're also 40% hybrid and 60% BEV, which is logical because we are bigger where the music is being played, being in China first and Europe second. So now how the American automakers are going to deal with the powertrain mix that they need in this country and outside of the U.S., I think it's a little early to draw conclusions. Hopefully, since now that market at scale in other parts of the world, and we have scaled too, the time to market, the necessary time to market that they need to launch product will leverage what we do at scale in other parts of the world. And we certainly are in discussion with the Detroit 3, in order to make sure that they get the right powertrain in the right mix at the right time. Did you have another [indiscernible] your question that I...

So it's still -- there's not a lot coming up yet because it's still...

For example, in China, we've announced and outside of China too in New York, we've announced for example, dual inverters for plug-in hybrids. Those are inverters that manage with the drive motor and also the regenerative motor. We're launching that, we're in production with that. At the end of the day, it's the same invertor, maybe not the same shape but it's the same gut. It does the same thing. It controls the motor. Motors that we're producing in China goes flawlessly in a hybrid or in a BEV. It's the same product. It's the same manufacturing line. And IBM can be a P4 for hybrid can be the main drive for BEV. For us, it doesn't really matter.

I guess this is more of a U.S. question again. We've seen pretty significant. I think even GM yesterday lowered their EV targets for this year. So we've seen a pretty big slowdown in EV penetration. I mean from the automaker side, there was all this talk about vertical integration. But now I think there's must be a view on their side that the volumes are going to be lower. And so then are you seeing more interest in outsourcing as they maybe don't have the scale that they were anticipating? Or is that, again, just too early for any sort of change there yet?

I think it's a little early. But if you look at the IR page, out of the $1.9 billion of light vehicle guide, for eProducts, only 15% is for North America, the rest is for outside of North America, for the reason you alluded to because they were planning to do everything in-house. So we don't count on these businesses to grow our eProducts. I think we need to wait another 2, 3 months to really see what they want to do. There are intense discussions, but I think they need a little bit of time to just figure that out.

What about Europe focus? Because some of the data in Europe, it seems like the Volkswagen on the other day like talked about how the ICE has a longer life or whatever, you're not seeing changes over there as much as in the U.S.?

Yes. So we see -- so back to the U.S. a little bit. If BEV reduces, and if the regulations are staying identical, it means that the carmaker is going to have to increase the plug-in hybrids and also increase the downsizing of combustion engines. The turbo take rate is a good proxy to see how downsized engines are in a particular region. So in the U.S., the take rate of turbo is about 44% versus 92% in Europe. That gives you an idea of the room to maneuver that the carmakers in this country have to downsize engines. So when you have less BEV, you need more hybrids and more efficient combustion, which is I mean is good for us, too, right? We see extensions of combustion lineups. We see usage of combustion engines for hybrid powertrains. We see fine-tunings of some of the combustion businesses and products that we do to be tailored and very efficiently designed for hybrid applications. We see all those trends.

Okay.

And we actually see, if you look at China over the past 3, 4 months, the fastest-growing segment is high-voltage, plug-in hybrids.

That a good point. How about -- when we think about hybridization and PHEVs, how does that impact -- I mean, you're kind of known for turbos. How does impact turbos in your core ICE portfolio? Do you see a higher, lower take rate, lower content on some of those because you do have that whole giant chunk of an e-powertrain stuff that maybe you don't need as big as a turbo or something.

Yes. So from a content of vehicle, we have -- I'm going to round it up $500 per combustion, powertrain, I think it's $548 but let's say $500, and we have a 5x content, whether it's a BEV or high-voltage plug-in hybrid. Because on high voltage plug-in hybrid, most of the combustion carries through. You are right, you might not need a turbo VTG because you don't have a transient behavior anymore. The transient behavior is done by the motor. So maybe a slightly lower content in combustion in the plug-in hybrid, but all the eProducts are pretty similar. That's why just said right, between the BEV and high-voltage plug-in hybrid. So content per vehicle is about 5x on BEV and high-voltage plug-in hybrid versus the ones that we have in combustion. And take an example an inverter average price maybe $750 is more than the $550 of content per combustion vehicle. Should we or could we sell all the content in one engine, right? So that shows you that electrification being hybrids or BEV accelerates the BorgWarner's growth. And with that acceleration, we're converting mid- to high teens.

Okay. And as you mentioned that there might be a lower cost turbo in a hybrid, historically, the take rate was higher though. There's actually more turbos. So you're -- a higher percent but maybe a little bit less dollar, just that product?

That's right.

Okay. And then maybe if you could just talk about the turbo market overall, which hasn't been a focus until, I guess, maybe in the last few months when EVs has slowed down. But how is that landscape trending? Because I think really you and Gareth are like the 2 big players. Are you seeing some of the smaller players exit? Is there some opportunities to gain market share and continue to grow well above the ICE market over there?

So, you're -- Gareth and I are sharing about 50% of the market. You've got another 3 or 4 and a little bit more total players around the globe. This is as far as we're concerned, everything that we're quoting being eProducts, being combustion products, being turbo or any other products that we do, we are brutally disciplined to go at 15% return on invested capital. And so we're not going to chase market share. We're not going to chase whatever volume. This is what we do for a living. And the business unit presidents know that there is no need to go below that because capital is not going to be allocated to them.

But are you seeing smaller players like that or are now -- are you saying that some of the players are being a little more...

Pretty stable, pretty stable.

Okay. But how are the smaller -- I mean I would have thought 1 or 2 at least might exit the market if they don't have any growth opportunity and you have to invest in some of the more complicated turbos, you're not seeing that though?

The space is a long hysteresis. It takes time. Things take time.

In Q1, one of the big standouts was Air Management. I think it was up 3%, was like 4% over market. What was there -- the driver there? Is that sustainable? I think it was a big surprise in the quarter?

Yes. So it was -- what's nice about Air Management segment in Q1 was we saw growth on both sides of the portfolio. So as Fred mentioned, one of the benefits of our Turbo and EGR business, it's creating a more efficient engine for the OEMs. We saw nice growth in the quarter from our combustion products. At the same time, on the heat product side of the portfolio in that segment, we sell high-voltage coolant heaters, which heats the cabin within a battery electric vehicle and hybrid at the same time it keeps the battery cool. So we saw nice growth there. So it was really a combination of both sides of the portfolio, which is exactly what we like to see.

And then on the drivetrain and battery also had an extremely good quarter. I mean how sustainable is that? And maybe some update on the battery side of the business? Because some of that maybe get more sustainable now that the plant is up and running.

Similar story on the Drivetrain and Battery Systems segment, saw a nice growth on the all-wheel drive components that are on the foundational side of the portfolio both in China and in Europe. And then the Battery business, obviously, that's growing pretty dramatically over year. Over the year, it's $460 million in revenue last year, at the midpoint of our guide right around $750 million. Right now, demand is higher than our ability to supply. So we've been putting capacity in over the course of this year. In the first half of the year, we are ramping up our Seneca, South Carolina facilities to support our customers in North America. That's complete. We're in the process of ramping up our German location. That will be complete by the end of the year. When you look overall, we're going to be -- our overall capacity will triple between 2023 and 2024. And that really will support us from a revenue perspective for the next several years. Everything is on track. And so far, it's been a really nice success story for us.

Q1 was very strong, but you did make call out the poor conversion in ePropulsion, I think you call it unacceptable or something. How should we think about the actions that you might take there to kind of invest to the profit conversion levels you need?

Yes. Just like you mentioned, so in the quarter, we had about a 30% decremental in that segment, excluding Eldor. And that's just not acceptable from our seats. So we're looking at a number of cost actions that we can take. And the goal here is to not just support the short-term trajectory of the business and improve our cost structure there, but also setting up for successful to the long term. A big portion of our growth is going to be that segment. And we want to make sure as that scales over time, we're converting in the mid- to high teens on an all-in basis. So we're looking at multiple levers and there'll be more to come shortly.

We pull it all together in Q1, I think you were something with 8% or -- yes, I mean, 8% over market for Q1, a very strong start. The guide for the year is just 3% to 6%. So any -- why should we think about growth slowing after the Q1 pace? Anything unusual in Q1 we should be thinking about that?

Yes. So when you think about the 7.5% growth over market in the first quarter, the main driver was foundational. So we saw about 4% growth year-over-year, and our market assumption was flat to down 1% market. So that was the primary driver of that outgrowth. As we exited Q1, we didn't see the same level of foundational orders in Q2, Q3 and Q4. We don't really want to lean out and assume that was going to happen. So we didn't model that in Q2, Q3 and Q4. Obviously, if those orders come in like they did in the first quarter, then that provides a nice tailwind for us, but we didn't assume that as we exited the first quarter.

Okay. Maybe if you talk about -- I touched on my comments at the beginning too, your China exposure, how much is local, what the trajectories there and maybe any notable customers to highlight?

So I'll take that one. So when you think about our China mix and the customer base there, overall China revenue is about 75% local. And that's a big shift from where we were at the end of last decade. And then in 2016, that number is 40%. If you actually drill down into eProducts side of that business, is actually 95% local lay-out. And it's some of the larger names that you know there, it's BYD, Great Wall, Li Auto, XPeng and others that we've announced. So it's a pretty diverse business base, and you really see the pull from those customers there for our technology solutions.

May I add one thing. That slide in China is important for us. First, because in [ GRA ] revenue in China; second, because one of the Chinese export cars, they have a tendency to export powertrain components with our content to make sure that nothing reaches outside of Mainland China with potential IP infringement. Two, when the Chinese come and localize outside of China, already happening in Hungary, in Italy, in Spain and Mexico, we are in a good position being their suppliers of IDMs, inverters, motors, and also other combustion businesses in China to be their partner of tariffs, when they localize in the Western world. So that's why we were very early in China. We have scale in China, 95% of our e-products is with those big names, and that is something that is -- that I'm very happy with.

You mentioned BYD. Have you disclosed what product is yet or no?

We would love to...

Okay, I wasn't sure if I missed an update. I mean how should we think about any of the major puts and takes for the margin guidance? I mean, I know there's a $40 million outdoor drag. Anything -- any other major factors, commodity, ER&D, recoveries, labor? Any of those things noteworthy to kind of call out? Or is it just a straight growth conversion?

Yes. Commodity, labor, we don't see as a major headwind for us to share. So not a big factor. You mentioned eR&D. So we are assuming a $40 million to $50 million increase in eR&D to continue to support our growth. But importantly, when we talk about conversion this year, it's on an all basis. So that 13% to 16% all-in conversion assumes that $40 million to $50 million eR&D spend. When you think about our guidance in the years past, it's been excluding eR&D step up. So it's a really important pivot. And I think it's the right time because of what Fred mentioned earlier, we have scale in eProducts. We have scale on the foundational portfolio, and we're going to get back to BorgWarner basics.

And how should we think about capital allocation? Obviously, buybacks seem to be a popular theme. I mean how should we think of the cadence there? And it sounded like you're pausing a little bit on M&A. I mean, how should we think about the opportunities there that you might be thinking about in long term?

So taking a step back, we repurchased $177 million of the company's stock in the fourth quarter of last year, $100 million in the first quarter. When we think about capital allocation, really think about it in priorities. So our first priority is liquidity. Make sure that we have enough liquidity to sustain the company in a very negative environment, think about 2008, 2009. And we have a target for liquidity of about 20% of sales. Then we look at leverage, we want to be right around 2x on a gross basis. Then we have a dividend. We view that as a fixed obligation. We're not going to turn it on and turn it off. We have a really strong balance sheet. We're going to pay that to any type of environment. And then we would hold cash if we have an acquisition that's on the horizon. And then we look at stock buybacks. And we've been very opportunistic about our purchases. I'd say I was happy with the repurchases that we made in the fourth quarter and the first quarter. One other comment on repurchases, we had $267 million from the Board that was approved in the first quarter. We got approval from our Board for another $0.5 billion. So we have $767 million of authorization. And again, we'll look to make those repurchases opportunistically.

Can you talk a little bit about the growth opportunity in your core ICE business? I mean, obviously, that I think S&P's forecast, I think it tends to be falling 4%, 5% or something like that a year. Maybe not so much as to some of the cost. How should we think about your growth relative to that market? How much over that ICE decline can you manage?

Yes. So we think about this, when we think about what our foundational business, what the addressable market is, we think about it in the context that if you got to look at ICE vehicles, but you also have to look at hybrid vehicles because they're all going to have all those efficient technologies. So if you look at that market this year, our foundational forecast for our revenue is that we're going to be flat to down a couple of percent. That's about a 400 to 500 basis points outperformance versus what we think that combined ICE plus hybrid markets going to do this year. And that kind of makes sense, the historic outgrowth that you've seen in that business, and that's what we'd expect to do going forward. Because the key is there's going to be a lot of volatility in the various volumes, whether or not it's combustion growing, hybrid growing or BEV growing over the next several years. We want to make sure we're outgrowing all their respective end markets. because then it doesn't really matter what the mix ultimately turns out to be, we ultimately outperform the market.

What's driving the outperformance? Are you gaining share? Is it just added like Turbo penetration rates in North America, stuff like that's keeping you above that declining ICE...

Mostly the penetration side. So I mean North America, Turbo is a good example, that's going to be growing over the next several years. Today, it's 44% of the market versus almost 70% in China, over 90% in Europe, and we expect that 44% to go to the mid- to high 50s by 2027. And there's other examples where in you're looking at EGR, variable cam timing, a lot of those different technologies.

And how about one of the concerns investors have is you have very strong market share in your ICE products today. How should they think about your potential share on the ePowertrain, eProducts area? Do you think you could get a similar share there or just sort of a line of sight to getting there?

So, in motors, we think that we are within the top 3 drive motors makers in the world. For investors. It's fair to say that I think we are in the Top 2. And depending on the different -- on high voltage coolant heaters, we certainly in the Top 2, depending on the competition intensity that Turbo one or 2 might not translate to a market share that we enjoy in combustion because, for example, for motors, it's still pretty fragmented. But we're starting strong from a global position of let's say, top 1, 2, 3 in all the products that we do on the eProducts side.

Got it. How about -- you touched a little bit on M&A, what kind of EV assets might look to acquire Eldor was more on the onboard charger DC converter, same area, you did mention it, but that's fairly fragmented I think from ....

Very fragmented. Eldor was the acquisition of 2 engineering centers, right? We have all our engineers tied up launching inverters, and we want to go into on both charges and DC-DC converters. We've announced a few wins already, but it was important for us to have boots on of the ground in Europe. When we think about M&A, we think about technology and efficiency of our product, we think about industrial logic. And more and more, we think about the short-term impact to our cash and P&L. Do you want to talk a little bit about that?

Yes. So when you look at the short-term impact on our earnings profile. We're really proud of our margin profile. We want to make sure we can maintain that over time. And then we're going to look at a bunch of different NAV adoption scenarios because ultimately, we work on a discounted cash flow model. We need to look at a bunch of different scenarios to make sure we're paying a fair value for the asset. So it's really those 3 things, industrial logic, what's the impact on our near-term earnings profile, and then let's make sure we pay a fair value for the asset...

Are there any questions from the audience? How about -- I mean, where do you stand on -- if we just talk about onboard chargers, AC/DC converters, it wasn't really clear. Is that an area you look to consolidate more? Or you're just going to see how that market shakes out or you look to grow organically?

I don't think that we want to make comments on particular product specifics. It has to bring, as you mentioned, industrial luxury, product efficiency and we want to be disciplined on the way we look at the financials of that -- of those targets. When you take a step back, when you look at the acquisition that was done, that were done, post and including Delphi, none of those companies were for sale. So it's a very thorough analysis on where we want to be, what product differentiation we want to create. Can we do it organically? Do we have the capacity to do it organically? Or do we have to grow inorganically? If we go inorganically, we go through the long list to the short list of companies. And then I'm just picking up the phone and call the person. That's how we do it.

You mentioned, how do you think some of these EV markets play out over time? You said your number, I think, 2, you think of the Top 2 in Inverters. Do you think there'll be a dozen inverter players or are we going to end up going down to just 5 or 3?

The key inverter players are the key high-volume Tier 1 electronics player in powertrain. So people that do engine control units, people that do transmission control units are the people that you see in power electronics and inverters and onboard chargers, DC/DC converters, etc. If you take a step back, from charging to moving the wheel, you're converting power of many, many different times. From this -- from AC to DC with a charger, from DC to DC with an onboard charger, from DC to DC on an accelerator from DC to AC to control the motor. Those power conversion devices carry the same guts. Computers, capacitors, silicon and silicon carbide power modules and software. And you see the same players that the ones you seeing in high-volume electronics in low voltage, I would say, in the car industry. So no, if your question is are you seeing a lot of new comments? The answer is no. 5 years ago, you would ask me the question, I would have paused a little bit. Now my answer is clearly, we are not losing against someone that we don't know.

Okay. What about in-sourcing risk particularly like on the eMotor side, that seems like a lot of automakers talk about bringing stuff like that and how?

Yes. So if you think about eMotors, I think we are about 60% outsourced, 40% in-sourced in the world. The real question that you should ask when the car marker tells you that they are in-sourcing the motors is what do they in-source? Because some of the times, we sell the stater and the rotor to the car makers who's putting it together in the transmission case, if that is what they call in-sourcing, I'm very good with that. So because stater and rotor might be already 60% of the bill of material, right? So -- but that always in the detail in that -- I mean sourcing things, right? What do you actually in-source?

You talked a little bit about turbos. How about the rest of the internal combustion engine products? Do you see smaller players exiting other areas of the market? Or is it just going to be a slow burn -- I get if you don't have scale today, I mean taking time line for some of them if the market is eroding and it requires R&D investment?

It's going to take time, but if you are the head of purchasing and you are in a global auto player and if you have 4 turbo suppliers in your portfolio or 3 GR suppliers, do you need that going forward? Most probably not. And probably you're going to focus on companies that have financial strength committed to those products, and we have both also companies where you can manage the different volume volatility between combustion, hybrid and BEVs, right? Because cutting a relationship and repeating another relationship in other business segments are very expensive things to do. So we think that we are in a position where we can be the partner of choice for customers who want to use BorgWarner when it comes to efficient mobility, being with engine downsizing, BEV or the combination of both being hybrids. Now you're going to hear a lot about hybrids. I even heard people saying a step stop is a hybrid. I wouldn't go that far. So you have hybrid powertrains that are propelling the count for about 300 yards and hybrid powertrain that you see in China, I was in China again last week, who propelling car in an electric mode for about 100 miles. Those are very different and were very different animals. The first one doesn't really move the needle from a greenhouse gas emission requirement. The latter actually moves the needle quite a bit. And so when you think about BorgWarner, you need to think about -- the higher the e-range is the more content we have.

Okay. You mentioned up to 4 suppliers. I mean I think yesterday, someone mentioned some companies are actually considering going sole source on internal combustion stuff, that maybe has shifted. Is that -- where do you see companies maybe for the last gen engine, missing still -- at 4 different suppliers. I mean are they consolidating down to just 1 or 2?

I think all that takes time, right? It is logical that this happens over time. But we've not seen it in a very meaningful way yet.

Okay, any last questions before we wrap it up? All right. Cool. Well, thank you very much.

Thank you Colin.

Thank you.