BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

All right. Good morning, everyone -- for joining us in the session with BorgWarner and Emmanuel Rosner -- Wolfe Research. BorgWarner has been one of the most proactive auto suppliers working to optimize this portfolio, both organically M&A and industry shifts, including securing new business with high growth Chinese OEM. Today, despite the uncertainty around powertrain adoption, the company is positioning itself to outgrow its end markets regardless of industry mix while maintaining a focus on cost efficiency and capital allocation. And we're very excited to discuss the company's outlook with you, welcoming brand new CEO, Joe Fadool; CFO, Craig Aaron; and our Head of Investor Relations, Pat Nolan. Thank so much for being with us.

Thank you.

Maybe just to kick things off. I believe you officially became CEO earlier this week. Is that right? But you have been part of the BorgWarner management team for a long time. In the last few years, BorgWarner has undergone a large strategic transformation, spinning off PHINIA, growing electric solutions -- with you taking over, but also -- may be a little bit less. What changes do you plan on making to strategy.

Yes. So first of all, I think it's important to note, if you go back over time, I joined the company about 15 years ago, but even if you go back 10 years, we've always been a strong combustion technology player. So things like turbochargers and EGR, timing systems, four-wheel drive, we're #1 or #2 in nearly every product on the combustion side. And about 10 years ago, we decided to start making investments in the EV side, starting with Remy International. That brought us motor technology and in the last 6 or 7 years, as you mentioned, we've done a number of acquisitions to accelerate our transition toward EVs. So as we sit here today, we're in a very strong position, arguably having one of the strongest portfolios in power train side with the foundational business and also the growing EV business. Now our strategy is to really outgrow all of our end markets, and we do that through leveraging the core competence across the entire portfolio. So I'm focused on leveraging that growth, also building on the strong portfolio that we have. We want to build on it organically. We also want to build on it through inorganic means and then finally drive financial performance, which means growing margins and cash flow.

Is there room or appetite for BorgWarner to allocate capital differently than what has been [indiscernible]?

Yes. Maybe I can start and Craig can add in. If you think about our priorities, our top priority is to invest organically. We've been very successful to take the core competence that we have, win business, deploy that capital, launch and bring revenue in the company. M&A will continue to be a tool for the company. As we mentioned, we've done a number of acquisitions over the last 6 or 7 years. And as we sit now, the turmoil in the market is actually quite an opportunity for BorgWarner. We've got a great balance sheet and strong financial discipline. So we want to take the next few quarters to evaluate some potential targets. But lastly, we're not shying away from returning immediate capital to shareholders. I think Craig would tell you, we've deployed $3.4 billion back to shareholders over the last 5 years. So it's the use of all those tools at the right time and moment that we feel is our strength.

Let's talk about tariffs. How do you think about the impact of tariffs and trade dynamic, not just for BorgWarner, but for the broader industry? How are you managing it?

Yes, I'll take that one. So when you think about how tariffs impact BorgWarner world, generally, we produce in the same region that our customers produce. When you look at 2024, the impact of material imported into the U.S. for BorgWarner was about $875 million. When you break that down, about 50% of it is imported from Mexico, 10% from Canada, 5% from China. Obviously, a lot of news swirling, different tweets happening from our President. I think we need to kind of just watch that. And ultimately, if there's an impact to BorgWarner, we're going to have to share that -- share with our customers and suppliers. We're actually very -- we had a lot of success with inflation when that impacted the company, working with our customer and supplier, we're going to utilize the same playbook.

So -- and then just as a follow-up, how should we think about your exposure to potential steel and aluminum tariffs?

Yes -- as we sit here today, minimum impact. But again, we're going to have to take a look at the specifics there, but we don't think it's a material impact to the company at this point.

And that includes if steel and aluminum prices were to go up as a result of it? Or are you saying just in terms of direct impact.

Direct impact.

Okay. Your 2025 guidance assumes outgrowth across all of your end markets, which is also generally the message of the company, but particularly also in EV driveline where you're expecting growth to accelerate after a bit of slower trajectory in 2024. What will drive the EV growth acceleration this year? Can you share any specifics on some of the launches that would be part of that?

Sure. If you think about broader context, we do plan to outgrow our markets, 2% to 3%, and we've been now growing in that range in the last few years. Specifically to the e-side, it is true on the pass car business, we plan to see growth and potentially outgrowth. If you look toward the specific launches, we've got over 30 launches on that e-side between last year and this year. And those launches as they ramp up, we expect them to generate the growth.

So on our math, and definitely correct us if we're wrong, it looks like potentially expecting something like 30% growth in the EV driveline product this year? How do we reckon -- I don't know, is that true? And how do we reconcile it with the write-downs and restructuring actions that you're also taking at the same time in that part of the business?

Yes, so I'll take that one. When you look at S&P, the 30%, we see S&P increasing on the e-side of the portfolio, meaning hybrid plus battery electric vehicles in the mid-teens. We expect to outgrow that on our PowerDrive business. How are we doing that? It's what Joe just spoke about. It's those 30 plus launches that are primarily in that business unit segment that is driving the growth this year. Those are launches we did in 2024 and 2025. We didn't provide a guide for eProducts this year. Our focus is really on outgrowing our markets, both on the foundational side and the eProduct side. With that said, we did realign our business unit segments. Back in July, we have 2 really focused foundational BUs, 2 very focused eProduct BUs, and we want to see outgrowth on both sides of the portfolio. As we release our financial information, our 10-Qs, you'll be able to see those businesses and both sides of those portfolio, and you'll see us be successful, I think, on both the foundational and eProduct side of the business. And coming back to the drivers, can you give us any color on the launches, either regionally or the technologies that will drive that where -- how do we acquire comfort from the outside on what is essentially a fairly meaningful acceleration?

Yes. Unfortunately, we can't give you customer level disclosures or particular platforms, as the IR guy, unfortunately, we're a little restricted. But I can tell you that those launches this year, particularly on the eProduct side are heavily weighted towards China and Europe, less so in North America as North America is lagging a bit in the electrification side, but it's basically China and Europe where those launches are.

And these are typically on BEVs, hybrids, the combination of both?

It's a mix. When you think about hybrids for work, they play on the higher end of the higher voltage, think about high-voltage hybrids and full...

Your point is they have already launched in '24, and this is essentially the ramp in volume this year or.

It's both. Launches in '24 and upcoming launches in '25, and typically a launch curve takes anywhere from 6 to 18 months to grow into its program volume.

And then turning to the foundational side, historically, BorgWarner's products have outgrown the market by sometimes mid-single digits. Last year, ICE and hybrid industry volumes were down 2%, but your foundational revenues declined actually more like -- or maybe around 3%. What drove the underperformance last year? And what are the key drivers of going back to outgrowth in this segment this year and going forward?

I'll take that one just from a numbers perspective. When you look at the hybrid plus combustion market last year is down about 2.5%. Remember, in our business, the number that you quoted, there's some FX in there. There's also some differences in regional exposure. So if you look at our business, how we performed last year, the foundational business is actually down less than 2% versus that market that was down 2.5%. So we outgrew modestly in that business. And we've been outgrowing in that low single digits in that business. But taking a step back, remember, a lot of the hybrid growth last year was on some of these lower voltage hybrids that have already been established in the market. So that business outperforming that market, we feel pretty good about it. When you take a step back and you compare that business versus what combustion-only volumes did last year, combustion-only volumes were down almost 9% for the industry last year. So in that context, when you strip out FX, that business being only down 2%, we feel pretty good about that result. And we fully expect it to outgrow as we go forward as Joe said.

And I want to mention or reiterate something Craig mentioned, last July, when we reorganized into the 4 distinct business units, there were a couple of objectives we had. The primary objective is we are used on outgrowing all of our product lines, okay? So it's a little bit different tone. I think it shows our agility toward each parts of the portfolio, the foundation and the e-side. So I'm clearly focused on outgrowing leveraging all the core competence we have. We see excellent organic and inorganic opportunities. And of course, we've been executing well. So when it reaches the top line, 2024 is a great example. We had a great year of execution by our teams. We expanded margins, we expanded cash flow. The main focus is driving our growth across the portfolio.

And the equivalent of your math, Pat, on -- applied to 2025 on the foundational side. So what would be sort of like the underlying industry decline assumption? And then what would you expect BorgWarner to outperform it by?

We can follow up with the specifics online. The one thing I'd just caution you is obviously, we have a $400 million FX headwind. When you think about that business, I don't want to give you a projection for foundational revenue for next year because I haven't given an eProducts revenue guide. But the objective is for those businesses ex FX, to outperform their end markets.

Got it. And then some suppliers have been flagging a slowdown in order intake as OEMs reassess their powertrain and geographic strategies. What are you seeing from your customers? Are you really seeing this slowdown where automakers are saying, "hey, look, we've got to really figure out which products do we need, which ones we don't." And now there's a little bit of a lull in the attribution of new business. So that's not something you're flagging.

Yes. I would say we've seen -- and let's speak outside of China. We've seen a slowdown in some of the ERFQs. Some of the OEMs are delaying their new programs and just extending the current programs that they've launched. On the other side, we've seen a small uptick in foundational opportunities. Those aren't always in the form of an RFQ, it may just be higher volumes because they want to sell more of their existing vehicles. It might be an extension of a program they're already on. So there is some, I would say, more turmoil in the customer cycle plans than we typically see. In addition to that, I think hybrids, we are discussing with customers the path toward more of these advanced hybrids. We haven't seen, I would say, a major uptick in RFQs yet, but we expect that to come shortly after.

Focusing on China for a minute, about 75% of your China sales are to local OEMs, I think you've disclosed. And most of that is in plug-in and electric vehicle. But your Asia sales were down slightly last year, even though local NAV volumes are up 30%. How do we reconcile that? And what's your China outlook for this year?

Yes. So maybe, Pat, do you want to handle the number piece. I can talk more broadly. It is true. China is a big part of our BorgWarner revenues, just to give you some context. It's 20% of our total makeup. And in the business that we have in China, 75% is with the locals. And we would even say 50% of our Global E-business is in China. So you can see we've got a substantial business there. The reason for that is we've been there for a long time. So we've got a staying power between customer intimacy, but also they want competitive technology. So BorgWarner is a very attractive partner for them. We have been for a long time. Long term, why are we still betting strongly on the China OEMs? First of all, the speed that they require, we can match their speed. We don't talk about it a lot, but our decentralized operating model gives a lot of autonomy to our China team. So that is what our customers expect. And we feel as we win in China, we're going to be a strong partner for them outside of China.

And from a market perspective, we're expecting that market to be basically flat this year, maybe down modestly which was against a pretty good result last year. The Chinese OEMs saw nice growth in exports last year. They're now the largest export market around the globe, which is benefiting parts of our business, too. So as Joe said, market that's very important to us and we...

Any color on the math around last year's Asia performance where your Asia sales were down slightly and -- but local NEV volumes are obviously up a little bit.

Yes. So you got to parse out different parts of the business. Because remember, even with our PowerDrive Systems business, there is part of the business that is foundational. 1/4 of that business is foundational [ ECU ]. And that business, particularly in Asia, saw some headwinds last year, plus they had some headwinds of a specific e-program reaching its end of life. The business is starting to lap both of those headwinds. So we'd expect to see that gap close as we move forward from China, but it's really just a time issue.

In China, you're competing with some -- in some cases, with low-cost suppliers, in some cases, with local OEMs in-house capability even. Describe for us or how do you see the competitive landscape? Where does BorgWarner fit in?

Yes. So as we were just discussing, we've been doing business in China for a very long time. We built a very successful foundational business with them. So customer intimacy, I would say, is quite high in China. What do the Chinese OEMs look for in a supplier? So if you want to boil it down to 3 things, the first is competitive technology. They still want technology, but they want competitive. The second is they want a supplier that knows how to work with them, how do they launch products, what are their quality expectations, how do they go to market? The third is they want someone that can move quickly. So many of you have heard, the Chinese OEMs, they move twice the speed or sometimes more than some of the western OEMs. What we hear from our customers, they like our decentralized model, our teams can match their pace to get products into the market quickly. And we have to continue to work on that. China is a very dynamic market. New models are coming out all the time, but we feel we've got a winning formula there that will prove out over time.

Is the pricing environment different in China? I mean, certainly, yes, for OEMs. But in terms of the technologies you supply because of the level of competition? Is it -- is there an expectation of also just steeper price downs than your average business?

I mean it's very competitive in China. There's no surprise there. We're constantly looking for ways to remove waste, reduce costs. One of the advantages that we have in China and others may too, is due to the shorter times to go to market, you're spending less on engineering money, less on investment. The Chinese are also very open to reuse and maybe taking what you have today, tweaking it for their application. Why is that? So back to the speed topic. If we can reuse our capital and tooling and leverage our suppliers, that all goes towards lower-cost product.

Shifting to the Commercial Batteries business, your commercial vehicle battery business was up, I think, 35% last year. What's the midterm or longer-term growth potential for this business? And how do you think about the margin opportunity?

Yes. So it is true. Last year, we saw excellent growth in batteries, over 30%. And our teams, I have to say they executed that growth very well. They're performing at a very high level. This year, we see flattish from a unit perspective year-over-year to work through a little bit of the backlogs. We'll also have a little bit of a headwind on pricing. That's mainly due to sell pricing coming down. So although that impacts the short-term. Long term, we feel good about lower sale pricing because it makes these vehicles more affordable and the market will likely embrace them more quickly. We really like this battery business. You think about how far we've been able to take it, despite being flat this year, we're a little bit ahead of where we thought we would be when we bought AKASOL. We're the second largest independent player in commercial vehicle. We've got a couple of very, I would call them, our customers that we've had in our portfolio for nearly 30 years through the foundation side. So we're very bullish on the market. And just to give you maybe a proof point of where we think the market is headed, Europe, who has some of the most stringent carbon requirements by 2030, 90% of their bus fleets need to be BEV. So we're in a perfect position, I think, to capitalize on that front.

Can you talk a little bit about the competitive landscape in there? What are some of the moats that BorgWarner has?

Similar to some of our other businesses, a few of the moats. One is this customer intimacy. We've been working with these particular customers for a long period of time. We know there are expectations for launch. Some additional things specific to the batteries. If you think about a battery pack, it's a complete system. So they need somebody who can integrate the system both on a hardware and software side, which we have a lot of competence in. Another area is thermal management. So batteries like to operate at the temperature of a human being, no warmer, no cooler. And if you can do that and manage the thermal piece of it, you're going to get better range, faster charging, better longevity of the battery. So with our thermal competence, which we have in the company, I think, puts us in a strong position to deliver really high-quality battery pack.

With the industry shifting back to hybrids, is it fair to assume that BorgWarner benefits from off-the-shelf solutions, how does that impact margin?

Yes. So if you think about a hybrid, specifically on advanced hybrid, like a plug-in or a range extender, it pulls from both sides of our portfolio. So we're #1 or #2 on the foundation side. We've got a scaling business on the e-side. And the multiple per vehicle, the content per vehicle is a few multiples higher than just pure combustion. So it does put us in a great position. The products are really not that different. Maybe the inverter is a little bit smaller, but the guts of the inverter are more or less the same. A motor, maybe it doesn't have to be the same size as it is in a BEV, but you're using the same rotor, maybe it's a little bit short in housing, same winding technology, same magnets. So for all intents and purposes from our view, it's more of an adjustment of a particular product than all new products. So we feel we're in a good position to win with those advanced hybrids.

You've announced restructuring on both the foundation ICE side of the business, but also the EV side to keep contribution margins in the mid-teens. Can you walk us through the specific areas you're taking out costs?

So first, really proud of the team. The team around the globe has taken a lot of actions to take cost out of our business, both on the foundational side and the eProduct side of the portfolio. If you take a step back, the last restructuring we announced was in the summer last year related to our PowerDrive Systems business. We saw about $25 million of savings recognized in 2024 and we expect $20 million to $30 million as we move into 2025. That's implied in our guide. And when you think about our growth this year, a lot of it's going to be on the PowerDrive Systems business, and we expect that business to increment in the mid-teens, really leveraging the cost savings coming out of the restructuring actions that we've taken.

So what sort of costs are we talking about in terms of what you're taking out?

Both people cost and footprint-related costs.

And any specific focus in terms of geography?

A lot of the costs being in North America and Europe because of some of the turbulence in production related to battery electric vehicles, but it's a combination of things. It's not just 1 or 2 actions. We're looking at multiple actions, both people-focused and footprint focused.

And have you sized the spend for this and the payback?

Yes. So we said $75 million of costs. We expect, again, we realized $25 million of savings last year. We expect that to increase between $40 million and $60 million cumulatively as we go out to 2025 and ultimately $100 million savings as we go out to 2026.

And then shifting to capital allocation. The 2025 free cash flow outlook benefits from some pullback in CapEx spending. Can you talk to us about what the right level is for the business?

Sure. So when you look at capital expenditures, let's go back a couple of years. CapEx as a percentage of sales was right around 5.5%. We had a lot of investment going in for all of these launches occurring across the globe. As we ended this year, CapEx came in at about 4.8% of sales. When you look at our guide this year, we're around that same level. I think that's the right level of CapEx for our business. So we're really focused on utilizing our capital. Joe mentioned this, both on the foundational side, let's make sure we utilize that capital, make sure we're running it efficiently on the e-side of the business. If we have some excess capacity that's available, let's use that before we put new capital to work. That's what our business units are really focused on, that's what we're focused on.

So the new level is very much the right level?

I think so. Yes. Right in that high 4s, low 5s, that's where we want to be as a company.

And now you're at about 2x gross leverage with $2 billion in cash, another $2 billion on the revolver, and you're expecting $700 million of free cash flow this year. How should investors think about your priorities for this cash?

Sure. So like you mentioned, we have $2 billion of cash on our balance sheet at the end of the year. It's important to note that $350 million of that, we have a bond coming due right around the corner in March. So we got to hold cash to settle that at maturity. As we look into this year, Joe mentioned, we see a lot of interesting opportunities, organic opportunities, inorganic opportunities that we want to assess. Some high-quality options we want to look at, but we will certainly look at buybacks as an opportunity. If you go back a few years, Joe already mentioned this, $3.4 billion of capital returned to shareholders since 2020. $1 billion of that being buybacks. We just did $400 million last year. It's certainly a lever that we'll pull. We want to take a couple of quarters to assess. And ultimately, we want to make sure that with this cash, we're creating shareholder value, whether that's through inorganic opportunities, organic opportunities or buybacks. That's our focus.

There clearly seems to be some appetite for potential, I guess, for inorganic growth. Can you talk to us about the types of opportunities you're looking at?

So we won't get into specifics, but if you think about maybe how we are valuing particular assets. So first, it needs to make some strong industrial logic. So BorgWarner has a great portfolio. We have a lot of competence. And we're always looking how do we build on that competence. So that's the #1 priority is does it make industrial and technical sense? The second thing is we've tightened up, I would say, our aperture a little bit on how quickly we want these assets to become accretive. So that's an area of focus. I would say the third is, especially given all the turmoil, having a keen eye on how we value those assets. I think those are the 3 ingredients that are going to make us successful. And as Craig mentioned, we want to take a few quarters to evaluate, hey, what are some opportunities. Given all this turmoil, a company like BorgWarner with very strong financial balance sheet, great product portfolio, we expect quality assets out there.

And in terms of types of powertrain, is there any specific areas where you're focused for potential acquisitions?

What I would say is we're constantly looking at how do we continuously build on the confidence we have. There's lots of opportunities across the entire portfolio. I think we're seeing the world is unfolding differently depending on what part of the world you sit in. And I think this speaks to the strength of our portfolio. We're in such a better place than many of our competitors and even where we were just 5 years ago, we're ready to serve, whether they want more combustion products, hybrids or BEVs. Maybe one additional point. It's not specific to your question. But our decentralized operating model we think is also a differentiator for us. So you combine the portfolio, our ability to move fast and according to what our customers demand in a particular region and our financial discipline to us, that's going to be a great -- great recipe for success.

So you're not limiting yourself to the eProduct side. You could also potentially view yourself consolidator on the foundational side as well?

We're not limiting our outgrowth opportunities in any part of our portfolio. So we want to outgrow on both the foundational and the e-side. We're going to focus on organic and inorganic opportunities. So I think for us, we want to open up the aperture a little bit to what's possible and then action it accordingly over the next few quarters, next 2 years.

Great. That's great color. We have a few minutes to open it up if there's any questions in the room.

Maybe I'll repeat it for the rest of the room. So the question is on commercial vehicle. Do we think hydrogen is a viable option as a part of our road map? So we're working with customers who are investing in hydrogen. The way we view hydrogen is there may be a role for it, especially when you think about long-haul trucks, you really don't want to carry a ton of batteries around on some of those use cases. So they're looking at hydrogen as way to reduce the carbon footprint, but be able to reuse a lot of what they have in terms of diesel technology. So the way we've positioned our portfolio, that will benefit us by extending some of our combustion assets. We're making sure they're compatible with the hydrogen economy, if that comes to fruition. We're not investing, I would say, specifically into a hydrogen-only technology because we do think it will be a little bit more of a niche market than a broad scale part of the market.

Getting slowed down, eRFQ is getting slowed down. Are they being canceled? Do you get a new schedule when they're slowed down? Do you -- how do you think about how permanent that process is?

So maybe just to clarify, we're mainly speaking, outside of China, in the western markets. So you'll see a variety of things. You'll see the demand be lower than what they had projected. I think we're dealing with a little bit of that. Sometimes you see a pure cancellation. Ford made some announcements, I think, which didn't really affect us, that was more -- some of the work they were doing. And then you also see product plans pushed out a little bit. So instead of freshening a vehicle in 2026, maybe they do it 1 or 2 years later. So it's a combination of these things. I think the OEMs are also looking at what is the best way to invest in their business. And so they're using all the levers they can. It's important to note with our portfolio, we iterated this a few times, we're in a position where if they're delaying some of the e-programs, we're seeing the pickup on the F side. And remember, on the F side, we are #1 or #2 in nearly everything we do. So our customer diversity is very high. Our regional diversity is very high. So more times than not, we see an opportunity there if they delay some of that [ EV ] product.

I had a quick question on turbos. As we think about the Western world focusing more on hybrids, plug-in hybrids, EREVs, how does that affect the turbo business? I understand that some of these engines can still have turbos. Is the size of the content smaller than what the legacy ICE car might be replacing? Or how do you view kind of the foundational business in that context?

Yes. So we don't see a definitive pattern yet. There's a number of ways to architect a hybrid vehicle. Many with turbos, some without. Japanese are known, not that they have as many turbos. They have much more naturally aspirated engines. I would even say they're looking at the application of smaller turbos on hybrids. So I wouldn't say there's a definitive trend yet. I think we could have a variety of hybrid architectures. At the end of the day, they're focused on reducing emissions and improving fuel economy. So our portfolio, 85% of it is focused on doing just that. So they're going to look toward technologies like Turbo and EGR, timing systems to help support their objective.

Just one final one from me strategically. So it's been pretty striking over the last few weeks, how many suppliers are trying some pretty bold strategic moves. We've seen some companies announcing that they will split themselves. Some are selling noncore assets, others are merging with each other. It seems like there's a tremendous amount of pressure to unlock some shareholder value, including exploring strategic options that were not necessarily pursued before. When you look at BorgWarner's portfolio, are you happy with the various pieces that you have? Obviously, you spoke about the inorganic and organic opportunity to grow them, but does everything fit within the portfolio now?

I mean, I think if you look on a whole, we're very pleased with portfolio. And again, compared to just 6, 7 years ago, our portfolio is arguably one of the strongest in the powertrain space. We're constantly evaluating our products and how we can advance them, how we can build scale, how we can grow our margin profile. I'd say, overall, we're very pleased with the portfolio, and we want to keep building on the competencies we have. We see lots of opportunities, both organically, like we spoke about, to outgrow those markets. And also on the inorganic side, we think, as you mentioned, there's a lot of turmoil in the OE and Tier 1 space, and we think we're in a great position to maybe identify some high-quality assets outside of that.

Awesome. Joe, Craig and Pat, thank you so much for joining us and for your insights today. Thank you.

Our pleasure. Yes. Thank you.