BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Great. Thanks. Okay. Great. Thank you for joining us as we continue day one of the Barclays Industrial Select Conference, the autos track. I'm Dan Levy, I lead autos and mobility coverage at Barclays. Very pleased to have with us BorgWarner. You've come to the conference many times in the past. Glad to have you back. So thank you so much.

Thank you.

Joe Fadool, the company's newly minted CEO, although a long-time veteran, CFO; and then Pat Nolan, who leads the IR as well. So we're going to go through a series of fireside chat questions. And we've reserved time at the end for any questions if anyone has.

So maybe I'll kick off, Joe. Maybe just big picture. You're new to the CEO role, but you're a 15-year veteran of BorgWarner. What are the priorities or the agenda as CEO? How is that similar to your predecessor? How may the agenda differ a little bit?

Yes. So I've been with the company 15 years, and BorgWarner, as you know, is renowned for our foundational products, whether it's turbochargers or 4-wheel drive systems, EGR and timing drive systems where we're #1 or #2 in each of those markets. About 10 years ago, we started, I would say, the journey more into electrification. We purchased Remy International, which brought us some great motor technology. And over the last 4 or 5 years, we've done a number of acquisitions to really accelerate our portfolio into the space of inverters, motors, drive modules, onboard chargers. So when I step back today, one could argue we have maybe one of the strongest powertrain portfolios out there. So I'm really pleased with the portfolio. It's very resilient. And in today's market where there is a lot of turmoil. And I would say where the regions are growing at different rates of hybrids and BEVs, we're in a great position to capitalize on that, whether it's in the combustion side or whether it's in the E side. So my focus is to really drive our growth across the entire portfolio, and we're going to do that by leveraging our core competence. The second is really to build on the strong portfolio we have and achieve that growth both organically and inorganically. And then finally, drive financial performance across the company, and we'll do that by expanding margins and strong cash flow.

Great. Okay. Let's start with the growth dynamics, which you just alluded to. And maybe we could just start with the setup on 2025. You've guided to sort of flat organic growth at the midpoint, it's roughly 2 points of growth over your underlying markets, it's below some of the levels you've had in the past. How should we think about the ultimate return to growth? What's going to drive this? And how does customer mix factor into the guide in 2025. How much of that is a drag on the overall growth?

Sure. So the last few years, we have had out growth in that 2% to 3%, including last year, about 2.8%. We expect this year to continue to outgrow. If you look at some of the outgrowth we've had, it's been on both sides of the house. So power drive systems, Morse timing systems and driveline have all really seen solid outgrowth. What you see in 2025? We're going to see really strong growth also in PDS. In the pass car side, we've won a lot of new business. And in fact, we've got about 30 launches between 2024 and 2025, just on our E products. So we're expecting solid growth into 2025. And again, we're focused on driving that outgrowth independent of where it can come from. And I think we're well organized as a company to do that. Now you mentioned customer diversity. Diversity is something we get asked less and less about it. It's really a core strength compared to many companies, especially when you look on our foundational business. We enjoy really having many, many customers. And that's -- why is that a strength? It's not only offsets some mix issues, but we have insights across our customer portfolio and what their cycle plans are. And our job is to drive convergence on technology, build scale. So from time to time or quarter-to-quarter, we might see some lumpiness, but we really have to look across the entire year to compare outgrowth. So despite some large OEM launches that have maybe not gone as well. I think last year is a good proxy, we still outgrew the market 2.8%. So we're going to stay focused on that for the coming years.

Okay. Another point on your growth in the context of maybe some of the broader macro conditions that we're seeing. Maybe you could just talk about if there is any volatility that's embedded in that growth outlook? And specifically, I would just refer to, I think we know in Europe, the big thing that's happening this year is the onset of stricter CO2 regulations, has the opportunity to potentially drive a lot of EV business or could create volatility. So how much has that been factored into the outlook?

Yes. So if you think about Europe, there's what they call the strategic dialogue right now and whether they're going to continue with the fines that have been regulated in 2025 or not, there's arguments on both sides. Some countries are pushing for the fines to be fully enforced. We believe, based on the information we have, probably the fines will come in a little bit softer. Our focus is really on helping these OEMs meet the regulatory requirements. So whether that's emissions, lower emissions or better fuel economy on the combustion side or of more affordable EVs. And of course, all these OEMs are working on the affordability side for the EV. So we feel, regardless of what happens, again, we've got a very resilient portfolio. We expect to thrive independent of what happens on those fines.

Okay. E-Drive, if we could just talk about the opportunity in Power Drive. Last year, it was roughly flat if we exclude the sunset of some of the ICE piece of that segment. Give us a flavor of when this can inflect, when this can match global EV growth? I think that you're talking about -- you're always looking for outgrowth in your portfolio. I think some of the implied comments of your assumptions get EV growth up 25% to 30% this year. Is this to say that sort of some of the core power drive business on the EV side or E product side can improve that much?

Yes. So let me take that one. When you look last year, you're right. Our foundational portfolio within Power Drive Systems was down as our customer program was ending. When you look at the E-product side of that portfolio, it was relatively flat. We're going to enjoy a number of launches that are going on across the globe, both in '24 and '25. We have about 30 E-product launches around the world and over half of those are in power drive systems, primarily in Europe and in China. So as those launches occur, we expect to see outgrowth. I won't comment on the 25% to 30%, we look at the industry production for BEV and hybrid vehicles, and we expect to outgrow that market. But really, the driver is going to be those 16-plus launches in PowerDrive Systems across the globe. That's what's going to drive our growth this year. So I encourage everybody in the audience to really watch our PowerDrive Systems segment as we report Q1 through Q4 this year.

And key products within that segment. I know there's a broad range. But in the past, I think we've always looked at sort of signature products to us, I would assume it's inverters, right? You've talked about a lot of really large inverter wins. How is it by the product? Is inverter still the dominant product here?

Yes. We have a very strong E-product portfolio, what Joe said. We've acquired all these companies to have what we believe is one of the best portfolios in the industry. And when you look at the E-product side of our portfolio, is inverters a key technology? Absolutely. It's about 1/3 of our total 30 launches happening this year. But we have other great products. We have high-voltage cooling heaters. We have battery systems. We have E-fans. We have iDMs. I mean, we have this great portfolio that's going to support our customers around the globe. So we're not just an inverter company. We're much more than that in those 30 programs around the globe, and we believe that will lead to strong outgrowth in our portfolio.

Okay. Another element of the E-product, Power Drive, I would say, dialogue debate was the question of vertical integration. There was a point in the past where everyone thought automakers were going to do everything themselves and then what BorgWarner be left with? I think we've seen clearly automakers changing course a bit. So where are we on this vertical -- the threat of vertical integration from automakers?

Yes. So vertical integration is something we get less and less questions about just to kind of put it in context, although there is vertical integration by some of the OEMs across the portfolio, the content per vehicle, opportunity for us is 4 or 5x higher than it is on combustion, which, from our view, this well overcomes this risk of in-sourcing. We don't see material changes one way or another. Why do OEMs come to BorgWarner? It's really for 2 reasons. It's we can develop and bring them technology at an affordable price. And the second is really what I started to mention earlier, our customer diversity allows us to bring scale that they otherwise may not be able to bring on their own and many of us know scale is very important when you talk about electronics and semiconductors and power modules, it's what really helps you develop that new technology and get it into market.

And then maybe just from a product standpoint, where you believe you have the most moat because in the past, I think there was a slide you gave that had some estimates of what mix was in-house versus what mix was going to be outsourced. Is inverters still the area where you think you have the most moat, let's call it.

Yes. I would say we enjoy a strong moat across a number of products, including inverters. Inverters were, of course, focused on growing market share there. and good customer diversity. So what do customers care about at the end, they want efficiency. They want low thermal emissions out of those products, which means they're much more efficient. This allows you a better range on the vehicle, it allows you to have better reliability of the vehicle. So inverters is just one of the areas another great extent Craig mentioned is high-voltage cooling heaters. This is a product that didn't even exist for us 6 or 7 years ago. And now we're a market leader in that space, and that's an organically developed product. So we're really excited because we have created, I would say, some great technology. And then finally, on the foundational side, we expect those moats to continue and maybe even expand because companies still need to invest. If you're a turbocharger company or an EGR company, you still are investing to achieve efficiency from one generation to the next. And we see some of the smaller companies, they may not be able to continue to invest and they may lose some of the scale they have. So for us, that's a great thing where we expect to grow some market share.

Okay. I'll get to foundational just 1 second before we do that battery. Maybe we can talk about some of the dynamics in battery. You've guided revenue to be down this year. Volumes flat. There's some dynamics on cell pricing. Maybe you can talk about the underlying dynamics in that commercial vehicle battery business? And when might growth eventually resume here?

Yes. So last year, we did see excellent growth, 30% or better, and we executed well on that growth. So I'm really proud of our team. This year, from a unit perspective, we're going to be flattish I would say we'll have a little bit of a headwind on the revenue side because cell pricing is coming down. So I'm really bullish on the battery business. If you think about the targets we set for ourselves when we bought AKASOL, we're slightly ahead of those targets today. We're also continuing to invest in established partnerships. Last year, we established a strategic partnership with FinDreams, which is a subsidiary of BYD to deliver LFP technology outside of China. So LFP is a very affordable cell base, it's 30% less expensive than NMC packs, which we're producing today. So we feel we're in a very good position. We're the second largest independent battery pack maker in the world. And maybe one additional proof point on batteries. A lot of these commercial vehicle batteries go into trucks and buses. And if you look at Europe, the bus market, 90% of the buses need to be electrified by 2030. So that's right around the corner. So for us, we see the market pull, we see the regulatory requirements there. So we expect good things out of that EV bus market, especially.

Okay. Great. Let's talk about foundational. And I want to start by asking one of the things we had seen is auto makers delaying new renewals of ICE business focusing on EVs. But obviously, with some of the changes of uptake curves, now we're hearing about some potential ICE extension. So is there an opportunity down the line for maybe some renewed ICE business where we could see an enhanced ICE powertrain content from you?

So if you think about outside of China, we definitely see an uptick in interest, even RFQs and our last quarter, we announced a number of wins across our foundational business. So transfer cases in North America and China, variable can timing in China, turbocharger extensions in this part of the world. So for us, we will expect to see more of this in the future as the regions play out differently on what powertrains will be available. These extensions or let's say, this additional business comes in a couple of forms. One could be just higher volumes. They start ordering more of what they have to support their own engine volumes. The second, our extensions, which is what we're talking about. Rarely would we expect a brand-new engine or new transmission. We think those are further in few between. But in the event that OEMs want to bring something to market, we're in a great position to support them with that.

And as far as the core sort of product, again, you have a wide range of foundational product. Are you seeing your moats there wide, meaning turbos, I think historically, you had, call it, like 25%, 30% share. Is that becoming a more dominant position for you?

Yes. I think the best way to view that is, since we are #1 or 2 you're going to see some of the weaker players, we believe, not able to invest in technology. If you think about it from an OEM standpoint, the reason they're going to EVs is for lower emissions and improve the overall economy of energy. If instead, they're going to shift back to hybrids, which by the way, pull from both sides of our portfolio, or pure combustion, they will often need better technology to meet the emission requirements. So you need to keep investing. So we think we're in a great position because we can continue to invest in those businesses as necessary. But also maintain scale in that business. So we expect the moat will stay or even widen.

Okay. And then just to marry the point on E-product and foundational. Hybrids, obviously, has been a big focus. In fact, I think we saw EV uptake globally, did really well last year, but a lot of that came from PHEVs. Maybe remind us again of your exposure on the hybrid side, be it on plug-in hybrids or non-plug-in hybrid and whether we're seeing an inflection there.

So what we call advanced hybrids are these plug-in hybrids or range extenders. The beautiful part of these is they pull from both sides of our portfolio. So they need combustion engine technology and technology you see on a pure EV. We feel we're very well positioned with this resilient portfolio. If you just drill down a little bit in China, for example, where they've enjoyed a lot of hybrid growth. We're well positioned with a number of the launches, Craig mentioned to see outgrowth across that hybrid space. So it all comes down to which customers are winning and not winning but from our standpoint, we want to drive outgrowth across the entire portfolio and hybrids is a great example how we can do that.

Okay. Great. Okay. Double-clicking on what you've mentioned before, Power Drive in China. You're heavily overweight on the domestic OEMs. Maybe you could just give us a little more color on customers or what products? And when do we start to see that position with the domestic OEMs who have been growing really well start to lead to more of a positive revenue inflection on your China business.

Yes. So it's really coming from those 30-plus launches that we spoke about earlier. And when you break that down, 10 of them are coming just in China this year. So it's going to be a really important year for our PowerDrive Systems business, but also all of our businesses where they're launching products in China throughout the globe. And what's beautiful about all of the customer diversity we have, especially in China, is we're working with all the major OEMs. So when you think about Great Wall or BYD or Chery, et cetera, we're working with all of them. So the important thing for us is to continue to support those customers as Joe mentioned, it's hard to predict the winners and the losers. What our objective is, is to support all of the domestic OEs, where we're having great success and make sure that they're successful in the market, if it's within China or eventually outside of China? That's our focus.

And the margins on the China business, how should we look at that relative to the rest of the world?

Yes. So when we quote business, it's always through a view of ROIC and what we are requiring internally is 15% ROIC or higher. That's how we quote business, whether that's in Europe, Americas or Asia. And that discipline is ingrained in the culture of our company. And you can look at any of our ROIC metrics externally. We enjoy, I think, a strong return on invested capital. When you think about our margin profile across regions, they're quite similar. And it all comes down to that ROIC discipline.

Okay. Let's talk about margins. And I want to just take a look back at 2024 first. Very interesting margin performance because you had revenue down slightly, but your earnings was up, [ call it $50 million or $100 million] revenue decline, margins up 50 basis points. So can you just unpack what we saw on the strong margin performance despite the revenue decline? And how does some of this carry over into 2025 as well?

Yes. So I'm really proud of the team, like you mentioned, hey, revenue wasn't our friend because production was down 3% year-over-year across the globe. And what did we focus on? We focused on cost controls across the business. So when you think about our savings from restructuring, supply chain savings, productivity, all key drivers that we had to pull to ultimately expand margins 50 basis points year-over-year. As we look into 2025, what are we doing on relatively flat sales at the midpoint of the guide, we're maintaining that 10.1% margin. So good performance in a flat market. If we get a little bit of tailwind from a revenue perspective because market production is only down 1%, then we expect to increment in the mid-teens. Again, really good performance at the top end of our guide. If you look at the low end of our guide, if the market is down 3%, that's going to be a decremental to us and what are we going to do? We're going to decrement about 10%. So again, when you look at any point of the guide it really speaks to strong performance, again, focusing on those cost drivers that I mentioned earlier.

And in 2024, we saw that margin performance really outstated in -- overstated in the foundational segments. So Turbo, thermal, drivetrain. Can you explain what's going on in those segments that's making that margin dynamic more pronounced?

Again, the same levers. When you look at the performance of those foundational businesses, they really benefited from the restructuring savings. We've executed a number of programs with short payback periods. You're seeing that come through the P&L. You're seeing our focus on supply chain savings and really leveraging that our supply base as well as productivity. I mean it's really those same key drivers that are supporting that margin expansion even with revenue coming down. So great work by the team around the globe.

Okay. Can we talk about the restructuring? Because you've done, I would say, a couple of layers of restructuring. There's been restructuring in Power Drive to get those margins to be on track. You've also taken restructuring in the foundational side. I think we know Europe is structurally overcapacity. This is the case for everyone. To what extent do you think that there's further action that's required? And do you think that your E-product footprint matches the maybe, let's call it, the new EV outlook that we're seeing as opposed to the more euphoric outlook that we saw from a couple of years ago.

Yes. So we continue to look at restructuring actions across the globe. There are -- there's a tremendous amount of focus on that as a company, making sure we get the right cost structure in place on both sides of our portfolio. Dan, you mentioned, we've taken a number of actions on the foundational side on the E-product side. Our latest announcement was on the Power Drive Systems business unit. We had won a number of programs following the Delphi acquisition. And we supported those programs with R&D resources. Well, obviously, the world changed on us and all of us know in the room that the E-world in Europe and in North America slowed down a little bit. We had to get that cost structure right. And so that's what our July announcement was all about. We saw about $25 million in incremental savings in PowerDrive Systems last year. We expect another $20 million to $30 million of savings this year, ultimately, $100 million of savings cumulatively as we look out to 2026. Why did we do that? Because that's going to be one of the growth drivers of the company. And our goal is to convert an all-in conversion of mid-teens, inclusive of R&D. So we had to get that cost structure right. So as that business grows, we convert in the mid-teens. And actually, when you look at our guidance, the growing part of our business next year is PowerDrive Systems, with all those launches we spoke about earlier. And what does the guide imply at the high end of the guidance, mid-teens. That's exactly what we want to see.

Okay. One last one on margins before. And then I do want to hit on a couple of the ARS questions and we'll wrap with one last one. Maybe you can talk about how you're looking at R&D on an absolute basis, but also how is the resource allocation between foundational and E-product how might that be shifting given we've seen some uptake curves on EV changing?

Yes. Maybe I can take that one. So we resegmented the business last year around midyear. And part of that recent segmentation was a fundamental change in the way we're running the business. And what I mean by that is all of our BUs are now being held to the same objectives. . As Joe has talked about, we want them to all outgrow their respective end markets. But more importantly, we want them to deliver an incremental margin in the mid-teens across every business, which means R&D versus a few years ago when we were talking about it then, Dan, we would say, well, we're going to increment the mid-teens, but then we're going to invest R&D, so that's going to dilute that down. Now we're seeing inclusive of that spending, whether or that's on the foundational side or the business units need to deliver that mid-teens conversion. So I guess we don't view it as how are we allocating resources between one side or the other. The benefit of our decentralized operating model is it allows the BUs to manage that as long as they're hitting that conversion target.

Great. Let's pull up the ARS questions. And I want to start with, if we could go to -- let's -- okay, fine. Do you currently own the stock? We'll do a couple of these lightning round. I hope you own the stock.

[indiscernible].

Everyone here on the stage own some [indiscernible] stock.

Absolutely. Absolutely.

Okay. Okay. Good. Second question, general bias towards the stock right now. And I think that part of this is we need to -- you can start the clock. In the context of the broader supplier universe, I would say there's broader macro pressures that all of you are managing. So I think this is maybe. Okay, positive. Through cycle EPS growth, if you go to question number 3. And I think this has always been BorgWarner in the past has been you can start the clock. Growth, but I think you're hitting on both levers on the margins and the growth, I assume that, that's still the focus for you. Okay. Okay. If we can go to question number 4, please. And question number 4 capital allocation. Okay. Well, while it's getting pulled up, maybe we can just -- a question on [ capital allocation]. Maybe share buybacks versus M&A. Your multiple is compressed. That is the case for all suppliers. How are you thinking about that M&A versus share buyback calculus right now?

Yes. So if we think about the overall allocation of capital over the last couple of years, we've used share buyback, I would say, quite well, especially in 2024 where we bought back $400 million of shares. And actually, since 2020, about $1 billion of shares. So we're very assertive on that side, using that as a tool I would say with regard to M&A, this is a tool we've always used and we will continue to use it. If you look at the industry turmoil right now, it's actually a very unique opportunity to evaluate potential targets. But when we do that, we're very thoughtful. So there's 3 things that really are important when we look at M&A. The first is -- is there a strong industrial logic to it? Does it leverage our core competence as a company? The second is really around how quickly can we make it accretive. We had to do some very challenging and, I would say, strong bets on to the E side in the last few years, sometimes taking assets that weren't always accretive quickly. Going forward, we see that these assets need to be accretive sooner than later. And the last is valuation. We don't want to overpay. And with also this turmoil in the industry, we need to run through a number of different scenarios to make sure we can achieve that. So those are the 3 things we're looking at. But we're going to use both share buyback and M&A as a way to drive overall shareholder growth.

Okay. Great. I think we're out of time. Joe, Craig, Pat, thank you so much.

Thank you.

All right. Thank you.