BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Okay. Let's go ahead and kick it off here. Good morning. Thanks for joining us. My name is Luke Junk. I cover vehicle tech and mobility for Baird. And my pleasure to introduce you today to BorgWarner, who, as you probably know, is the global -- a global leader in both legacy combustion technologies, like turbochargers and leader in eProducts as well. Really happy this morning to have with us Joe Fadool, CEO seated to my right, Craig Aaron, CFO of the company; and Pat Nolan from IR. All of them will be in the discussion today. Before that, let's just jump into Q&A. If you've got questions, you can send those to, I think this is session 3@ rwbaird.com. Joe, you stepped into the CEO chair, earlier this year, you've outlined some key priorities. Why don't we just walk through those to kind of set the table for the conversation this morning.

Sure. Great to be here. Our first priority, we kicked off this year is really driving financial performance of the company. We spent the last 5 years building a really strong portfolio. So we want to make sure that a lot of the business that we won, we're launching it well around globe doesn't matter if it's combustion or some of the new EV products. The second priority is really take advantage of the environment right now, which is to win a lot of the RFQs that are out there. So if we compare today versus a year ago, the amount of RFQ flow is significantly higher. We're winning our fair share of those new businesses and it's across the entire portfolio. So whether it's our strong turbocharger or EGR business, but also inverters, motors, complete drive systems, and then finally, it's -- as that growth comes, which we expect out in the '27, '28 time frame, converting on that growth and expanding the earnings power of the company. We want to do that as we bring in that new business, but also having a very balanced capital allocation approach. So returning shareholder value in the short term with a balanced buyback approach, but also it's a great opportunity for us to look at some inorganic investments, we're in a very unique position to do that.

Okay. Cool. Well, why don't we start the macro and I want to touch on what you just mentioned the workflow that you're seeing out there and capturing those awards. Can we maybe just double-click on what you're seeing sort of in the foundational side of the house versus e-products, advanced hybrids, especially and then maybe geographically, what you're seeing, the lift certainly seems like it's a after shock in a good way of kind of the confusion that had existed in the West that maybe is now freeing up incrementally.

Yes. So when you think about eProducts, the market where eProducts are playing out most strongly is China. We continue to grow and win there. We're very pleased with how our teams are performing. China also has quite a few combustion programs. So it's not all e. And our portfolio serves that market well. When you move west toward Europe, it's a balance of EVs, advanced hybrids, also some combustion extensions. So I would say, a little bit less EV focused in the short term, but we still see good growth there with our eProducts. When you move more toward this market, as we all know, EVs have more or less flattened out. So it's a great combustion business for us. So that's evidenced by some of our awards when we look at extension of turbocharger businesses or conquest wins, also on the EGR forward drive side. So if you just take all of that in total, we've announced in the last 6 months about 17 wins, which is just a sample of the wins across the globe, and it's across the entire portfolio. So we're excited. This move, which was unexpected, where the regions are moving at different speeds toward electrification actually, it plays well both into our portfolio, but also in our operating model. Our teams in China are able to run fast, chase that e-growth and similarly in Europe and here, we're able to serve the customers with what they're expecting.

Yes. Like you said, you've shown a lot of awards in your earnings reports so far this year, that's just a subset of the total awards. I mean, any way to think about the dollar impact, it's a question that we get. I mean it seems pretty material, but I don't know, just any context or guardrails you can put around that?

Yes. We don't really declare any particular award or the dollar impact. And in February, we'll give a more concrete guide for next year. If I step back for a minute, a lot of the wins on the EV side the last couple of years haven't come to fruition like we expected here in Europe. So we've seen a little bit lower outgrowth in '24 and this year, especially, that overhang is going to continue as we get into '26. But what I am excited about is a lot of the new business that I just referenced that we're winning will start to show up in '27 and beyond. So we expect that overhang to be with us a little bit longer before some of those new launches.

Maybe nearer term, certainly, supply chain as we came out of 3Q earnings, some just things bubbling up in terms of aluminum supply and chips, just real time, what are you seeing in the production backdrop.

Yes. So as we mentioned in our full year guide update, the North American truck maker in this market had a supply issue due to a fire. They're working through that. And we've included about $50 million to $100 million of impact into our updated guide. So they continue to work through that topic, and we're hopeful that they're able to recover a lot of those units next year. When you look at Nexperia, that was, I would say, an issue more concerning about 4 weeks ago. But as we're reading in the headlines, it's becoming really less material. We did include what we expected to be the impact in our guide, but a couple of points I think are important. Although it's disrupted us slightly here and there on some production, we have not shut down any customers, and we're working closely with them to ensure this becomes very little in terms of material.

If we look just at the production backdrop, it large, I would say, certainly, the theme of 2025 has been less bad just at a high level, how do you think about the production environment as we head into '26. Are you planning for growth? Or do you just have to control what you can control from an execution standpoint?

Yes. It's a little bit early to talk about '26, we'll do that in February. As I mentioned, we've got this overhang. We're working through on some of the e-announcements from a couple of years ago. With that said, we are focused on the things we can control. And I think that's playing out very well in 2025. Our teams are executing well. We're launching well. We've been able to upgrade the guide, we're expanding margins. We're increasing cash flow. So we're really pleased with the performance. You can expect more of the same in '26 .

Certainly, governmental policies have been impactful this year, I mean tariffs. Of course, top of mind that we've got the one big beautiful Bill. You've got maybe USMCA renegotiation in '26, interest rates like what's on your horizon, what maybe could be most important and maybe even some good news potentially on policy next year.

Well, we always hope for good news and policy, difficult to plan for. If we take us back to earlier in the year, tariffs became a big topic. As we've worked through that with our customers and our supply chain we found it to be a very manageable topic for us. So we expect that we'll put a lot of that behind us moving into next year. . I would say some of the other regulations like around emissions or fuel economy, especially in this market, it doesn't really play heavily one way or another in our portfolio. We've got a very resilient portfolio. If it does turn out, we're going to have more combustion vehicles due to the recent clarity on the road in the next 3, 4, 5 years, that's good for us. I mean we're #1 or 2 in each of those markets. So this doesn't really play a lot into our thinking. I would say we have to be ready for any change on the governmental side.

Craig, you also stepped into your role in the last 18 months or so. Similar to Joe's comments, maybe just any high-level priorities or sort of incremental priorities in your role as CFO.

Sure. Joe mentioned it, we're focused. I'm focused, but also the leadership team is. We're going to grow the earnings power of the company. And actually, that's what you've seen this year, really growing EPS from '25 -- from '24 to '25. And we're going to continue to do that as we move into 2026. How are we going to do that? Well, first starts with growth, what Joe mentioned, we're going to continue to outgrow our markets. We're going to turn that growth into income on an all-in basis, inclusive of R&D. We're going to drive strong free cash flow, and we're going to find a balanced capital allocation approach that allows us to invest organically, inorganically, but at the same time, reward shareholders, return cash to shareholders through dividends and buybacks. And I think we're doing all of those things really well this year, and we're going to continue to do that into '26 and '27.

Yes, Craig or Joe feel free to jump in here. Just 2025 in review, curious what has surprised you both good and bad. And if I look at it through just the lens of guidance and some of those priorities that that you just spoke to, Craig, midpoint operating margins have moved up in the guidance, about 30 bps year-to-date. That's despite tariffs, of course. Can you impact maybe some of the major drivers or areas of execution that have been most helpful this year.

Yes. I think every business unit and corporate is contributing to our overall goal, which is growing EPS. So when you look at our different businesses, our Turbo and Thermal Technologies business. They're expanding margins on relatively flat sales. They're focused on cost controls, same with drivetrain and Morris systems. So we're using levers like supply chain savings, productivity, restructuring savings, lower cost support quality, all to drive margin expansion with revenues being relatively flat. In our e-segments, Power Drive Systems, we're seeing really strong growth year-over-year, and we're planning on converting that growth in the mid-teens, and we're on track to do that this year, which is an important threshold for us, because we had to take important restructuring actions last year and how were we measuring success this year, convert in the mid-teens on an all-in basis, and we're on track to do that. And for our battery business that's having some headwinds from the top line, they're controlling what they can control, controlling costs, holding income relatively flat in the third quarter despite revenue being much lower through cost actions including restructuring. So I think the teams around the globe are doing the right things, and it's leading to a great result for BorgWarner. Like you said, revenue is relatively flat. We're expanding margins, 30 basis points. We're growing EPS. We're delivering $900 million in free cash flow, and we're returning that back to shareholders, and we're in a great position to execute an inorganic opportunity when it presents itself. So I feel really, really great about what we've done in this year.

What about just managing through tariffs in the nearer term and tariffs from just a timing standpoint have been a headwind. The last couple of quarters. I think you're expecting those to reverse into the fourth quarter. Can you just help us understand the mechanics driving them. .

Sure. So maybe just for the group, the key statistics as it relates to tariffs. So 1% of sales is our exposure. Right now, as we sit here today, we have agreements in place with our customers to cover about 80% of that exposure. The remaining 20% we're working on. As you think about the cadence of recovery, it's been a headwind for us Q1 through Q3. There's accounting rules in place. We have to go through an audit process. So we provide the input to our customers the exposure, they have to audit it. Once we get that positive audit outcome, we can recognize it in our P&L, and we expect that tariff recovery to flip positive in the fourth quarter. .

AI. It's obviously all the buzz in the markets these days, but I think there are some real opportunities to actually use AI tools. Are you -- I know it's probably not material at this point, but are you looking at those sorts of things for Borg?

We are using machine learning, GenAI. We started maybe about 18 months ago with some pilots across the operations and also some in R&D to see where the value is. And we've since autopilot is about 30% of them, maybe a little bit better, look really positive. They're mostly focused on quality improvement, cost reduction, if you think about a plant, we do a lot of visual inspection. We found great application to use it there and train the model quickly, reduce some of our labor costs. We're also finding on some of our back-office processes or in R&D. If you think about the very first step whenever you get a new program, you have to go through a big stack of requirements from the customer. So processing through that with GenAI techniques and an agent by your side you can really reduce the time and the amount of engineering workloads, so you can free those people up to work on some of the more value-added areas. So it's mainly been used in quality and cost reduction at this point.

Let's shift to China. Just be curious to get your thoughts to kick this off, just around moving at China speed. Certainly, the company has a strong position with local OEMs in China and just areas you can lean into incrementally either that you have this year or maybe areas of opportunity into next year on that front?

Sure. So for context for the group, about 20% of our sales are in China, and about 75% of that revenue is with the domestic OEMs. So a little bit overweight to the domestics, but we think that's a great position to be. We've been operating in China for over 30 years. So we have great customer intimacy there. We have business with all the leading Chinese OEMs. Why do they pick BorgWarner? Well, besides the customer intimacy, it's -- we're able to bring competitive technology to the market, which is really important. The second, which is almost as important as the speed. So when you hear China speed, think about they get to market about half the time that it takes a western OEM to get to market. And they want to pick partners that can run fast with them. So that's been a game changer, and that's due to our decentralized operating model. We spent the last 30 years building up very strong and competent teams in China. Now we're seeing some of the fruition of that as they move faster to get products into the market, so it's been a positive process for us.

We look at just your eProducts growth overall, is there a way to contextualize sort of how much of that is expected to come into China over the next few years versus just everything else globally?

Yes. Maybe a few data points to how. About 50% of our light vehicle e-product sales is in China. So that's where the music plays that sort of makes sense. If you think about the growth we saw from last year to this year, our light vehicle eProducts is up about 27%. So we're really pleased with that. So you can imagine where a lot of that growth is coming from. And if you look since 2021, we've been growing that business steadily year-over-year. I think a nice change. You've started to see is how we're incrementing on that business more toward a breakeven position. So China plays a big role in that.

Is working with local OEMs outside of China, something that's becoming more real. I mean certainly, we've seen some movement in Europe. If you look in South Asia, I think that's already something that that's happening, just what works perspective on that opportunity?

Yes, we're starting to work with them how to localize. If you look over the last couple of years, the Chinese OEMs have been really successful, not only in their market, but in export -- so last year, over 5 million vehicles exported. A lot of it with BorgWarner content. So we're really pleased with that. This year probably be a little bit higher than that. Now they're moving to the next step, okay, how can they localize and import less into the markets they're playing in. I found it interesting, I was in Munich 2 months ago for the IAA Conference and probably 15% or 20% of my meetings were with Chinese OEMs who are looking for help to localize. So we start to see them taking the steps. They want to be successful in the markets that they are gaining revenue. So that's a very positive sign in my view.

Maybe if we could just some out to eProducts. Overall, I think your current business mix is around 60% BEV and 40% advanced hybrid, correct me if that's wrong. Can you maybe just speak about the backlog? I think there's maybe a perception, especially if you live in the west of EV moderation, but especially that hybrid story seems to be one of the best stories in automotive. Can you talk about your leverage to hybrids, advanced hybrids, especially.

We don't really provide a backlog breakout like you're referring to. But I'll talk about how do we measure success for each of our businesses. And when you think about our foundational business, we measure success or outgrowth by outgrow your end markets and your end markets are the combustion for us, hybrid end market. That's the fine success for you. When you look at our e-product business units, it's the hybrid plus BEV markets, outgrow that end market. And so that's the goal for each of those different segments of our business. Joe spoke about the 17 awards that -- we spoke about externally over the last couple of quarters. And it's those awards that are happening on both sides of our portfolio, that's going to help us outgrow those end markets as we go into 2027 and beyond.

Is there -- would you see an advantage to owning both combustion and eProduct assets when you're going after those hybrid awards? .

I mean, certainly, there is -- if you think about the 3 major types of vehicles, you've got combustion, you've got advanced hybrids and you've got EVs. As we mentioned in the last 5 years, we've spent a lot of effort and resources to build the portfolio we have. So as the regions now play out a little bit differently in that mix of powertrains we're in a great position to serve the customers what they want. So in China, some of the RFQ flow has been more weighted toward NAV. So advanced hybrids, EVs. So that's why you see more wins in China, representing the NAV market. In Europe, it's a pretty good balance between advanced hybrids and E. And then in this market, it's likely, as we talked about, probably the next 3, 4, 5 years, EVs aren't going to really grow materially. So taking advantage of our strong position on the combustion side. So we think it's a great strength to have a portfolio we do. We can serve our customers from that portfolio regardless of the mix that they're looking for.

Craig, like you mentioned you've been incrementing at the mid-teens incremental in the business overall or higher. And in PDS specifically this year, I know you've got some tools in the toolkit in terms of Zebra plants and some flexibility that you're building in. Can we think of ways that can get to breakeven faster in PDS and maybe is looking at China may be part of the conversation, given that, that's half the company may be a little more mature business that maybe some clues to the future of PDS overall?

Sure. Yes. I mean for PDS, the clear avenue to breakeven and beyond is scale. And when you look at this year, we're having nice growth through the first 9 months over 20-plus percent growth. So it's really nice to see that. With that said, if you go back a year or so ago, we had announced a restructuring for PDS. We had won a lot of awards following the Delphi transaction, but the market didn't cooperate, and we had to rightsize that cost structure. So what Joe and I have been focused on this year is, hey, let's continue to grow in PDS, which is what we're seeing. But more importantly, we're going to increment in the mid-teens on an all-in basis and PDS is on track to do that. And that's how we're going to measure success. If we see that continue to convert on an all-in basis in the mid-teens, it means we have that cost structure right. If that's not happening, then we're going to have to revisit that cost structure. And so that's what we're watching this year, but we feel really good about the execution in that business through the first 9 months, and we expect to continue that in the fourth quarter. .

And China, I mean, the level of profitability better in China and not just curious if there's anything to read into getting that scale on what China tells us about it.

Yes. I mean our China business is pretty successful. We don't talk about profitability for any one region. But certainly, if you're going to increment in the mid-teens and China is the growth engine, you can kind of conclude that we're doing pretty well in China.

I want to talk about the foundational business. Maybe I don't know if I'd say this is more of a cultural question. Joe, you mentioned, obviously, over the past 5 years, the focus the company has been building the portfolio, now you're moving into leveraging the portfolio, just be curious from a foundational point of view, maybe to compare and contrast the overall mindset in the company now versus 2 to 3 years ago and recognizing that you actually, of course, spend a lot of time in the company's combustion businesses before becoming CEO.

Sure. No, we have a great combustion business. I mean, we're #1 or 2, if you think about turbochargers and exhaust gas management, forward drive. Our timing systems business. And if I take us back to 5 or 6 years ago, we were facing an existential threat to that business, which is why we made a lot of investments on the east side. Well, if you step back now, the world's changed. The growth opportunities aren't only in E. We see now great growth opportunities across the whole portfolio. So that was the change Craig and I made a little over a year ago to the strategy. We didn't want the foundational businesses to primarily be funding in E only. So leveraging growth across now all the BUs, I mean, it's been well received inside the company, as you can imagine. And you see us winning the programs, that's the exciting part. The amount of wins in the last 6 months, we've just shared 17 of them. That's what I'm really excited about.

What about just the -- Craig, you've talked to some of the successes in terms of margins this year and certainly the foundational businesses have played a really key role in that story. Just how do you think about opportunities for margin resilience and expansion from here be it, I don't know if restructuring is necessarily part of the conversation, operations and growth. And is there maybe opportunity to kind of stitch these 2 businesses together in terms of the Zebra plant concept or being similar to that.

Yes. I mean, first of all, really happy with the execution in those businesses. They've done extremely well, expanding margins or holding margins relatively flat, despite limited growth in those portfolios. But with that said, those businesses are using all types of levers, restructuring, productivity, supply chain savings, lower cost support quality, all of those things have been really important to expand margins in the foundational business -- and I don't see that stopping. We're going to continue to use those levers to continue to expand margins with the goal. Hey, we're growing EPS for BorgWarner and part of that equation is continuing to elevate our game on the foundational side of the business.

On the time we got left, I want to talk about M&A. So I think there was a single takeaway from Borg. It's that you want to grow the earnings of the company and the M&A is one of the levers that you're looking to use -- can we just talk at a high level about industrial logic and sort of maybe a hypothetical business that you could buy, given that we haven't seen an acquisition yet or maybe more importantly, I think people are just -- there's -- if you're the unknown, maybe what -- something that wouldn't be interesting to you or even that you've already passed on?

Yes. So we wouldn't comment on any particular target, but to give you maybe more depth on our industrial logic. How do we think about it? So it's about leveraging the core confidence the company has. So when you think about BorgWarner we've got extensive competence in rotating mechanics, high-speed rotating electrics, software, electronics, hardware, system engineering, tribology. So how do we leverage that to make an inorganic investment where 1 plus 1 can equal more than 2. So that's what we mean by industrial logic. For us, what's important is we're not trying to fill a gap. We're really pleased with the portfolio we have now, because of all the work we did the last 5 years. But we want to continue to strengthen the portfolio and expand the earnings, as you mentioned. So -- we've been very disciplined in the process. We're pretty strict to adhere to the criteria. But we have opened up the aperture. What is possible given the extensive confidence we have. So I'm really pleased with the discipline we're following, and it's true. We've passed up a couple of deals that didn't fit those criteria, but I'm really happy with the process.

Craig, how do you think about M&A just from a balance sheet standpoint, I'm thinking more valuation, returns? Like what are some of the key commitments that investors should think about from that point of view? .

Yes. I mean the first key commitment, which we've emphasized a couple of times is we're looking for inorganic investments to drive the earnings growth of the company. So we're going to make sure we're focused on that. When it comes to valuation, we have a very disciplined process. We're going to run a discounted cash flow model. We're going to look at a lot of different scenarios, as Joe mentioned. The regions are adopting electrification differently. We have to put that -- we have to put that intelligence into our DCF model, make sure we run a lot of different scenarios to make -- to ultimately make sure that we feel comfortable with the valuation and can articulate that value externally. So -- we're going to focus on that discipline. And when we have an organic investment, we're going to make sure it's very clear why we think we paid the right value for that asset.

Just in terms of scale, I guess another question that we've gotten is -- are these the sorts of acquisitions that you would press release? Or are these more likely to be tuck-in type things that are more [ gating ] in nature would you say?

I mean I would say we haven't taken anything off the table. So when you think about inorganic opportunities, there's larger ones where you create more synergy and value and expand the earnings power which we're heavily focused on. But of course, we're a technology company. So we're going to find some smaller players that are sort of tuck in, like you mentioned, that help us accelerate a gap that maybe we're looking to close organically, we can do it faster with a small technology acquisition. So we're opening up our aperture, but we want to have a strict, I would say, set of criteria for any decision if we go forward with an inorganic investment. .

Yes, Craig, you mentioned, obviously, the company is generating cash. Just how do you think about returning cash to shareholders if nothing comes to fruition on the M&A front? Or do you want to have a little dry powder for M&A?

Yes. I mean, first, we're operating from a position of strength. So we have a lot of liquidity on our balance sheet. Our leverage is very moderate. So we feel really good about the strength. When you think about opportunities that are in front of us, we're going to continue to focus on those accretive deals. And when you think about returning cash to shareholders, what everybody should understand is we're focused on discipline and consistency. And that's what you've seen in the last actually 2 years from us. Last year, we returned $0.5 billion of cash to shareholders. We're on track for $420 million plus this year of cash returned to shareholders. And BorgWarner can do it all. We don't have to focus on one or the other. We can return cash to shareholders through repurchases and dividends. And we're in a great position to execute inorganic investment when the right opportunity presents itself. So again, we're operating from a position of strength and we can do it all.

Okay. Well, we'll leave it there. Management will be available for a breakout in Salon A here in [ 12th ]. Thank you for the presentation.

Thank you.