BorgWarner Inc. ($BWA)

Why don't we kick off the next session with BorgWarner. Today, we have the CEO, Joe Fadool and CFO, Craig Aaron, as well as Pat Nolan, Head of IR. Most of you probably know, BorgWarner is obviously an auto powertrain leader, both in ICE and EV. And it has been actually our top pick for quite a while now, mostly on my view of them proving out the EV story and e-powertrain story. However, recently, pretty well known now as you've made a pretty smart pivot into data centers, which is, I think, a pretty very compelling diversification opportunity. And I think it has generated quite a bit of excitement, obviously reflected in the stock year-to-date. It will probably be most of the focus of my questions today.

But -- maybe just sort of more maintenancey. Any color on -- I know you guys don't preannounce, but how is the quarter trending? We've seen S&P has cut numbers a bit. Does that sort of present a risk to you guys? Any thoughts there in terms of the quarter and the outlook?

Yes, sure. I can take that one. So when you look at our full year guide from an industry production perspective, we said flat to down 3%. S&P is coming in right around 2%. So we're right in the middle of the guide. We did reconfirm our February guidance in April, sales coming in right around $14.15 billion at the midpoint. When you look at Q1, Q1 came in at $3.53 billion. You sort of annualize that, you get pretty close to the midpoint of our guide. So we feel good about how we executed in Q1. Margins up 50 basis points, revenue, again, coming in at $3.5 billion. We feel like we're right on track to deliver our guide. So we're pretty pleased with the way the year has played out so far.

Okay. So obviously, a lot of excitement on the new products and data centers. You announced a win on the turbine generators on the Q4 call. And last call, you highlighted storage and the microgrid inverters. Can you talk a bit about how long have you been developing this product? It sounds like it's been several years. And how much overlap is there with your current auto tech in these products?

Sure. So thanks for having us, Colin. If we first start with the problem we're trying to solve, it's all around power availability. That's the problem. So these 3 products all addressing that issue. Starting with the power generation or turbine generator, we've been working on this with our partner, Endeavour over 3.5 years. But if you consider all the technologies and size, for decades. When you look at the inside of this, it's turbocharging, it's high-speed rotating machines, power electronics, software and controls. So we bring quite a bit of know-how and IP to the table here. And we're pretty pleased with this partnership we've had with Endeavour. When you think about the battery storage business, this is a business -- we actually started talking about this topic of nonautomotive for a couple of years now since 2023. But this is the window that we see the opportunity to move into the space more concretely. So we have been working to leverage the open capacity we have. We all know the CV market, which we position this business for has been much softer than we all anticipated. But these systems are designed for very high reliability and tough use cases on a commercial vehicle. So it makes them very suitable for stationary power. When we look at the microgrid, which is a little bit newer product to market, the basis of that is the convergence of 800 volts in data centers with automotive technology, which already operates at 800 volts. So that's the piece or the window that really gives us a chance to move into this space fairly quick. If you look at why are people moving to 800 volts, it's really driven by the NVIDIA chipsets. On the next generation, which requires the higher power, higher power density. And we're a market leader in inverters and have been shipping 800-volt systems for years. So for us, that gives us a right to win. When you cut across all 3 of these products, so power generation, storage and conversion, the one big common theme is the automotive scale and competitiveness. When I talk about automotive scale, you're talking about high volume with very high-quality requirements, very competitive space in automotive, and that cuts across all 3 of these, which allows us to sort of accelerate the disruption.

Can you talk about starting with the first, the turbine generator. I mean, what is the Endeavour relationship? What kind of products is that exclusive to? What can you do in that area beyond that partnership?

Yes. So with Endeavour, as I mentioned, we've been working with them for over 3.5 years. And the way you want to think about it is they're the front end of the relationship. So the customer-facing piece, their principals have been in the data center space for 25 years or more. They see the world similar to us, more efficient, lower emissions, so it was very easy to work with them. We're providing the guts of the system. So we're designing and developing more or less the content of the turbine generator, and this is where we're able to leverage all of our internal knowledge. The combination of the 2 of us makes complete sense. We want to be laser-focused going to market. They provide that customer relationship with many of the customers like the hyperscalers. And you've probably heard us on our calls, we've had visits at our Asheville location from some of the hyperscalers. That never would have happened without Endeavour. They're the ones that have those relationships. So each of us bring pretty strong contributions to the relationship, and we couldn't be more excited about it. Now with regard to the other 2 products, the battery storage, we can serve Endeavour, but we can serve the rest of the industrial and data center market independently. Same with microgrid inverters. We can sell them to Endeavour for their use case or we can sell to other players. So we're not in an exclusive relationship like we are with the turbine generator just to contrast the 3 product lines.

And with the turbine generator, though, is it a certain size generator and only data centers? Can you do any of that on your own or everything in that space is through the...

Not everything. So what we have an agreement on is what we call a 350-kilowatt system. And that's the one we're going to market first with and quite frankly, has a lot of interest and demand. So that's where we're putting all of our efforts. I mean we've developed smaller systems in the past. We have a 100-kilowatt system that we've worked with a different start-up on for a sort of waste-to-energy conversion. So we've been playing in this space for, I would say, 12 to 15 years in some form or another. But the exclusive relationship is with the 350-kilowatt system.

Okay. And then -- but you have -- you're bringing 2 gigawatts of capacity. So is that just a whole bunch of those systems together, Joe?

Right. So if you want to imagine, and this is in our investor deck, these 350-kilowatt systems, you can also put them in a single enclosure for a 1-megawatt system, okay? That is likely the first application, but may not be the only. And then as you need more capacity, you add more of these generator systems in place. One of the things we probably don't talk about enough is the flexibility of that. So when a hyperscaler designs and develops an AI farm, let's call it, they don't start with maximum capacity. You even hear today, some are building 2 gigawatt to 5 gigawatt data centers. Well, they don't start there. They start at maybe 0.5 gigawatt. And then over time, they add on, and that makes our system completely flexible for them. So they don't have to build a complete turbine power system that meets the whole needs at once. They can do it incrementally as they bring more capacity out.

Can you maybe talk about the competitive landscape? Who are the main competitors? And in terms of size, cost and efficiency, how does your products compare?

So there's really 2 use cases. One is primary power and the main competitor there are turbine companies. So you think of Siemens, GE Vernova, Mitsubishi. Now the advantages our system has to theirs is going to be lower emissions. It's designed for Tier 4 emission levels, a little bit less noise. I would say the big advantage right now is if you were to order a large turbine right now, you probably won't see it until 2030. Let alone find an EPC that's going to build it for you. So for us, we're installing that capacity. We know how to scale quickly. And we're going to make a decision later this year, do we add additional capacity given the demand and the backlog. So the other use case is backup generation. Backup generation usually is with diesel gensets, a little bit natural gas. These are guys like Cummins and Caterpillar are well-known players. Now how do we compare to them? So significantly lower emissions, which is becoming more and more talked about today for our system. The total operating cost, also much lower. Diesel fuel, pretty expensive compared to natural gas. So even -- let's just say this power to compute starts to subside and you don't have such demand, which has really given us the window to play right now. Let's say that gets back to more normal situation. We still have a very competitive product for the reasons I mentioned. So we think this business is very sustainable over time.

And your initial launch in 2027, that's primary? Or is it backup?

We believe it's going to be primary. I'm not sure we announced it yet. But when we started this journey 3.5 years ago, 80% of the applications were going to be backup and 20% primary. But with the acceleration of generative AI and companies like Anthropic and others, we think it's going to be just the opposite, 80% primary. So I think we're in a really strong position.

Those are more lucrative, I believe, right?

I'm sorry.

Primary is usually more lucrative. I think...

Yes, we haven't delineated between the 2 of them. I mean, for us, they're both great business cases. But let's just say if you're solving the primary need, you're in a lot stronger position because the utilities can't get there fast enough. Once you're there, you're building your brand and your knowledge of the site much more than you are as the backup. We're going to learn a lot more in that primary position. So yes, we're happy to serve both markets. But yes, it's more likely the primaries will be larger.

And on -- if we look at the BESS battery storage. Obviously, that was a pretty smart pivot. So any color on where did this tech come from? This was part of AKASOL, I believe, that was already in the capability set? And any color on the capacity that you have to pivot over to storage and the opportunity there?

So yes, we purchased AKASOL 3, 4 years ago, and the primary purpose was to serve this CV space and the e-bus space. And we installed quite a bit of capacity to serve that space. Unfortunately, those trucks and buses are more expensive than their equivalent diesel. So the market hasn't developed like we all expected. Given that, though, the technology is very fitting to these industrial and data center applications. So it's more how do we design the form factor different. We're cell agnostic. So we're not stuck to one cell type or chemistry. And then, of course, we're leveraging the open capacity. The name of the game right now is if you can provide generators, if you can provide stationary storage, people are moving you way up the list, okay? So they're willing to take more risk on a player like BorgWarner, which is unknown in the industrial space, but we're well known in the auto space. So that existing capacity, we haven't released a number on it, but let's say it's able to serve the next couple of years what we expect the demand to be. And if we see that demand is going to be even higher, we're happy to put more capital in, more investment in. But I would say we're able to leverage that pretty fast and be in production by next year.

Okay. So I thought in the past, you've capacitized to $1 billion and then you closed one of the facilities further.

Yes, we did announce we capacitized 6 gigawatt total storage between the 3 facilities, Darmstadt, Seneca and Hazel Park. We've since closed Hazel Park. So we have -- in total capacity, we have less than 6 now, but we haven't really given those numbers yet.

And when we think about transitioning from the EV to e-bus type packs to storage, they're pretty much the same technology, just one sitting flat and one is up and down.

Yes, I would say it's similar technology. There's not a lot of new invention going on. We're pushing these down the same production line. We're using the same end-of-line testers. We had to make some small investments to adapt to the new form factor and there's some software changes needed for stationary power. But in all essence, they're a very similar product.

And where are you looking to compete? Because I think there's some big players that are doing more grid-type applications. I assume you don't have that kind of capacity or plans. And what gives you sort of an edge in the areas that you're going to compete?

Right. So some of the big announcements from Ford or LG are more in the segment of those very large container storages, which support the grid directly. We're not playing in that space. We're more in the custom tailored solutions for particular use cases. So think about smaller form factors that are designed specifically for an application. And again, speed to market is important here. I think in Ford's announcement, they're not going to start shipping until 2028. So the need is now for some of those customers, we're able to fulfill that.

I mean any sense of how quickly, because you actually already have showed some customers on the storage side?

Yes. So we're actively quoting battery systems. We're doing everything needed to support a 2027 production launch. So not that far away. And I would say it's likely we're going to be successful.

I thought one -- I was talking about last week. The microgrid inverter, can you talk about the competitive landscape there? And any way to frame the sort of revenue opportunity from these systems? I guess it's sort of interesting with the 800-volt shift, the current product set, the current players in that space don't have -- or aren't used, currently supplying. So is that the big window for you to kind of get into that?

That is the window. As a technology company, you're always looking for the right time to jump into a market because there's incumbents that are very strong. We have a lot of respect for the current players. The shift to 800 volts is the moment. Why is that? First of all, these 800-volt systems are not just higher voltage, they're higher power in general. And we've been serving that market in automotive for quite some time. We're a top 3 player in inverters. So we understand the requirements there. We design and develop and produce our own power modules, which is the guts of the system. We do that in Singapore. So for us, this is the moment to move, and we're getting very good feedback from the 4 customers we have samples with. So I would say we would expect the next step would be to make sure this is UL certified and that we can support production again in 2027. So we feel we got a very good right to win in this space.

And how should we frame the revenue opportunity there? Because I think a car inverters is like $600, $700 per car or something like that.

Yes. Thank God, they're not at that pricing. But -- we haven't quantified. Automotive is a different space. You're talking about 1 or 2 inverters per car, highly competitive, and we're very successful in that space. So we haven't released any numbers for industrial. But if you think about the backdrop of data centers, they're growing in the mid-teens every year for the next 10 to 20 years. I mean, it'd be hard to believe we wouldn't see a significantly different landscape, especially using 800-volt technology and higher in the future. So pretty sizable TAM. Also outside of data centers, power conversion plays a big role anytime you're trying to adjust power from AC to DC or up and down the voltage level. Like in a data center, you're generating power at, let's say, 480, you need to move it up to 800, maybe even 1,500 DC. And then when you step it into the building, you got to step it down again to serve the individual racks. So there's tons of opportunity for inverters throughout that entire data center. And those -- that inverter technology is applicable to other industrial applications as well. If you think about oil and gas or power security, power gen applications, they all need inverters that operate at this higher voltage.

In terms of sort of sizing, like are you looking for a handful of wins here? Because it sounds like they'd be in the very large in terms of revenue for just one individual win because it's massive data center versus a car.

Yes. I wouldn't put a number on it. I would say we don't enter any market lightly. We want to make sure we have a right to win in the space. So based on our assessment, we continue to invest R&D into this area, and we're prepared to capacitize for that microgrid inverter that we've been talking a little bit about recently. But I think we have walk before we run. We want to make sure we get it right out of the gate. And that's why it's important to have samples with customers. We'll get important feedback from them, then we can fine-tune the application and make sure we go to market with something that's really different and of value to those customers.

And can you talk about the financial profile? I think you've talked about mid-teens type margins or converting at mid-teens businesses not really exist today. So is that a mid-teen EBIT margin overall that we're thinking about?

Yes. When we publicly discussed the power generation opportunity, we've shared $300 million in revenue in 2027, and we would expect that to convert in the mid-teens, consistent with our auto expectations. We're, of course, expecting some inefficiencies in that mid-teens conversion because it's our first year of launch. We're just ramping up. We're not at full capacity. So that's the expectation in the first year. And that's what would mean success for us as we look at power generation. As we get into battery and power conversion, the same discipline applies in our auto business. So we're looking for 15% ROIC or higher. And I think Joe and I feel pretty bullish that we'll meet or exceed that threshold as we look at those other opportunities.

And what about R&D and CapEx in these areas? Because it seems so far, it's extremely CapEx light, but how are you thinking about those headwinds going forward?

What I think is really impressive about our business, and I'll use power generation as a great example. We've been working on it for 3 years. That's what Joe mentioned. But when you look at TTT that's been doing all of this work, they've exceeded or expanded or at least maintained their margin while still investing in this technology. That's incredible work by that team. And we have the same expectations as we jump into battery and we jump into power conversion. We still think we can meet our mid-teens incremental conversion while still investing in these new technologies. So that's how I think you should think about it from a margin perspective. As we jump into the capital side, we did a phenomenal job last year really managing capital. We had a lot of eProducts capital in play. We need to make sure that we utilize that capital throughout the world. And that's why CapEx as a percentage of sales is only at 3%. As we step into this year, our guidance assumes about 4.5%, which is more in line with our historical range. And as we move forward, Joe and I think, hey, that 4.5% to 5% of sales range is likely where we're going to stay as we expand into these new opportunities. And we see that as a very achievable level of CapEx as we move forward to support all this growth that we expect to see in the near future.

How much -- if you were to add more capacity, I mean, how should people frame that in terms of the CapEx needed?

Yes. So when we think about power generation and this expansion, we publicly disclosed it cost us about $70-ish million to stand up this greenfield site in North Carolina. So that's probably a good baseline as we move forward. But again, I think as you think about -- as this revenue comes into our P&L and we're going to continue to expand, that 4.5% to 5% of sales range is probably a good modeling assumption as we move forward. That's the best way I think should think about it.

And I think what's important to note, in the automotive space, efficiency of capital is super important, of course. It's no different in this industrial space, but the demand is so high. We'd be happy to invest more capital because ROIC is super attractive. So people shouldn't think about us constrained too much on the capital side. If the demand is there for the products, we're going to invest because it's very attractive for us.

And don't forget, we're generating $1 billion of free cash flow. We have plenty of opportunity to invest if the business case makes sense. So I completely agree with Joe.

Got it. And maybe going back to the core business. You didn't change guidance last quarter. S&P has gotten a little bit worse. Raw mats are a bit worse. I mean, any puts and takes to kind of kept things sort of held in line?

Yes, it is really what I mentioned earlier. S&P has come in about 2% down for the year. It's right within our range, flat to down 3%. So market production is right in our assumptions for the guide. Q1, Q2 seem to be holding up pretty well from a revenue perspective. Really happy with how the team performed in the first quarter, 10.5% margin, up 50 basis points. It's a continuation of the great performance that we've seen over the last couple of years. As Joe and I sit here, I think we feel really good about our guide, and we're just going to continue to focus on Q2 and execute. So we feel good about where we're going for 2026.

Got it. I actually going back a second for the -- when would you decide to put more CapEx in place? Do you need the orders in hand for the turbine generator opportunity? Or would you do it just anticipating those orders? How are you thinking about that?

Yes. What we've said is second part of this year, we'll likely make a decision on whether we put more capacity in. So the criteria we're using for certain demand is part of it, but not only. If you think about bringing a new product to market, we want to make sure the quality is right, the first time through on the manufacturing side, our supplier readiness. So we're evaluating all those things. Hey, we want to come out strong and make sure the BorgWarner brand really shows well in our first big industrial play. So those are the criteria. Also, we're looking at where would we put that investment. Would we put that in Hendersonville or will we put it in Europe? We see demand on the data center side in Europe or would we put it in Southeast Asia. So that's also part of the decision so that we can balance the capacity and serve the customers in their markets.

Got it. Okay. Switching back -- going back to the core guidance. One question I have gotten hasn't been too much year-to-date, but Q1 organic growth was a bit weak. I mean even if you take out batteries, it was down 3%. How should we -- what sort of drove that sort of weaker growth? And how should we think about it playing through the rest of the year? Because you've historically been very solid grower over market.

Yes. So if you look at Q1 and you remove battery, we're basically right in line with market, which is right in line with our full year guide. So that's one data point. When you break it down by region, North America, we saw some strength. It was really coming from our DMS business from some transfer case growth in that market. On the European side, we did have a thermal program ending. So that was a bit of a headwind for us. And then in China, it was really timing of an eProduct program. So those were kind of the puts and takes. But I wouldn't over-index on any one quarter. When I take a big step back, $3.53 billion in revenue in the first quarter, you annualize that, we're right around $14.15 billion, which is in the middle of our guide. So it seems like we're right on track. That's, I think, the best way to look at it.

And how should we think about -- you mentioned sort of an organic growth. I think you've highlighted this year was a tougher year going into this year. The '27 still on track to be a strong recovery with some launches coming? Is that the right way to think about it that picks up on the core auto business next year?

Yes. So when you think about where have we been in the last couple of years, it's been -- we've been moving in this flat to 1% growth over market. And it's because we've had this EV overhang for the last several years. Obviously, there were a lot of expectations that EVs were going to grow, and we won our fair share of business, but those programs either didn't launch or they launched at much lower volume. And one of the things that Joe and I were really focused on as we took these roles was we're not happy with the outgrowth profile of our business, and we want to change it. And Joe set a tone of we want all of our business units to grow, find your growth opportunities. And that's led to a lot of energy in our company being released and 40-plus wins that we've announced over the last 5 quarters. And as we look into '27, '28, '29, we expect to see some of those programs into our P&L. And we see it as a step function. So we should see outgrowth in our auto business in '27, further outgrowth in '28 and further outgrowth in 2029. And so we're really excited to get to a place where we're seeing outgrowth and increasing revenue in our P&L because it's amazing what our company has done to expand margins and the earnings power of the company despite revenue being relatively flat. I think we're really excited to see what our company can do when we see that top line growing again in '27, '28, '29. It's going to be a really powerful story for us.

Got it. Any questions out there? I got a quick check in there. Raise your hand if you have any. I'll try to get you before we end.

Yes, one question on the backup power when you talk about [indiscernible] so coming up faster [indiscernible]?

So it matters to a certain extent. Our system comes up in about 45 seconds, which is a main requirement. Diesel gensets has come up a little bit faster than that. So we feel that where we're positioned with that 45 seconds is adequate for what the hyperscalers are asking for. Remember, they got -- they often have battery storage on site too. The trio effect here is primary power, backup power and battery storage to help smooth out transients and also interruptions to primary power.

Follow up on the comments made on the auto business returning to growth in '27, '28, '29 [indiscernible]. Just what's driving that [indiscernible] program specific launches or anything else?

Yes. I mean, as we had mentioned on the calls, the change we made to leverage the entire business for growth, not just electrification, resulted in the business units really working on and winning new business. And we've been trying to share many of those awards in the last 18 months. If you look in those awards, some of them are conquest businesses. So this whole idea of the strong get stronger in these -- especially the foundational businesses, we're starting to see it now in the wins. So those wins take 2 to 3 years to bring to production. So this year, we're still living with this EV slowdown in the Western world, but we'll start to see those programs launch next year and then pick up volumes in '28. So that's our thesis there.

Maybe to add just a little bit more. I love the profile. It's across region, it's across customer. It's across technology. When you think about where the world was 2 or 3 years ago, it was really focused on eProducts. Now it's across all different technology, all different customers. That gives us a lot of confidence that we're going to see this growth accelerating in '27, '28 and '29.

Color on maybe China. It seems like you're very strong position globally in your technologies. But what is the competitive landscape in China, particularly on the e-powertrain, where there's just a lot of emerging suppliers, at least in other segments that seem to be taking share. Is that -- are you seeing the emergence of pretty good competition out of the Chinese suppliers at this point?

So there are a few new players in China, but we're competing extremely well. A number of those wins that we've announced over the last 18 months have been in China. So why are we winning there? First, we've been there a long time, over 30 years. We have very close relationships. And especially when we think about the leading 6, they're the ones that are gaining the export market benefits. What do Chinese OEMs want? They want speed and they want competitive technology, and we have both of those. So we run shoulder to shoulder with them to get products into the market usually in the 12- to 18-month time frame after you kick off a program. So that's half the time of the Western OEM. So speed is super important. So as we see those Chinese OEMs exporting more, over 7 million vehicles last year, this year, it's likely going to be higher. We're on a lot of those product lines and a lot of those vehicles. We even get a little tailwind here and there, like in the 4-wheel drive business. because the take rates are higher in Europe than in China. So we feel real good about our position there. And the next step is they're going to have to localize, and we're going to be the likely partner of choice if we're supporting them in China. We already have factories, people, knowledge. We understand the local laws. We can move fast because we've already got existing assets and folks that can stand up localization for them in those markets. So that's our game plan for China so far. It's working quite well. And I think being nimble as they adjust is also important.

How about overall eProducts profitability? So you've shown really, really good growth. It seems like the competitive landscape seems like you're emerging as a leader. But when should we think -- what needs to get that to profit levels overall and then sort of in line with the rest of the business?

Yes. So if you go back a couple of years, we were investing heavily in that side of the business, and it made a lot of sense the world was moving to electrification, and we were supporting a lot of programs that we had won. But it was important as time went on that we rightsized that business to the level of revenue that we were seeing. And so we went through a restructuring that started in 2024. And one of the things that Joe and I were really watching last year, besides the growth, and we had phenomenal growth, 31% light vehicle eProduct growth was, are we converting that growth into income at the mid-teens. That's our expectation. And that would give us confidence that we got that restructuring -- and that's exactly what we saw last year, 31% growth, and we converted in the mid-teens. That's something that we need to continue to watch as we execute this year. We're expecting growth in light vehicle eProducts around 10%. And we've got to make sure that we can continue to convert that growth into income. If we do that, we got our restructuring right. But we also need to look at the regions. The regions are adopting electrification differently. You know that very well. So we need to make sure that we're continuing to adapt our cost structure to what's happening in the various regions, and I see our business units doing that.

Maybe to wrap it up, there's so much focus on data centers. How are you now thinking about M&A, which is a big -- seem to be a big -- historically has been a big focus of the company, doing smart deals. What are you looking at now? Are you looking more outside of auto? Or how should we think about what you're focused on in terms of M&A priorities and types of assets from here?

Yes. First of all, we're really pleased with the portfolio and the move back toward growth and growth above market, and we're getting good traction there. When we think about M&A, we've really raised the hurdles around M&A. We're in a different situation than we were 5 or 6 years ago. So we can be a little more selective. But we've opened the aperture. So we're not just looking at automotive, we're looking at nonautomotive, including industrial and data center spaces. The criteria we use is straightforward. It means to make industrial logic, leverage our core -- the second is near-term accretion is important. And then third, how we value it. We want to pay a fair price. So we are very active looking at targets. We've passed on a number of deals that didn't meet one or more of those criteria. But I feel Craig and I and the team will be as disciplined around M&A as we're being around the rest of the business, and you can see the benefits of that's yielding. So if we can't action something, we then return much of that cash back to shareholders and buybacks, dividends. In fact, the last 5 quarters, we've returned 70% of it back to shareholders in that form. So we're looking for balance and consistency in the capital allocation side.

Great. I guess we'll wrap it up there. Thank you very much for joining.

All right. Thank you.

Thank you.