BorgWarner Inc. (BWA) Earnings Call Transcript & Summary

Thanks, everyone, for joining. My name is Rajat Gupta. I'm a member of the Automotive Equity Research team at JPMorgan. Very pleased to have with us the team from BorgWarner; Craig Aaron, Chief Financial Officer; and Patrick Nolan, Vice President of Investor Relations. So we'll just go right into Q&A. And thanks, Craig, for being here.

Thanks for having us.

So maybe like a little high-level question to start. BorgWarner, you spent the last couple of years expanding margins and earnings against a pretty flat and at times declining revenue backdrop, which is an unusual place for a supplier to be. Could you give us a sense of what's changed internally to make this possible? Whether investors should think of this as a company that's being rebuilt rather than one that has just simply managed a difficult cycle pretty well?

Yes. So I'd really point to going back a couple of years ago, I took over as CFO of the company and Joe was the Chief Operating Officer, and obviously, he's the CEO now. But we really sat down and said, "Hey, what do we want the company to look like? What do we want to do differently?" And we really decided on 3 things. The first one was, we wanted to ask all of our business units to grow. If you go back 3 or 4 years ago, it was really all about eProducts' growth, focused on hybridization and electrification. And that was really engaging only $2-ish million of the organization. We wanted to engage all $14 billion of revenue to grow. And we're really pleased with the progress that we've made. We've announced around 60 awards over the last 18 months or so. That's phenomenal. The quality of the awards are across our foundational business, our eProduct business. So we're really excited about that. That was priority #1. We want to make sure that we're moving towards growth over market. The second item was, grow the earnings power of the company. We need to focus on what we can control and growing the earnings power of the company is important internally, it's important externally. Let's make sure that we're growing profitably. And the third was, we want to have a really consistent, disciplined, balanced capital allocation approach that rewards shareholders. Let's make sure we're creating value with our cash. We focus on those 3 items that will be good for our employees. It will be good for our customers and for our shareholders. So those are the 3 items that we're really focused on.

Got it. No. Helpful. Just quickly moving to the quarter and some of the guidance items. Obviously, a pretty strong quarter across the board. Margins up meaningfully, every business unit contributing. Can you just talk us through the quarter briefly why the sales and margin guidance were left where they were? Obviously, you talked about the R&D spend pickup. But just given how the first half has tracked, like how much cushion should we think there is in the fresh guidance?

Yes. And I would say cushion, I think we have a really realistic guide for the full year, but I was really pleased with the quarter. The business units and corporate delivered in a really great way. Revenue came in about $3.6 billion. That was flat year-over-year, but we expanded margins 100 basis points year-over-year getting to 11.3%. Like you said, every business unit expanded margins in the quarter. Corporate provided a nice tailwind. So that was phenomenal. We grew earnings per share 17% year-over-year. part of it, operating income enhancement, the other increase coming from share repurchases. And then we delivered about $0.5 billion in free cash flow. From every KPI, it was a great quarter. As you walk first half to second half, we do expect revenue to be down about $200 million first half to second half. There's really 3 components there. It's foreign exchange is an $80 million headwind. Our battery business, we expect to decline about $60 million. And then we do expect industry production to be modestly lower, about 1%. But when you look at our margin profile first half to second half, and you exclude the step up in industrial R&D, our margins are right on top of each other. It was 10.9% in the first half, 10.8% in the second half. So that's why I believe it's realistic. But we are stepping up in R&D in the second half $10 million to $15 million. When you take a big step back, what is the company doing year-over-year in a relatively flat environment? We're expanding margins, we're expanding EPS and we're leaning forward into industrial R&D because of strong feedback we're getting from our customers in that space. To me, that's what success looks like.

Got it. And then just quickly, just a very early peak into '27. Obviously, we'll talk about the power products in a bit. But outside of the $300 million you've already communicated on the turbine system, any puts and takes around what's going to drive outgrowth in automotive, any regions or segments that might do more of the heavy lifting next year?

Yes. Well, really happy that we expect the contribution from turbine generating next year. Let me start there. But that's not the only driver of our improving growth as we look out to 2027. If you rewind back to 2024, we really do start to see a pickup in our order activity then. And that should start flowing through, right? We saw that in '24, picked up again in 2025 and has continued into this year, as Craig referenced. What's really exciting, though, is it's not 1 product, it's not 1 region, it's not even 1 customer group, it's a nice broad array of products, which means you should see the benefit versus -- our different business units have different markets that they serve, but their performance versus those markets should benefit from this award activity that we saw pick up about 3 years ago, and we're excited to see that come through because the past couple of years, we've been performing more or less in line with the market.

Got it. So there's not like 1 specific like driver? It's pretty diverse?

No. And that's really the positive takeaway here versus if you rewound back 4 years, it was all E, right? What's nice -- we love our eProducts, too, but it's nice to see a much broader base that if 1 program doesn't take off, there's a lot of others that can make up.

Got it. And maybe going just quickly on the margin side and the durability of that. You cost control has obviously done a lot of work in a flat environment for you guys. Could you give us a sense of how much of that is structural versus just running lean through like a tough phase? And what happens once volumes eventually come back and all these opportunities that you're seeing? And how do you maintain and keep growing margins?

Yes. So I would say it's all structural. So when you go back a couple of years ago, we won a lot of awards coming out of the Delphi acquisition. It was primarily on the eProducts side of the business. And because of all those awards, we heavily invested in R&D resources to support those programs. Those programs either didn't launch or launched at lower volume. So it was important for us to rightsize those businesses. So we restructured our PowerDrive Systems business. We restructured our battery energy storage business to get those cost structures in line with the current level of revenue. On top of that, the company has done a really phenomenal job focusing on what we can control as well, which is lower cost of poor quality, productivity in our plants, supply chain savings, those are all sustainable items, and we found success in those areas to ultimately expand margins year-over-year. So it's a combination of a lot of different factors.

Understood. Maybe just moving on to like the fun stuff, which I think everyone wants to hear about on the Turbine Generator System. Could you just walk us through like quickly for some who might still be new to the story how you got there? And what makes you believe that you have a right to win against companies who've probably been doing this for decades?

Well, I think starting with the technology and what we're leveraging there, if you look at our turbine generator, what is it leveraging within the BorgWarner competence? Well, it's leveraging our turbocharging technology, leveraging our rotating electric technology, our thermal technology, our electronics controls technology, right? So I think bringing our automotive scale across those different technology portions of the product is a big benefit that we have in this market. And we've spent the past close to 4 years now developing this product that we believe is going to be competitive versus traditional offerings. And I think what's going to bring our credibility to that market and allow us to be competitive is, from a performance standpoint, we're really confident in the technology that we have developed. But not only that, bringing the automotive scale, cost competitiveness, viewpoint of constantly improving the efficiency of the product, we think that really is going to be a competitive advantage in that market.

Got it. I know you're going to get this question asked like in a lot of your meetings, but I just -- I probably have to just throw it in there. Are you at a stage where you're getting close to sizing what the 2-gigawatt capacity might mean from a revenue standpoint? I know you've given us the multiples number on the earnings call, but any more breadcrumbs on that?

So what we're laser-focused on is launch. This successful launch will set us up for a multiyear cycle that we're going to be taking advantage of. This is the first inning, right? So we're focused on launch and successfully achieving that $300 million of revenue that we've set out for us in 2027. We'll give more updates as appropriate as we go along. But we're really excited with what we see from the demand side, and we need to continue to focus from our perspective, hitting the key KPIs of the different certifications, different testing, durability testing and getting into production.

Got it. You've said there's a capacity decision coming in the second half and that it may not necessarily serve the same market or sit in the same geography. Can you talk us through what you -- how you're weighing demand again, as you said, like, again, proving out quality and just a supply readiness first?

Well, I think it's both sides of the equation, right? I think we are continuing to receive indications of demand, not only in the near term, but on the mid- to long term, and I think that's important. But I think we have -- I mean, let's be clear, this is a new product for us in a new plant, for a new market. We want to make sure we ramp production in a very measured way and hit a lot of these key KPIs before we make that decision on capacity. And then what we see from end demand will dictate not only when we add capacity, but which region of the world does it make most sense is another consideration we have to look at as well.

Got it. And you've described Endeavour as owning the customer interface while you're providing the guts of the system. Could you walk us through how that has evolved? As you've just had more discussions and the businesses scaling or at least the testing is scaling, whether the division of labor changes as you build more and more direct credibility with the end customers?

So maybe I'll walk you through kind of the relationship and how it's evolved over a period of time. So the relationship started about 4 years ago. They came to us with certain intellectual property and they could see our turbo competence, and that started with a proof-of-concept and seeing if we could bring this type of product to market. So we worked through a proof-of-concept phase, made sure the attributes of the turbine generator was meeting the requirements that we had set out together. And then ultimately, we ended up signing a supply agreement late this year -- late last year, early this year, and that's what we announced in February. I would say the relationship is great because: one, they bring that customer interface, like you mentioned. They bring expertise in the data center market and BorgWarner stays true to our core competence, which is we are able to manufacture at scale. So I think that's the beauty of the relationship. They're bringing that customer interface, that data center knowledge, and what we're bringing is manufacturing capability at scale.

Understood. Just one last one, maybe on the system. The mix has flipped versus what you originally underwrote moving from the backup to primary power. Could you give us a sense of what that changes commercially, and how customers evaluate you? And just how durable that position becomes once you're on the site?

Yes, I won't go into the details of the contract and our pricing. But I think it's a strong indication of the durability of the product that we're able to pursue this primary power market. And I think that's where we're seeing pull from our customers. That's -- to give an indication, when we started down this road 3.5, 4 years ago, we would have said we skewed more towards backup power. But given where we're seeing the supply-demand dynamic in the market, definitely skewing a bit more towards primary.

Got it. I just want to pause there for like a second to see if there are any questions from the audience. We've got a couple. Go ahead. Yes.

[indiscernible] in your space maybe not have said yes, we'll add capacity because you're going to pay us and take long-term contracts. So how would you think about that?

Yes. I'd say we always look at business cases the same, whether you're talking about an automotive business case or an industrial business case, what's the goal. The goal is 15% ROIC or higher. So I'd start there. I'd also point to, we're generating a lot of free cash flow. So cash or capital is not a constraint for us. We want to create value with that cash. And if it's investing further in the industrial space, we have the capability to do it, and we'll certainly take advantage of it.

Jim, do you have a question?

Yes. Can you hear me okay?

Yes.

Good to see you guys. I wanted to just double check the competitive landscape on all the products that you have kind of geared towards electrification, not the traditional ICE product, which I think you've got a very clean line of sight on the competitive landscape, but on things like inverters, e-motors, things like that. Are you seeing anything on the business that you're winning? Because I know you've been very successful getting wins in China. But from the contract standpoint, the competitive landscape, are you seeing anything on that front that is deteriorating? Like some of the newcomers in the space and maybe getting, wow, it's amazing they're putting that price out or those terms. Anything on that front that gives you a little bit less visibility on that incremental margin regardless of where it comes from?

Yes. I'll start and maybe Pat can add. Our goal ultimately is we need to convert that extra revenue into income in the mid-teens. And yes, is pricing dynamics, are they a challenge whether you're in China or outside of China? Of course, that's always a major point of the conversation with any customer, but we need to find a way to make sure that we're turning that growth into income. And that just means we need to lean into other things if pricing is going to be a challenge. It means we have to lean into supply chain savings, and we've done that really successfully, continue to drive productivity. So we need to continue to work on our bill of material, our cost structure within the plants to make sure that we can ultimately deliver that income. I would say, as time has gone by, we see the same competitive dynamics and the same players in most of our quotes. So when you're going after an inverter award, it tends to be the same 3 or 4 players. In the past, if you were to take a step back 3, 4 years ago, I think the concern was that there was going to be 10 players in the market. That's not really what we're seeing. We're seeing kind of the same names over and over again. Any thing to add?