Can BorgWarner Turbo Boost your Portfolio?
James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With the structural issues in the Eurozone economy and the threat of an overall global slowdown, many cyclical companies have retreated significantly in anticipation of what seems like perennial concerns about global recession 2.0. Signs of a slowdown especially in Europe are real and have merit, so why invest in BorgWarner (NYSE: BWA)?
BorgWarner may fall within the category of a cyclical company as they are directly tied in to the success of global automobile market and thus correlated to the global economy. But if you dig deeper, you should see a technological innovator tied to long-term global trends toward better fuel efficiency and more powerful (but smaller) engines. It is rare to find a company that is part of a trend that serves regulatory concerns, macro-trends, industrial wants, and consumer needs. The stock trades at an attractive valuation, and while susceptible to near-term economic pressures, I believe BorgWarner has many years of market-beating growth ahead of it.
What BorgWarner Does
BorgWarner’s products are split in two main groups: engine and drivetrain technologies. The drivetrain group has benefited from the strong adoption of all wheel drive in different classes of vehicles, but the strongest growth is in the engine group (80% of projected net new business), with turbochargers representing the lion’s share. That said, it is the integration of engine timing, ignition, and boosting systems along with air/exhaust management and cooling systems that work in tandem to create smaller engines with better fuel efficiency, reduced emissions and improved performance.
Turbo chargers are most prevalent in light production vehicles but not limited to them. In fact, 10% of global sales are commercial. Of the top 25 customers in BorgWarner’s net new business in the last 3 years, 6 are commercial vehicle customers, including large agricultural machinery. They have a diversified customer base, including the top global market share holders, and are globally diversified, with projected 2012 sales of 26% from the Americas, 24% in Asia, and 50% from Europe.
Many smaller internal combustion engines of today (due in part to BWA) are more efficient than hybrid engines from just a few years ago. Electric cars have yet to make the leap to a mainstream alternative because of the expense, limited range due to battery capacity, and the consumer preference for powerful, snappy engines.
The Trifecta: Serving Regulators, Consumers, and Partners
The global trend in autos is for smaller turbo-charged engines that provide better emissions and fuel economy, but also increased power. Consumers want to spend less on gas (i.e., get better fuel efficiency), but not sacrifice power. Governments around the world are increasing emission standards to reduce pollution, but also because they realize that fuel will increasingly get more pricey and is a threat to growth in their respective economies. One of the best ways to curtail fuel consumption (and consequently price) is to increase efficiency. To that end, in 2011 President Obama formed an agreement with the world’s largest automakers to have autos from model years 2012-2016 achieve over 35 mpg, and 54.5 mpg by 2025.
Europe has historically increased fuel emission standards (currently requires automakers to reduce CO2 tailpipe emissions to 130 g/km by 2015), and European drivers not only want, but need better efficiency because of their particularly high fuel costs. While sales in May and June have shrunk considerably, especially in Southern Europe, the long-term trend toward more fuel efficient cars continues. While emerging markets do not have the same strict standards as the U.S. or Europe, China realizes the importance of fuel efficiency to their future growth, and represented BorgWarner’s fastest growing market in 2011.
In the U.S. automakers have rebounded from 2008-2009 with great success. GM (NYSE: GM) is now the leading brand in global sales with 40% pf revenues from international sources, including sales of many models that utilize BorgWarner Turbo chargers. GM had 16% (YOY) June auto sales growth where many top brands saw meaningful growth. Future growth bodes well in the U.S. where the average U.S. car is 11 years old, and 21% of cars on the road are 16 years or older.
The Valuation
BorgWarner had $7.1 billion in 2011 revenues, $4.45 per diluted share with an operating income margin of 11.2%. The first quarter year over year EPS growth rate was 28% with average EPS growth over the last 5 years of over 19% and a PEG Ratio of .73. BorgWarner has a P/E of 13.33 (TTW) and a forward P/E of 11.2-less than half of their eps growth rate.
Last summer the stock reached a high of $82.28 but ended the year at $63.74, an 11% decrease from the end of 2010. The stock surged again in early 2012 to $87.45 on May 16, but is now back to $63.54 (July 16 close). The stock decline does not reflect company performance, but rather nervousness about Europe, China, overall slowing in global growth and increased worries about a double dip recession.
On their year end conference call, BWA forecasted 6% growth in global production in 2012 (that includes a 4% decrease in European production and an 8% increase in China production). America has been the bright spot with light auto production growth of 9% in 2011 (over 2010) and significant growth in the first half of 2012. While the company forecasts modest global growth in global automotive sales, the company foresees sales growth in 2012 of 10-12% (14-16% excluding currency). Their first quarter performance supports their previous guidance, and reiterated full year guidance on the Q1 call. European auto production was down 4% in Q1, but BorgWarner sales in Europe (excluding currency and the Haldex Traction acquisition) were up 6%.
BorgWarner’s balance sheet is also strong. Approximately 5% of revenue is free cash flow, which should also be considered in light of the fact they earmark 4% sales annually for R&D, which accounts for a significant percentage of capital expenditures. They are continually innovating and have steadily increased their cash flow and that bodes well for protection against potential short-term risks.
Risks
The structural issues in Europe and slowing of the world economy could affect BorgWarner earnings in the short term. Ford (NYSE: F), a significant BorgWarner customer, recently noted that their European sales were down 10% in the first half of 2012, and they will make cuts in production. This was followed by cutting 440 jobs in Australia.
It is not only Ford. Many companies have suffered slowdowns in sales especially in the Southern European countries. Because 50% of BWA's revenues are from Europe, if sales continue to decline, and thus production, there will be an adverse effect.
That said, the long-term story remains intact. Advanced power train adoption will continue to increase as Europe remains on the forefront of innovation. Potential near term risks are not limited to Europe. In 2011, China took steps to slow their economy, which has influenced production including limiting new auto registrations and reducing government incentives. Even so, China remained BorgWarner’s fastest growing market and is forecast to continue that trend.
It is worth noting that BWA has a backlog of $2.5 billion of net new business over the next 2 years -- another record performance metric for the company. Interestingly, even with the current turmoil, 45% of the backlog is in Europe. 35% is in Asia due to its rapid growth, and acknowledgement of the need to be at the forefront of innovation. The remaining 20% is from the U.S. where there is a continued focus on improving fuel economy and lower emissions. Consider that global automotive production grew 3% in 2011 (over 2010) while BorgWarner sales grew 26%. The company itself has projected that even with an anticipated slowdown in European auto production and sales that they will have record gains in revenue because of their focus on fuel economy and lower emissions.
The Bottom Line
BorgWarner is not a short-term trade, it is an investment in a company that is at the forefront of innovation in a long-term trend supported by every major stakeholder, from regulators to consumers. Structural issues in Europe will continue for a long time especially with the short-term stop gap measures that have been adopted. Investments should be made in increments -- it never hurts to buy at better value points and remember it is a marathon not a sprint.
If you look under the hood of your car, you may find BorgWarner products, which may be getting you here and there a bit quicker with less money out of your pocket when you fill up, all the while helping the environment. If you have a long-term outlook it may help your finances as well. Fill her up!
James Fantaci owns shares of BorgWarner. The Motley Fool owns shares of BorgWarner and Ford. Motley Fool newsletter services recommend BorgWarner, Ford, and General Motors Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
