There are any number of dynamics that come to play in the markets at any given time. That means that the ebb and flow of economic health on either a national or global scale can be tied to a lot of other societal elements.
Those varying elements include political and geopolitical shifts, social perceptions and changes, and as we have seen since the start of this decade, most certainly to national and global health concerns. The latter is a more extreme case, as the kind of health issues that tend to creep into discussions of economic health are usually once-in-a-century kind of occurrence. But then, prior to 2020, the last global pandemic came in the form of the Spanish Flu in 1918 – a little over a century ago.
Most of this year has been marked by uncertainty on multiple fronts – inflation, rising interest rates, war in Ukraine, and renewed trade tensions between the U.S. and China are all just a few examples. The market’s uncertainty and increased volatility since have forced the major market indices, and most stocks in the market down to their own respective bear market levels. That makes it tempting to start thinking about pulling your money out of the market and sitting on the sidelines until things start to simmer down.
This morning as I listened to some early market commentary, an analyst I’ve followed for some time was talking about how other analysts are pointing to a mostly mixed, to possibly even underwhelming earnings season as a reason to expect stocks to have limited to no upside in the near term. Many of these analysts are recommending staying out of the market, including pulling out of existing positions. This analyst, surprisingly took a contrarian view, saying that he saw the stark, overwhelmingly bearish view as a reason to start looking for good buying opportunities. As a value-oriented investor, I’ve learned to operate in a similar fashion; these kinds of conditions can often lead to useful opportunities to buy very good companies on a very selective basis at much more attractive prices.
The Auto industry has experienced quite a bit of bearish pressure for most of the past few years. Even before COVID-19 became a global health and economic crisis, sales were down globally, reflecting economic declines in various parts of the world as well as the effects of an extended trade war between the U.S. and China that held investor’s attention through most of 2018 and all of 2019. Just as the trade war seemed ready to fade away at the end of 2019, the global economy ground to a halt amid massive quarantine and shelter-in-place orders that closed down businesses and sent consumers home to limit the spread of coronavirus. For most of that year and 2021, the industry continued to struggle as sales remained tepid. The exception to those unimpressive sales results have come from the emerging electric vehicle segment, which has been getting more and more market buzz over the past couple of years, and where demand continues to be high. Public shifts from the most of the major automakers to shift combustion engine product to electric vehicles only validates the consumer trend even more.
BorgWarner Inc. (BWA) is an example of a U.S. company that provides parts and services to major auto manufacturers, and that made a big move at the beginning of 2020, however, the company announced it had entered into an agreement to acquire Delphi Technologies, a 1999 spinoff of GM that specializes in combustion systems, electrification products, and software and controls. The “electrification” side of that description was the primary motivation for the deal, since it gave BWA a solid foothold in hybrid and electronic vehicles. New electric vehicles sound sexy, but the biggest long-term opportunity in the EV segment for BWA comes from the generally under-appreciated aftermarket, where auto components and parts are regularly needed for basic vehicle maintenance of all types. I think that puts the company at an interesting intersection of future growth with established presence and strength. In fact, BWA’s 2021 reports indicate that this new segment provided the biggest lift to the company’s sales and earnings through that year.
The Delphi deal notwithstanding, another remarkable thing about BWA is that while the pandemic absolutely had an impact on the company, its earnings reports throughout the pandemic show that the company actually managed to absorb the initial blow better than most of its industry brethren. While the stock showed a fair amount of volatility in 2021, in 2022 it has experienced a significant downward trend, falling from a January peak at around $50 to find a low in July at around $32. Buyers have driven the stock to a recent peak at around $39 per share last month, with the stock temporarily fading at the start of September, but gapping up in the last two days to approach that same resistance level as of this writing. That looks like a strong, potential technical signal of a bullish trend reversal, which also begs the question of whether the stock’s current price also offers a useful value proposition to consider on a long-term basis. Let’s dive in.
Fundamental and Value Profile
BorgWarner Inc. is engaged in providing technology solutions for combustion, hybrid and electric vehicles. The Company’s segments include Engine and Drivetrain. The Engine segment’s products include turbochargers, timing devices and chains, emissions systems and thermal systems. The Engine segment develops and manufactures products for gasoline and diesel engines, and alternative powertrains. The Drivetrain segment’s products include transmission components and systems, all-wheel drive (AWD) torque transfer systems and rotating electrical devices. The Company’s products are manufactured and sold across the world, primarily to original equipment manufacturers (OEMs) of light vehicles (passenger cars, sport-utility vehicles (SUVs), vans and light trucks). The Company’s products are also sold to other OEMs of commercial vehicles (medium-duty trucks, heavy-duty trucks and buses) and off-highway vehicles (agricultural and construction machinery and marine applications. BWA has a current market cap of about $9.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by -2.78%, while revenue growth was flat, but positive at 0.03%. In the last quarter, earnings growth was also flat, at exactly 0% while sales slipped by -2.97%. The company’s margin profile is generally narrow; over the last twelve months Net Income as a percentage of Revenues was 4.36%, and improved to 5.75% in the last quarter.
Free Cash Flow: BWA’s free cash flow is generally healthy, at $392 million over the last year. That marks a decrease from about $458 million in the last quarter. The current number translates to a Free Cash Flow Yield of 4.29%.
Debt to Equity: BWA has a debt/equity ratio of .58. This is a very manageable number that suggests the company should have no trouble servicing their debt. Their balance sheet shows about $1.4 billion in cash and liquid assets (versus $1.5 billion in the quarter prior) against about $4.15 billion in long-term debt. The long-term debt number is made up mostly of debt assumed at the beginning of 2020 ahead of finalization of its Delphi acquisition.
Dividend: BWA’s annual divided is $.68 per share and translates to a yield of 1.76% at the stock’s current price. It is also noteworthy that BWA has maintained its dividend, where other companies in the industry that previously paid useful dividends have cut or suspended their dividend payouts to help weather the difficulties of the last two years.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. In the case of BWA, its integration of Delphi into its operations, and the foothold it provides in the hybrid and EV space also offers a reasonable argument to include growth estimates in this evaluation. Together, these measurements provide a long-term, fair value target around $49 per share. That means that at its current price, BWA is undervalued by about 24%.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from January of this year to its low in July at around $32. It also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock rallied strongly from that 52-week low to start August, topping at around $40 to mark immediate resistance just a little above the 38.2% retracement line, with current support expected at about $37 based pivot activity seen from March through May and including August of this year. A push above $40 could find next resistance at around $42 based on pivot low in December of last year and January of this year, or $43 where the 61.8% retracement line sits if buying activity increases. A drop below $37 should have next support at about $35, with the stock possibly revisiting its 52-week low at around $32 if selling activity picks up.
Near-term Keys: BWA’s generally solid fundamental profile is something that I think lends credence to think about this stock as a practical, value-based opportunity. If you prefer to work with short-term strategies, you could use a push above $40 as a signal to think about buying the stock or working with call options, looking for a peak between $42 and $43 as useful profit target on a bullish trade. A drop below $37 would be a useful sign to think about shorting the stock or buying put options, with $35 offering a practical profit target on a bearish trade, and $32 possible if bearish momentum accelerates.