Even before the coronavirus pandemic started to take down entire sectors of the economy beginning in February, the Auto industry was experiencing quite a bit of bearish pressure. Sales were down globally, reflecting economic slowing 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. The completion of Phase One trade deal in late 2019 seemed to give reason for optimism that a turnaround for the industry was just around the corner – until 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 COVID-19.
The Auto industry took its lumps from February to March like every other sector did, and rallied into the beginning of May off of bear market bottoms, fueled primarily on hopes that as economies began to reopen while still dealing with pandemic issues, consumer demand would increase. If you watch TV, you see just about every auto manufacturer offering big incentives to trade in your existing vehicle and buy a new one right now, so clearly the industry is making the same bet. Whether or not that plays out as hoped, of course, remains to be seen.
BorgWarner Inc. (BWA) is an example of a U.S. company that provides parts and services to major auto manufacturers. At the beginning of this year, the company also announced it had entered into an agreement to acquire Delphi Technologies, which gives the company exposure and opportunity into hybrid and electronic vehicles, where media buzz and many growth forecasts are the highest. BWA agreed to pay $3.3 billion for the deal, which is a big price, and depending on the analyst, could be an onerous premium to pay to gain entry into this segment. The stock began a strong downward trend in November of 2019, dropping from a peak at around $47 to a March low at around $17 per share. The remarkable thing about BWA is that while the pandemic has absolutely had an impact on the company, the last quarterly report shows that the company has so far actually managed to absorb the initial blow better than most. Even with the stock about 50% above that $17 low, and the industry’s prospects for growth in 2020 and 2021 pretty slim given overall recessionary conditions that may last longer than expected, BWA’s value proposition is compelling enough to consider the stock as as useful long-term opportunity.
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 $5.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased -23%, while revenues slid -11%. In the last quarter, earnings declined a little over -34% while the decrease in sales matched the yearly number at -11%. The company’s margin profile shows that Net Income as a percentage of Revenues are healthy, despite some deterioration in the last quarter; over the last twelve months this measurement was 7.34%, and 5.66% in the last quarter.
Free Cash Flow: BWA’s free cash flow is healthy and improving, at $750 million. This number does mark a decline from September of 2019, when Free Cash Flow was about $894 million; but it also increased from the quarter prior, when it was $527 million. This also translates to a useful Free Cash Flow Yield of 12.4%.
Debt to Equity: A has a debt/equity ratio of .34. This is a very manageable number, that suggests the company should have no trouble servicing their debt. Their balance sheet shows $901 million in cash and liquid assets against about $1.66 billion in long-term debt. Both of these numbers have also improved since the end of 2018.
Dividend: BWA’s annual divided is $.68 per share and translates to a yield of 2.58% at the stock’s current price.
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. Together, these measurements provide a long-term, fair value target around $48.50 per share. That means that BWA is undervalued by 84% from its current price around $26.34.
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 since November 2019, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. Since bottoming in Marching at around $17, BWA has staged a nice short-term upward trend, topping out a little above the 38.2% Fibonacci retracement line at around $28.50. The stock has dropped off of that level and appears to be building some bearish momentum. Immediate support is in the $25 range, with resistance at $28.50. A break above $28.50 could give the stock room to rally to a little above the 50% retracement line, where next support sits at about $33 per share. A drop below $26 means the stock should find its next support at around $24 based on a pivot low in mid-April, but with additional downside to about $21.50 very possible.
Near-term Keys: The stock’s current momentum appears to be shifting to the bearish side, which could be a signal that the short-term upward trend is breaking down. Even with the stock’s attractive value proposition, that raises the likelihood of increased volatility in the stock in the near-term. The best probabilities right now lie with short-term trading strategies. Use a drop below $26 as a signal to consider shorting the stock or working with put options, using $24 as an initial profit target and $21.50 if bearish momentum remains strong. If the stock can pick up new bullish momentum and push above $28.50, you could consider buying the stock or working with call options, using $33 as a useful bullish profit target. If you don’t mind the prospect of near-term volatility in the stock, and are waiting to work with a very long-term perspective on the Auto industry at large, BWA is a stock that has been holding up better than most of the rest, with an undeniable value proposition that might be too good to ignore.