As a value investor, the search for stocks trading at useful values gets more difficult the longer bullish conditions extend themselves.The market appears to have broken out of doldrums that had some people starting to wonder if all of the good news was already baked into stock prices. That’s generally good news for stocks you’re already holding, but it complicates the process when it comes to find new ones. That’s one of the reasons that under these kind of situations, I like to start looking through sectors or industries that most have been dismissing for one reason or another.
Even before COVID-19 became a global health crisis, 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. Just as that headwind seemed ready to fade away with a trade deal at the end fo 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. The news hasn’t really gotten better since then for the industry, even though stocks in the industry have generally performed well. Sales have generally remained tepid, with the possible exception of the emerging electric vehicle segment, which has been getting more and more market buzz throughout the past year.
BorgWarner Inc. (BWA) is an example of a U.S. company that provides parts and services to major auto manufacturers, and that until last year I wouldn’t have considered as having a significant role in the electric vehicle segment. At the beginning of 2020, however, the company announced it had entered into an agreement to acquire Delphi Technologies. The deal closed in October of last year, giving the company exposure and opportunity in hybrid and electronic vehicles, which I think puts the company at an interesting intersection of future growth with established presence and strength. BWA agreed to pay $3.3 billion for the deal, which is a big price, and depending on the analyst, could either be an onerous premium, or just the price they had to pay to gain entry into the next important source of industry. The acquisition also involved BWA taking on about $2.1 billion in new, long-term debt to finance the deal, which along with the high price paid is why some analysts suggest that while the deal was a good strategic, long-term fit, BWA paid too much. The flip side of that argument has come following the company’s latest earnings announcement, which suggests that deleveraging that debt is well under way and the company has already seen measurable benefits from adding Delphi’s business to its portfolio. That positive progress has some of those analysts changing their tune.
Even before that deal was announced, 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 Delphi deal notwithstanding, another remarkable thing about BWA is that while the pandemic has 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. The stock has rallied from its March 2020, $17 low to a a recent peak at around $45. It then surged to a new high at around $50 last month before dropping back again to around $42 late in the month. As of now, the stock is picking up bullish momentum again. Do the company’s fundamental strengths add up to useful value? I think so.
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 $11.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings were mostly flat, but positive by 0.85%, while revenues improved 53.42%. In the last quarter, earnings increased 34% (not a typo) while sales increased nearly 56%. The company’s margin profile had narrowed through most of the year, which isn’t surprising given broader industry trends right now, but has reversed that pattern and is now strengthening; over the last twelve months Net Income as a percentage of Revenues was 4.92%, and increased to 9.12% in the last quarter.
Free Cash Flow: BWA’s free cash flow is healthy and growing, at $739 million over the last year. That marks an improvement from $573 million in the quarter prior. It should also be noted, however that this number is just below the $750 million mark from the beginning of 2020. The current number translates to a Free Cash Flow Yield of 6.53%.
Debt to Equity: BWA has a debt/equity ratio of .56. This is a very manageable number that suggests the company should have no trouble servicing their debt. Their balance sheet shows $1.6 billion in cash and liquid assets against about $3.7 billion in long-term debt. The long-term 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 1.62% at the stock’s current price. It is also noteworthy that BWA has maintained its dividend in a year where other companies in the industry that previously paid useful dividends have cut or suspended their dividend payouts.
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 $52 per share. That means that BWA is undervalued by 11% from its current price around $46.50. It is also worth noting that at the end of 2020, my price target for this stock was around $42. I think it is also worth mentioning that my analysis depends on historical ratios as its primary reference point. As a general rule, I don’t like to factor forward-looking expectations on a stock’s value proposition, but I also think BWA’s acquisition of Delphi offers an interesting counterpoint. Analytics that factor future growth projections, which would include the benefit of Delphi’s contribution put the stock’s long-term target price around $60.50 price area – which improves the value proposition to a little over 29% from the stock’s current price.
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 upward trend over the past year, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. BWA has staged an impressive upward trend that peaked last month at a high point at around $50 per share. From that point the stock dropped back to support at around $42, picking up new bullish momentum in the last week. Immediate support should be at around $45 based on pivot highs seen in February, with resistance at $50. A drop below $45 should find next support at the last pivot low, around $42, with the stock’s current momentum giving it about $3 of near-term room to test its 52-week high at $50.
Near-term Keys: BWA’s strengthening fundamental profile includes a number of elements that I think make the stock’s valuation more attractive than my normal measures suggest. That’s pretty remarkable considering the state of the stock’s current upward trend. If you prefer to work with short-term strategies, you could the stock’s latest push above $45 as a signal to buy the stock or work with call options, using $50 as a practical profit target on a bullish trade. A drop below $45, on the other hand could be a signal to consider shorting the stock or buying put options, using $42 as a useful target on a bearish trade.