Even before the coronavirus pandemic started to take down entire sectors of the economy last year, 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 a 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 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 continues to draw market buzz and analyst attention.
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. The acquisition 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, may have been an onerous premium to pay to gain entry into this segment. 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 are the primary reasons 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 most recent earnings announcements, which suggest 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 last week at around $54. As of now the stock is a bit below that high, which for the purposes of my income generation system usually doesn’t attract me to the stock; however its improving fundamentals include a dramatically improving intrinsic value that could signal a much better valuation is in place than some of my traditional metrics suggest.
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 $12 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by more than 57%, while revenues improved nearly 76%. In the last quarter, earnings increased 2.54% while sales increased about 2.11%. The company’s margin profile has narrowed through most of the year, which isn’t surprising given broader industry trends right now. Over the last twelve months Net Income as a percentage of Revenues was 3.67%, and increased to 1.62% in the last quarter.
Free Cash Flow: BWA’s free cash flow is healthy, at $725 million over the last year. That marks an improvement from $573 million six months ago. 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 5.93%.
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 more than $1.75 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 1.36% 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 $50 per share. That means that BWA is fairly valued right now. 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 that is worth factoring into the discussion. Analytics that factor future growth projections, which would include the benefit of Delphi’s contribution put the stock’s long-term target price in the $62 price area – which improves the value proposition to a little over 24% from the stock’s current price.
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 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 just last week at a high point at around $54 per share, and which also marks immediate resistance. From that point the stock has begun to retrace, with current support expected between $50 and $50.50. A pivot and move higher off of support should see the stock retest the $54 peak, with additional upside to about $58 if bullish momentum increases. A drop below $50 should find next support at around $46.50, with additional downside to the 38.2% retracement line at around $44.50 if bearish momentum picks up.
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 – but the company’s narrowing operating profile is a warning sign that bears watching. If you prefer to work with short-term strategies, you could use a bounce off support at around $50 as a signal to buy the stock or work with call options, using $54 as a practical profit target on a bullish trade. A drop below $50, on the other hand could be a signal to consider shorting the stock or buying put options, using $46.50 as a good target on a bearish trade.