There are any number of dynamics that come to play in the markets at any given time, which means that the ebb and flow of a nation’s economic health can be tied to a lot of other societal elements, including political and geopolitical shifts, social perceptions and changes, and as we have seen for almost two years now, 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.
The coronavirus pandemic has certainly shifted much of the attention, economic and otherwise, back to health concerns. No matter how exhausted we all are of the subject, it has felt like every time things could start to move back to some other, regular state of “normal,” a new wave of infections starts up. The emergence of new, highly contagious variants of the virus only seems to exacerbate and prolong the crisis. Breaking news at the end of last week of the latest variant, omicron, detected first in South Africa but quickly finding cases in Europe, sparked a big, after-Thanksgiving selloff in the stock market and has kept the bearish pressure on in the early part of this week. That might make it tempting to start thinking about pulling your money out of the market and sitting on the sidelines until things start to simmer down. As a value-oriented investor, however I tend to find these kinds of sharp, short-term moves can also act as opportunities to buy very good companies on a very selective basis at much more attractive prices.
The Auto industry has been experiencing 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 with a deal 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 has continued to struggle as sales remained tepid, even though stocks in the industry have generally performed well. The exception to those unimpressive sales results come from the emerging electric vehicle segment, which has been getting more and more market buzz throughout the past year and a half, and where demand continues to be high.
BorgWarner Inc. (BWA) is an example of a U.S. company that provides parts and services to major auto manufacturers, and that until a couple of years ago 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 a 1999 spinoff of GM that specializes in combustion systems, electrification products, and software and controls. The “electrification” side of that description is the key; after the deal closed in October of 2020, it gave BWA a solid foothold in hybrid and electronic vehicles, both on for new vehicles as well as in the very attractive aftermarket, where auto components and parts are regularly needed for basic vehicle maintenance. I think that puts the company at an interesting intersection of future growth with established presence and strength. In fact, BWA’s most recent reports indicate that this new segment has provided the biggest lift to the company’s sales and earnings over the past year. That fact provided a pretty rapid confirmation that the high price tag BWA paid for the acquisition (and that was initially criticized by many industry analysts) was simply the cost required to increase its opportunity.
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 2020, bear market low at around $17 per share. 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. The stock rallied from its March 2020, $17 low to a peak at around $55.50 at the end of May this year before dropping into a downward trend that found bottom in September at around $42. The stock picked up momentum, pushing to $48 in October, and again in mid-November to about $49. Last week’s omicron scare has pushed the stock sharply lower, moving to around $44 as of this writing. While the roughly -10% drop from that $49 high in a short period of time is alarming at first blush, it is also a good example of the kind of move that can open the door of opportunity a little wider for a cautious, value-focused investor.
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 $10.7 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined a little more than -9%, while revenues improved nearly 35%. In the last quarter, earnings declined by almost -26% while sales were about -9.1% lower. The company’s margin profile is generally narrow, but is showing signs of weakness; over the last twelve months Net Income as a percentage of Revenues was 5.07%, and eroded to 2.81% in the last quarter.
Free Cash Flow: BWA’s free cash flow is generally healthy, but faded in the last quarter, at $463 million over the last year. That marks a drop from $845 million in the last quarter and $723 million a year ago. The current number translates to a Free Cash Flow Yield of 4.32%.
Debt to Equity: BWA has a debt/equity ratio of .61. This is a very manageable number that suggests the company should have no trouble servicing their debt, even with the declines mentioned above. Their balance sheet shows $1.51 billion in cash and liquid assets against about $4.3 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 1.52% 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 pandemic.
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 $53 per share. That means that BWA is undervalued by about 18%. It is also worth noting that at the end of 2020, my price target for this stock was around $42.
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. It also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock’s downward trend found bottom at the beginning of August and started to reverse in September. The stock pushed to a high at around $48, inline with the 38.2% retracement line in October and pushed to about $49 a couple of weeks ago. After a short drop and rally back near that level late last week, the stock fell with the rest of the market on news of the omicron variant, with the stock now approaching expected support, near the 61.8% retracement line, and around $43.50. Immediate resistance should be at around $45, inline with the 50% retracement line and consistent with yesterday’s temporary, failed push to that level. A push above $45 should have immediate upside to about $48, while a drop below $43.50 should find next support at around $42; however if bearish momentum continues to strong, it could fall to the stock’s September low point at around $40.50.
Near-term Keys: BWA’s strengthening fundamental profile has weakened in the last quarter, which raises a red flag, but doesn’t disqualify the stock as a practical, value-based opportunity. If you prefer to work with short-term strategies, you could use a push above $45 as a signal to buy the stock or work with call options, looking for a peak at around $49 as an initial profit target on a bullish trade. A drop below $43.50 would be a useful sign to think about shorting the stock or buying put options, with $42 providing a first, quick-hit profit target, and $40.50 possible if bearish momentum increases.