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, but over the last week a lot of the commentary around the pandemic has started to fade as indications increase that the latest omicron-fueled wave is finally starting to abate. That has left room for discussions around interest rates, and more particularly the geopolitical arena to take center stage. Most of the news over the extended weekend, in fact centered around what is happening in Ukraine, and not if, but when Russia would follow up on reported troop buildups at the border. Tensions increased yesterday on reports Russian troops had moved into breakaway regions of eastern Ukraine held by pro-Russia groups. The mix of interest rates fears along with geopolitical tension and drama has spiked oil prices around the globe and sent the major market indices back into the correction territory that marked the end of 2021 and the first month of this year. 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 continued to struggle as sales remained tepid, even though some stocks in the industry 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 over the past couple of years, 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 for new vehicles as well as in the very attractive aftermarket, where auto components and parts are regularly needed for basic all type of 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 2021 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. From that point, the stock settled into a range that has tightened since the end of January, with support sitting around $42.50 and resistance at around $45. Consolidation at the low end of a downward trend is often a leading signal of a trend reversal; if that is true, it 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 $10.4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined a little more than -10%, while revenues were about -6.9% lower. In the last quarter, earnings increased by 32.5% while sales grew by 7%. The company’s margin profile is generally narrow; over the last twelve months Net Income as a percentage of Revenues was 3.62%, and declined slightly to 3.53% in the last quarter.
Free Cash Flow: BWA’s free cash flow is generally healthy, at $652 million over the last year. That marks an increase from $463 million in the last quarter, but is still below the and $725 million mark from a year ago. The current number translates to a Free Cash Flow Yield of 6.24%.
Debt to Equity: BWA has a debt/equity ratio of .59. This is a very manageable number that suggests the company should have no trouble servicing their debt. Their balance sheet shows $1.84 billion in cash and liquid assets (versus $1.5 billion in the quarter prior) against about $4.26 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 1.56% 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 $57 per share. That means that BWA is undervalued by about 31%. It is also worth noting that at the end of 2020, my price target for this stock was around $42, and about $53 in the quarter prior.
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 June to mid-September 2021. It also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock saw a fair amount of volatility after touching its 52-week low in September at around $40, peaking at around $48 in October and November, and rallying to about $50 in mid-January. Since then, the stock has settled into a tight consolidation range a few dollars above the yearly low, with current support sitting around $42.50 and immediate resistance around $45. The stock is currently dropping near to the low end of that range. A drop below $42.50 should test the stock’s 52-week low around $40, while a pivot off of support will simply extend the consolidation a little longer. The stock would need to push above $45 to signal any kind of useful, bullish reversal, with next resistance at around $46, and $48.50 possible if buying activity picks up.
Near-term Keys: BWA’s mostly strengthening fundamental profile – punctuated by improvements in Free Cash Flow and cash and liquid assets – 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 $45 as a signal to buy the stock or work with call options, looking for a peak at around $48.50 as useful profit target on a bullish trade. A drop below $42.40 would be a useful sign to think about shorting the stock or buying put options, with $40 offering a practical profit target on a bearish trade.