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 since the start of this decade, 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 certainly shifted much of the attention, economic and otherwise, to health concerns, but for the past few months COVID has clearly been overshadowed by the reality of inflation, rising interest rates, and the long-term impact – political, social, and economic – of Russia’s invasion of Ukraine and the Western world’s response. The market’s uncertainty and increased volatility since then 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 conditions can also lead to useful 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 provided the biggest lift to the company’s sales and earnings through 2021. 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. From a November 2021 at about $49, the stock moved back downward, settling into a trading range beginning in March of this year, with support sitting around $35 and resistance at around $39. Consolidation at the low end of a downward trend can be an early indication of a possible 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 $8.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by -13.22%, while revenues were -3.37% lower. In the last quarter, earnings were flat, but slightly negative at -0.94% while sales grew by 5.99%. The company’s margin profile is generally narrow; over the last twelve months Net Income as a percentage of Revenues was 4.57%, and improved to 5.16% in the last quarter.
Free Cash Flow: BWA’s free cash flow is generally healthy, at $458 million over the last year. That marks a decrease from about $650 million in the last quarter. The current number translates to a Free Cash Flow Yield of 5.27%.
Debt to Equity: BWA has a debt/equity ratio of .58. This is a very manageable number that suggests the company should have no trouble servicing their debt. Their balance sheet shows $1.8 billion in cash and liquid assets (versus $1.5 billion in the quarter prior) against about $4.22 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 1.87% 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 $47 per share. That means that at its current price, BWA is undervalued by about 32%.
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 2020 to its low at around $35 in March of this year. It also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock has been consolidating since that March low, with current support around the stock’s 52-week low at $35 and immediate resistance at around $39. A push above resistance at $39 could see near-term upside to about $42, based on pivot low activity seen in August, September and December of last year, with the 38.2% retracement line not far away at around $43. A drop below $35 could fall to about $31 before finding next support based on the distance between current support and immediate resistance.
Near-term Keys: BWA’s solid fundamental profile 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 $39 as a signal to buy the stock or work with call options, looking for a peak at around $42 as useful profit target on a bullish trade. A drop below $35 would be a useful sign to think about shorting the stock or buying put options, with $31 offering a practical profit target on a bearish trade.