February 13, 2015 BorgWarner Inc. Current Recommendation Prior Recommendation Underperform Date of Last Change 03/24/2013 Current Price (02/12/15) $61.38 Target Price $64.00 NEUTRAL (BWA-NYSE) SUMMARY BorgWarner posted a 5.1% decline in adjusted earnings to $0.75 per share in the fourth quarter of 2014, in line with the Zacks Consensus Estimate. Revenues improved 6% year over year to $1.99 billion, missing the Zacks Consensus Estimate of $2.01 billion. Net earnings for 2015 are expected to rise to $3.35 $3.55 per share. Net sales growth for 2015 is projected between 2% and 6%. Organic compound annual growth rate is expected to be 10% 12% for the 2014 2017 period. BorgWarner is poised to benefit from the restructuring of the Drivetrain segment. However, pricing pressure from OEMs and intensifying competition could affect the company s results. Thus, we are reiterating our Neutral recommendation on the stock. SUMMARY DATA 52-Week High $67.38 52-Week Low $50.24 One-Year Return (%) 8.66 Beta 1.68 Average Daily Volume (sh) 1,985,346 Shares Outstanding (mil) 227 Market Capitalization ($mil) $13,933 Short Interest Ratio (days) 2.60 Institutional Ownership (%) 93 Insider Ownership (%) 1 Annual Cash Dividend $0.52 Dividend Yield (%) 0.85 5-Yr. Historical Growth Rates Sales (%) 12.8 Earnings Per Share (%) 44.8 Dividend (%) N/A using TTM EPS 18.9 using 2015 Estimate 17.6 using 2016 Estimate 14.7 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Average, Type of Stock Large-Growth Industry Auto/Truck-Orig Zacks Industry Rank * 70 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 1,851 A 1,894 A 1,806 A 1,886 A 7,437 A 2014 2,084 A 2,197 A 2,032 A 1,992 A 8,305 A 2015 2,148 E 2,219 E 2,110 E 2,326 E 8,803 E 2016 9,837 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.65 A $0.75 A $0.70 A $0.79 A $2.89 A 2014 $0.83 A $0.89 A $0.79 A $0.75 A $3.25 A 2015 $0.86 E $0.93 E $0.84 E $0.86 E $3.49 E 2016 $4.18 E *Note: Quarterly EPS in 2014 do not add up to annual figure due to roundingoff. Projected EPS Growth - Next 5 Years % 16 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
RECENT NEWS BorgWarner s Q4 Earnings In Line with Estimates, Down Y/Y Feb 12, 2015 BorgWarner posted a 5.1% decrease in adjusted earnings to $0.75 per share in the fourth quarter of 2014 from $0.79 in the prior-year quarter. However, earnings per share were in line with the Zacks Consensus Estimate. Including the impact of non-comparable items, BorgWarner recorded earnings of $140 million or $0.61 per share in the fourth quarter of 2014, down from $141 million or $0.62 per share a year ago. Revenues improved 6% year over year to $1.99 billion but missed the Zacks Consensus Estimate of $2.01 billion. The sales improvement was driven by global adoption of the powertrain technology and benefits from the Wahler takeover. Excluding the impact of foreign currencies and the Wahler acquisition, revenues went up 7% year over year. Operating income increased to $212.2 million from $187.7 million in the fourth quarter of 2013. Adjusted operating income stood at $246 million, or 12.4% of net sales. 2014 Results BorgWarner recorded all-time high adjusted earnings of $3.25 per share in 2014, marginally missing the Zacks Consensus Estimate of $3.26. In comparison, the company had generated earnings of $2.89 per share in 2013. Net income (on a reported basis) amounted to $656 million or $2.86 per share, compared with $624 million or $2.70 per share in 2013. Revenues increased 12% to $8.31 billion from $7.44 billion in 2013, narrowly missing the Zacks Consensus Estimate of $8.32 billion. Excluding the impact of foreign currencies and the Wahler acquisition, revenues went up 8% year over year. Segment Details Revenues in the Engine segment rose 9.3% year over year to $1.38 billion. Excluding the impact of foreign currencies and synergies from the Wahler acquisition, net sales went up 9% in the segment, driven by higher sales of turbochargers. Adjusted earnings before interest, income taxes and non-controlling interest (adjusted EBIT) increased 9.7% to $228 million in the reported quarter from $208 million in the fourth quarter of 2013. Revenues in the Drivetrain segment fell 2.1% to $615 million. Excluding the impact of foreign currencies, net sales increased 2% year over year on increased global sales of dual-clutch transmission modules, partly offset by the slow ramp up of a major program by a North American customer. Adjusted EBIT declined 6.8% to $66 million from $71 million in the fourth quarter of 2013. Financial Position BorgWarner had $797.8 million in cash as of Dec 31, 2014, compared with $939.5 million as of Dec 31, 2013. Total debt, including notes payable, stood at $1.34 billion as of Dec 31, 2014, compared with $1.22 billion as of Dec 31, 2013. Equity Research BWA Page 2
In 2014, net cash from operating activities increased to $802 million from $719 million in the prior-year comparable period. Capital expenditures, including tooling outlays, went up to $563 million from $418 million in 2013. Business Update In Nov 2014, BorgWarner opened a new production plant in Viana do Castelo, Portugal to expand its production capacity. This will help the company in meeting the increasing demand for exhaust gas recirculation technologies and glow plug control modules for passenger cars and commercial vehicles. The new plant has 50% larger manufacturing space compared to the previous plant. Moreover, it has provisions for further expansion if required. Outlook Net sales growth for 2015 is projected to be in the range of 2% 6%, driven by the demand for BorgWarner s product technologies, which enhance fuel economy, emissions and performance. Excluding the impact of weak foreign currency, net sales for 2015 are forecasted to increase 9.5% 12%. Net earnings for 2015 are expected to rise to $3.35 $3.55 per share. Also, net earnings (excluding the impact of weak currencies) are predicted to be in the band of $3.60 $3.75 per share, excluding nonrecurring items. Operating income, as a percentage of net sales, is expected to be more than 13% in 2015 due to higher net sales and cost management efforts. Effective tax rate of BorgWarner should be about 29% this year. Further, the company expects free cash flow of $350 $400 million in 2015. VALUATION Currently, shares of BorgWarner are trading at 17.6x our 2015 EPS estimate of $3.49. The company s current trailing 12-month earnings multiple is 18.9, compared with the 17.2x average for the peer group and 19.0x for the S&P 500. Over the last five years, shares of BorgWarner have traded in a range of 13.1x to 93.7x trailing 12-month earnings. The stock is trading at a premium to the peer group, based on forward earnings estimates for 2015. The current, which is close to the lower end of the historical range, is at a 12.1% premium to the peer group for 2015. Our long-term Neutral recommendation on the stock indicates that it will perform in line with the overall market. Our target price of $64.00, which is 18.3x our 2015 EPS estimate, reflects this view. Equity Research BWA Page 3
Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low BorgWarner Inc. (BWA) 17.6 14.7 16.0 13.6 18.9 93.7 13.1 Industry Average 15.7 20.3 13.3 10.5 17.2 122.8 12.4 S&P 500 16.5 15.4 10.7 15.1 19.0 19.4 12.0 Tenneco Inc. (TEN) 11.5 10.0 12.9 7.9 12.1 112.0 8.8 Autoliv, Inc. (ALV) 17.6 15.4 9.2 12.8 19.0 48.0 7.0 Visteon Corp. (VC) 19.9 18.1 5.7 8.2 21.9 99.2 9.9 Federal-Mogul Holdings Corporation (FDML) 11.6 7.6 N/A 5.2 15.2 38.7 4.7 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA BorgWarner Inc. (BWA) 3.2 3.8 2.0 20.1 0.2 1.0 10.9 Industry Average 2.5 2.5 2.5 19.9 0.9 0.7 10.5 S&P 500 5.3 9.8 3.2 25.5 N/A 2.1 N/A Equity Research BWA Page 4
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. Equity Research BWA Page 5
OVERVIEW Michigan-based BorgWarner, Inc. (BWA) is a leading manufacturer of powertrain products for major automakers. Its products include four-wheel-drive and all-wheel-drive transfer cases (primarily for light trucks and sport utility vehicles or SUVs), as well as automatic transmission and timing chain systems. These products are produced and sold worldwide, primarily to original equipment manufacturers (OEMs) of passenger cars, SUVs, trucks and commercial transportation products. BorgWarner s largest customers include Volkswagen and Ford. The company s production and technical facilities are spread over 60 locations across 19 countries in North America, South America, Europe and Asia. BorgWarner operates in two segments: Engine segment (68% of sales in the first nine months of 2014): This segment develops and manufactures products to manage engines. Products include turbochargers, chains as well as emission and thermal systems. The segment also produces fluid pumps including engine hydraulic pumps for variable cam timing and engine lubrication. Drivetrain segment (32%): This segment engineers and manufactures components for automatic transmission and systems that combine such components. Products include friction plates, one-way clutches, transmission bands, torque converters, and lock-up clutches for automatic transmission. The segment also offers polymer fans for engine cooling systems and sells products to OEMs of commercial trucks, buses as well as agricultural and off-highway vehicles, primarily in North America, South America, Europe and Asia. REASONS TO BUY For 2014, BorgWarner s organic sales are expected to increase 11.5%. Further, the company expects net earnings (excluding non-comparable items) for the year in the band of $3.23 $3.28 per share, up from $2.89 in 2013. Operating margin for 2014 is expected to be up 13% over 2013. Net sales growth for 2015 is projected to be in the range of 2% to 6%. Excluding the impact of weak foreign currency, net sales for 2015 is forecasted to grow 9.5% 12%. Net earnings for 2015 are expected to rise to $3.35 $3.55. Also, net earnings (excluding the impact of weak currencies) are predicted to be in the band of $3.60 $3.75, a rise of 11% to 14% compared with its 2014 net earnings guidance, excluding non-recurring items. BorgWarner is poised to benefit from the acquisition of Gustav Wahler GmbH u. Co. KG and its general partner that was completed in Mar 2014. The buyout has fortified BorgWarner s position as a producer of complete exhaust gas recirculation (EGR) systems and enhanced market opportunities in passenger and commercial vehicle application. The takeover will help the company in developing advanced technologies. The EGR valves are highly in demand as they reduce NOx emissions and boost fuel efficiency in diesel and gasoline-direct injection (GDI) engines. The increasingly stringent emission regulations and the need for higher fuel economy are contributing to the rising demand for EGR technologies. The Wahler takeover has enabled BorgWarner to expand and strengthen its operations. Moreover, Wahler s thermostat technology, which ensures higher fuel efficiency and lower emissions by optimizing engine temperatures, supports BorgWarner's thermal management capabilities. BorgWarner expects to generate about $2.9 billion worth of new powertrain business in the 2014 2016 period. This is expected to drive growth of around 26% over the last three-year period in the Equity Research BWA Page 6
powertrain business. Net new business-related revenue is expected to be $850 $950 million in 2015 and $1 $1.2 billion in 2016 and 2017. As a result, organic compound annual growth rate is expected to be 10% 12% from 2014 through 2017. About 70% of the net new sales for the period 2014 2017 are expected to come from engine-related products, while the remaining 30% will be generated from drivetrain-related products. China (38%) and North America (25%) are expected to provide a large portion of growth. The company is also expanding its Powertrain Technical Center in Auburn Hills, MI. This will support BorgWarner s programs in North America and enhance the global technical center network. In addition, BorgWarner has restructured its Drivetrain segment, which has led to increased profits. The company believes that this will enhance the Drivetrain division's competitive position along with its business prospects. BorgWarner expects this restructuring to lead to adjusted EBIT margin improvement of 100 basis points in the Drivetrain segment. BorgWarner is poised to benefit from its expansion strategy. In Nov 2014, the company opened a new production plant in Portugal to expand its production capacity. In Sep 2014, the company opened a new production facility in Taicang, China, marking its second turbocharger plant in the nation. This plant will meet the growing demand in the expanding Chinese automotive market. The facility will manufacture advanced turbo charging technologies for several automakers. In Aug 2014, the company announced its plans to invest $9.4 million to expand the Dixon, IL, plant over the next three years. The company expects this expansion to support the optimal supply of environmentfriendly technologies, including exhaust gas recirculation coolers, tubes and thermostats. These technologies lower emissions and improve fuel efficiency of passenger cars and on- and off-road commercial diesel vehicles. Notably, the plant started operating over 50 years ago. Over this period, BorgWarner has increased the manufacturing capacity of the plant to meet market demand. This has helped the company attain a leading position in the EGR products market for both passenger and commercial diesel vehicles. REASONS TO SELL BorgWarner faces stiff competition in the areas of technological innovation, application engineering development, quality, price, delivery and product launches. Many of its competitors enjoy advantages such as lower labor costs, lesser health care expenses, lower tax rates and subsidies related to export and raw materials. Moreover, peers of BorgWarner are developing innovative technologies, which could affect demand for the company s products. The company faces intense pressure from OEMs to reduce price. Annual price reductions for OEM customers have become a common practice. The company continues to improve its production processes to increase efficiency. Also, it updates product designs to reduce costs and develops new products to improve profits. However, it is unable to pass on any increase in raw material costs to its OEM customers. Cost recovery is often less than 100% and usually on a delayed basis. This affects the company s profit margins. BorgWarner s sales are largely dependent on major customers like Volkswagen and Ford. The company s worldwide sales to Volkswagen and Ford had accounted for about 16% and 14%, respectively, of the total sales in 2013. Thus, a loss of any of these major clients can significantly impact the company s performance. Equity Research BWA Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of BWA. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1125 companies covered: Outperform - 15.9%, Neutral - 78.3%, Underperform 5.5%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research BWA Page 8