BorgWarner Inc. – Strong prospects and attractively valued on multiple valuation indicators

Summary

  • Company expects growth in revenue to come mainly from global hybrid and electric vehicle parts
  • Company sees growing demand in China and Europe where emission standards are toughened
  • Stock trading at attractive valuations despite the good prospects

 

Prospects remain attractive

BorgWarner expects future growth to come from hybrids and electric vehicles and is well positioned for it. Over the past two years, it has broadened its product range across all product categories – combustion, electric and hybrid.

The compounded annual growth rate for electric vehicles and hybrids from 2016 to 2023 are expected to be 31% and 34% respectively according to market study “IHS Light Vehicle Forecast (May 2017).

Borgwarner Sales Breakdown

Source: Company presentation

 

Although auto parts for hybrids and electric vehicles account for only about 1% of revenue in 2016, the company expects the percentage to increase to 16% in 2023.

Company also sees growing demand in China and Europe where emission standards are toughened, spurring the demand for advanced emissions management technologies.

In China, for example, the government has proposed that 8% of all cars be either electric or hybrid by 2018. This percentage rises to 12% by 2020. In March this year, BorgWarner opened a new manufacturing facility in Ningbo, China to product products to meet this growing demand.

In Europe, there is the same push for reduced emissions, which augur well for BorgWarner’s advanced emission technologies. Large auto makers such as Volkswagen and Daimler have publicly committed to large-scale implementation of electric vehicles. German cities have been given authority to ban some diesel cars in order to tackle pollution.

Company also expects margin to continue to expand.

Borgwarner Operating Margins

Source: Company presentation

Notwithstanding its initiative to expand margins, the company is focused on being competitive in the long run through offering of state-of-the-art products. It has a policy of spending the same percentage of its revenue on R&D every year. That means, as revenue increases, the R&D budget increases to allow the company to keep competitive in its technologies.

 

Stock Valuation

Despite the favourable prospects, valuations are still attractive. We first look at valuation from the standpoint of popular indicators – Price to Earnings, Price to Sales, Price to Cash Flow, Price to Book and Dividend Yield.

Borgwarner PE Ratio

At the price of USD49.47 as at 01 Jun 2018, Borgwarner Inc is trading at a PE Ratio of 15.3 times last 12 months earnings.  This is a 16.5% discount to its historical average Price to Earnings Ratio of 18.3 times. (Price based on the historical average PE of the company is indicated by the red line.)

Borgwarner Price to Sales

At the price of USD49.47 as at 01 Jun 2018, Borgwarner Inc is trading at a Price to Sales Ratio of 1.0 times last 12 months sales.  This is at par to its historical average Price to Sales Ratio of 0.9 times.

Borgwarner Price to Cash Flow

At the price of USD49.47 as at 01 Jun 2018, Borgwarner Inc is trading at a Price to Cash Flow Ratio of 8.8 times last 12 months cash flow.  This is a 3% discount to its historical average Price to Cash Flow Ratio of 9.1 times.

While the above three indicators value a company based on what it is generating (i.e. profits, sales or cash flow), Price to Book ratio values a company based on what it owns (i.e. its net tangible assets).

Borgwarner Price to Book

At the price of USD49.47 as at 01 Jun 2018, Borgwarner Inc is trading at a Price to Book Ratio of 2.7 times current book value.  This is a 5% premium to its historical average Price to Book Ratio of 2.6 times.

Borgwarner Dividend Yield

At the price of USD49.47 as at 01 Jun 2018, BorgWarner Inc is trading at a Dividend Yield of 1.4%. This is a 28.6% discount to its historical average Dividend Yield of 1.1%.  (Note: The lower/higher the dividend yield, the more expensive/cheaper the stock is.)

Everybody has his favourite valuation indicator. Although most people would use Price to Earnings Ratio to value stocks, others believe that profits are open to manipulation and Price to Cash Flow is a better measure. Yet others rely on Price to Sales Ratio to value companies as this measure can be used even at times when the company is not profitable. Another way to value companies would be to value its assets and typically the Price to Book Ratio is used for that. Income investors who invest mainly for dividend income like to use the Dividend Yield to find companies that are undervalued.

We believe that each of these methods has its pros and cons. Furthermore, different types of stocks suit different valuation methods. Therefore, we reckon that the best way is to use all five indicators and let empirical data find us the best possible combination of these five indicators that explains the stock’s price. You can read more about our methodology here.

In addition, different indicators will give you different signals. Some may tell you it is overvalued while some tell you it is undervalued. This is no help to an investor who must make a definite decision whether to buy, hold or sell the stock.

Using a combination approach, we found a Composite Valuation Indicator that explains the stock price better than any of the standalone indicators above. And it gives you one signal to decide whether to buy, hold or sell the stock.

Borgwarner Composite Valuation Indicator

Based on the Composite Valuation Indicator, the stock has a Target Price of USD64.31. Our Target Price represents upside of 30.0% based on stock price of USD49.47 as at 01 Jun 2018.

We recommend that investors start to take profit after upside of 20%.

Other Considerations

Of course, in deciding whether or not a stock is attractive, it is more than determining its valuation. We need to consider other aspects of the stock such as growth, earnings quality, financial condition, operational excellence, cash flow, technicals, etc.

It is difficult to find a stock that is attractive valued and still pass every single criterion of the investor with flying colors. At times, we need to make certain trade-offs.

For a full quantitative analysis, you could refer to this report.

Conclusion

We believe that the current market weakness presents an excellent opportunity to buy into a stock that has good long-term potential. It is well tuned to new developments in the car industry and has positioned itself to benefit from growth in hybrids and electric cars.

The stock also looks attractive on a valuation basis and we use a thorough valuation methodology that combines five valuation indicators in an optimal way to best explain the stock price.

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