Guru John Rogers (Trades, Portfolio) of Ariel Investment LLC recently bought BorgWarner Inc. (BWA, Financial) at an average price of $33.77. With a 52-week range from $61.11 to $27.68, the stock recently closed at $33.66.
Is this company worth considering at these levels? Or is this a classic value trap on its way down even farther?
Based on its own historical valuations, it seems BorgWarner is worth further study for those interested in adding this sector to their investment portfolio. But first several key questions need to be answered: 1) Why the sell-off this year? 2) What is the company doing to address challenges? 3) What do company fundamentals suggest? 4) What is the relationship between the current market price and the company’s value?
A Quick Company Summary
BorgWarner Inc. is a supplier of highly engineered components and systems for automotive powertrain applications. Products are sold to original equipment manufacturers and include four-wheel and all-wheel drive transfer cases, manual and automatic transmissions, clutches and torque converters. At a market cap of $7.6 billion, this large-cap company employs around 30,000.
Why Has BWA Sold Off So Sharply This Year?
First, the company has performed below investor expectations for earnings, and guidance is cautious going forward. Second, the company has seen a sharp contraction in its backlog and its content share growth. Last, investors seem to be concerned that BWA puts too much emphasis toward internal combustion engines when the real growth will come from hybrids and electric vehicles.
Company Counter-Measures to Address Challenges
The company has a number of initiatives under way to address weak global production growth. First, BWA has a developed a new transmission to serve the emerging high-volume electric vehicle market. Second, management continues to highlight assumed increased adoption rates for automatic transmissions in Europe and Asia.
Company Fundamentals
To get a sense of BWA’s performance over a longer-term period, this review focuses on the 10-year period from 2006-2015. This allows us to get a sense of the company’s performance over multiple cycles.
Revenue Per Share
It is helpful conduct a top-line review to see the trend in revenue per share over a 10-year period. This is where a F.A.S.T.Graphs subscription saves time and portrays data graphically to assist interpretation.
In this case, it appears BWA has done a solid job growing revenue per share over longer-term periods, particularly since the Great Recession of 2008.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
Operating Earnings Per Share
It is really no surprise that BWA earnings suffered during the Great Recession and the company has some cyclicality. Have a look at the graphic below. Of note here is the improvement in operating earnings in the post-recession period. And while management remains cautious with forward guidance, based on past performance it is reasonable to conclude that current earnings estimates are reasonable going forward.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
Another Way to Look at Operating Earnings
To add additional insight, F.A.S.T. Graphs has a valuable feature where a person can create a line graph of historical operating earnings. In this case, those earnings are shown at BWA’s own normal P/E ratio of 16.8x (blue line) as well as a constant 15x earnings (orange line).
Please note no market prices are included below. The reason for including this graph right now is to demonstrate the earnings growth trend not only from a per-share perspective but also from a potential valuation perspective using BWA’s own normal P/E and an assumed 15x P/E.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
Is BWA Fairly Priced at Current Levels?
To determine whether a company is fairly valued, overvalued or undervalued, it is reasonable to review that company’s own historical valuation.
Here again F.A.S.T. Graphs provides valuable insight both with data and a user-friendly graphic. Recall above we reviewed historical earnings per share at a valuation at BWA’s 16.2x earnings and an assumed 15x earnings (orange line). Now let’s add the market price line. The valuable part of this summary is that we can visually assess periods where the market price (black line) is at fair valuation, above valuation and below valuation.
Note that the current P/E is 10.8x earnings and the normal P/E for BWA is 16.2x.
Historical Graph - Copyright 2016, F.A.S.T. Graphs - All Rights Reserved
In other words, at current levels is is reasonable to believe BWA is undervalued and worthy of additional study.
What Might Be a Reasonable Price Target?
If we apply the normal 16.2x multiple to estimated earnings of $3.26, this suggests a target price of $52 over the next 18-24 months.
Risks to This Thesis
It is important to note that while the company plans to achieve double-digit top-line growth and earnings, those increases will come from non-organic growth. For example, revenue increases from the Remy acquisition and more favorable currency rates are expected to be be key components. Absent these activities, management’s tone remains cautious and suggests that organic sales growth is expected to average perhaps just 3%. As for earnings: Expected volume gains and a lower share count are the primary drivers to support increased earnings assumptions.
Summary
BWA is a quality company with a solid balance sheet and a history of sound fundamentals. The company pays a modest dividend with a current yield of 1.5%. BWA's normal P/E ratio is 16.2x, and at today’s prices the company is available for about 10.8x. This possible undervaluation, combined with significant company strategies to address challenges makes this worth a look at these levels.
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