BorgWarner’s P2 hybrid module on display at the Automotive World 2018 forum in Tokyo, Japan.
Kiyoshi Ota/BloombergFor all the hard-charging talk about electric cars, you might think that they were taking over the U.S. market. In fact, they’re expected to hit only about a 3.5% market share this year, up from 2.5% last year, according to researcher IHS Markit. So why do auto stocks seem to be rising in proportion to companies’ plug-in announcements?
Look to Europe for clues. Electric cars there are suddenly 14% of the market, or 23% if we count plug-in hybrids that burn fossil fuel for backup. Tax incentives help explain the uptake. France offers 7,000 euros (about $8,300) toward EVs, plus €5,000 for trading in clunkers. Germany has €9,000 subsidies, exemptions from yearly car taxes, local parking perks, and more.
In the U.S., meanwhile, a $7,500 credit for every electric vehicle phases out after companies sell 200,000 of them, so Tesla (ticker: TSLA) and General Motors (GM), the biggest EV players, no longer benefit. There is talk of lifting the cap, raising the dollar amount, and multiplying the number of charging stations as part of an infrastructure deal. Politicians will call that either a needed boost toward modernity or an unaffordable sop, depending on which you ask. But if it happens, the effect will be “a significant bullish catalyst for EV sales domestically over the coming years,” according to Wedbush Securities analyst Daniel Ives.
Tax perks aside, vehicle selection could also explain why the U.S. has been slow to go electric, but could catch up soon. Many Americans are light-truck drivers. They will have their choice of six electric trucks this year and 30 electric vehicles overall, up from zero trucks and 17 vehicles last year, according to Edmunds, the car reviewer.
“That acceleration that we see now, you will see it on the street three to five years from now, because then the cars are going to be ready for sale,” BorgWarner CEO Frédéric Lissalde told me about electric vehicles this past week.
Bear in mind that he is largely in the business of selling clutches and turbochargers to improve fuel efficiency in conventional cars and trucks. EVs don’t need clutches, which are used to change gears, because they don’t need multiple gears. And they don’t need turbochargers, which aid combustion in cylinders the way a bellows aids a fire, because electric vehicles have no cylinders, and no combustion.
BorgWarner (BWA) has prepared for this moment gradually over the past eight or so years by designing components like electric drive modules. Last year, it bought Delphi Technologies, which adds power electronics to make plug-in cars more efficient.
“Some people think that efficiency of the powertrain doesn’t apply to battery-electric because we don’t have fuel efficiency, so who cares, right?” Lissalde says. “That’s absolutely wrong. Efficiency in the battery-electric vehicle is as, or more, important than fuel efficiency [in conventional cars] because it touches the range or the cost of the vehicle with the size of the battery pack.”
Lissalde’s view of customer orders gives him as good an insight as anyone into long-term EV adoption. He says that by 2030, about one out of three cars produced will be battery-only, and another one out of three will be hybrid. By then, EVs will bring in 45% of BorgWarner’s revenue, he predicted at an investor presentation last month.
You would think that would cheer shareholders. General Motors stock is hitting new highs —new since emerging from bankruptcy in 2009, anyhow—seemingly on its doubling down on EVs. Ford Motor (F) stock is hitting levels not seen in years, for similar reasons.
Yet while BorgWarner shares have bounced back from last year’s market collapse, they’re still below where they were three years ago. It’s not business. Lissalde says demand is strong, and that the main growth constraint in the car industry now is the semiconductor shortage. Wall Street expects BorgWarner to generate nearly $1.1 billion in free cash next year, 10% of the company’s stock market value, and sees that figure rising by about 10% annually over the following three years.
Surely that kind of financial firepower will be useful for funding electric vehicle investments. Anyhow, what happened to the investor rotation into value stocks? BorgWarner is less than half as expensive as the S&P 500 index, relative to earnings.
Count Morgan Stanley analyst Adam Jonas among the bears. Management has done a good job of responding to a once-in-a-generation upheaval in the car business, he wrote after the investor day. Still, the gradual runoff of the company’s products for conventional fuel-burning cars is a sure thing, and the eventual profitability of its newer products for EVs remains to be seen. Plus, car makers could always make more components in-house.
But James Picariello at KeyBanc Capital Markets recommends buying Borg Warner shares. He predicts that the shift to electrification will increase the company’s dollar value of content per vehicle. Earnings estimates look beatable, and free cash flow is more than enough to pay for record research and development outlays, plus electric deal-making. In February, BorgWarner agreed to buy Akasol, a German maker of battery systems for commercial EVs, for $880 million.
Lissalde, who became chief executive in 2018, once managed BorgWarner’s turbo business, and says it still has some oomph left. “With any good hybrid propulsion architecture, it’s usually a turbocharged, downsized gasoline engine,” he says. “So for a lot of our combustion product lines, we still see growth for about the current decade. And then we’re just going to manage a product that is declining and another one that is growing.”
Jonas at Morgan Stanley, however, says that some car makers might shun hybrid architectures and go straight to battery-only vehicles. General Motors, for example, doesn’t make hybrids.
There are clear risks. But BorgWarner’s free cash flow is pegged at $5.7 billion cumulatively through 2025. For an $11 billion component maker, anything close to that figure will offer plenty of paths forward.
Write to Jack Hough at jack.hough@barrons.com. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.
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