BorgWarner Reports a Strong First Quarter

By Lee Samaha Markets Fool.com

The auto industry is one of the most-discussed sectors of the industrial economy in 2017, and investors tend to watch the earnings results of automotive powertrain supplier BorgWarner Inc. (NYSE: BWA)for clues on where carmakers are heading. Let's take a look a closer look at the earnings.

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BorgWarner Inc. first-quarter earnings: The raw numbers

Starting with the headline numbers:

  • Net sales of $2.41 billion represented a 6.1% increase over the first quarter of 2016.
  • Organic net sales growth of 12.8% came in significantly ahead of guidancefor an increase of 2.5% to 6%.
  • Net earnings of $0.89 came in ahead of the guidance range of $0.81 to $0.85.

Revenue and earnings came in stronger than expected, but the full-year guidance was more or less kept intact:

  • Full-year net sales are still expected to be in the range of $8.81 billion to $9.04 billion, implying organic revenue growth of 3.5% to 6%.
  • Full-year net EPS is now expected to be in the range of $3.50 to $3.60 compared to previous guidance of $3.35 to $3.45.

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Although the full-year EPS guidance range was increased, it was "primarily due to a lower tax rate assumption." In other words, it wasn't due to improvement in outlook for revenue or operating income margin.

What happened in the quarter?

As you can see in the breakout of segment earnings below, BorgWarner had a strong quarter of underlying earnings growth.It all translated into reported operating income growth of 10.8% in the quarter.

Segment Net Sales Growth in Constant Currency Adjusted EBIT Growth in Constant Currency
Engine $1.495 billion 9.5% $253 million 6.9%
Drivetrain $925 million 18.8%* $105 million 23.1%

Data source: BorgWarner presentations. EBIT = earnings before interest and taxes, at constant currency. *Excludes impact from a divestiture.

The strong results are reflective of a good quarter of global light-vehicle production. For example, CEO James Verrier claimed industry light-vehicle production increased 6% in Europe in the first quarter, with China up 7% and North America up low single digits.

What management said

While first-quarter light-vehicle production was strong, it's clear that conditions over the full year won't be so favorable. Verrier outlined expectations for China to be up 2% for the calendar year, with Europe up 1% and North America down between 1% and 2% -- implying a notable slowdown from the first quarter. It amounts to a production growth rate of "slightly less than 1%," according to Verrier.

Image source: Getty Images.

On a more positive note, the long-sufferingcommercial vehicle market appears to be showing signs of improvement. On the earnings call, Verrier said:

In North America, we see orders and medium-duty sales improving. And as we look toward China and Europe, the outlook has improved, and we think it's going to be stronger. So, it's a good environment.

Another issue facing the company is the ongoing shift from diesel vehicles to gas --particularly in Europe. It's an issue because diesel vehicles tend to contain turbochargers (BorgWarner is a leading player in the market), while the percentage of gas vehicles with turbochargers is smaller. Verrier took time to placate investor fears on the subject by outlining that "the net revenue impact for BorgWarner with 100 bps [basis point] shift from diesel to gas mix is about a $20 million to $25 million annual number"--around 0.3% of annual revenue. Meanwhile, the penetration rate of turbochargers in gas-powered vehicles is at "75% to 80% and increasing." All told, Verrier sees the issue as negligible.

Looking ahead

All eyes will be on global auto sales in 2017, as production tends to follow very closely. The first quarter started strong, but with expectations for a slower end to the year, it's hard to know how conditions will progress.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends BorgWarner. The Motley Fool has a disclosure policy.