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Is BorgWarner (BWA) set to Rev Higher in 2017?

Tuesday, January 24th, 2017

After the recent market appreciation, finding good quality companies trading at fair valuations has been difficult. BorgWarner Inc. (BWA), however; appears to be one company that may be worth a deeper look.

BorgWarner is in the Consumer Goods sector and the Auto Parts industry. The company operates through two segments: Engine and Drivetrain. The Engine segment develops, manufactures and sells turbochargers; turbo actuators; and timing systems. The Drivetrain segment manufactures friction and mechanical products. The company’s technologies apply to combustion, hybrid, and electric vehicles and it sells its products to the original manufacturers of many types of vehicles and machines as well as aftermarket suppliers.

The current price for BWA is $40.33 and the 52-week range is $27.52 - $41.98.

Looking at the valuation ratios, many of them compare favorably to the industry average. The current Price/Earnings ratio is 16.04, which is below the industry average of 24.74. This is a positive as we like to see valuation ratios below the industry average as it shows we are getting a good value for that given metric. Price/Sales of 0.94 is slightly above the industry average of 0.92. This would be a slight negative, but is not a major concern. Price/Tangible Book value of 5.67 is more than half the industry average of 12.52 and Price/Cash Flow of 8.84 is also below the industry average of 11.22.

BorgWarner pays a small dividend of 1.42% and only uses 20.96% of its earnings to pay out that dividend. This is a positive as the company has the capability to increase the dividend, without using too much of its earnings.

Sales have grown by 17.53% quarter over quarter versus the industry average of 3.54% and by 13.22% year over year versus the industry average of 2.2%. These are both positives as the company grew its sales at a faster rate than the industry as a whole.

EPS looks to be problematic on the surface as it was down 44.05% quarter over quarter and down 10.5% year over year. Whenever a company is growing its sales at a strong rate but EPS is falling, a good investor must find out what is going on with the company.

By digging into the income statement, we can see the company had an impairment of assets of $106.5 million. Then reading through the 10-Q we can see the impairment charge was due to the sale of a portion of its business and the necessary adjustment of the net book value to fair value. This is a non-reoccurring charge that will not affect the future EPS for this company. Less the impairment charge, EPS has grown nearly 8% over the last 12 months.

Turning to the balance sheet, a current ratio of 1.35 shows the company has enough liquidity to cover its next 12 months of liabilities. A quick ratio of 1.06 is even more impressive as this calculation excludes inventory. It is important to analyze both ratios, because if a company has too much inventory on its balance sheet and a low inventory turnover, inventory control could become a problem. This means old inventory may need to be revalued on the balance sheet or sold at lower prices.

Total debt/equity of 70.5% is at a comfortable level as the industry average is around 66%. The interesting number here is the discrepancy between long term debt/equity of 56.3% and total debt/equity. This shows the company has a decent amount of debt coming due within the next 12 months. This is not a problem for the company because as we saw with the liquidity ratios, it has the capability to pay that debt off.

Looking forward to December 2017 and using a forward multiple of 16.5 Estimated GAAP EPS of $3.50 gives us a target sell price of $57.75. While this is over 40% away from the current price, there is further research that should be conducted before buying this company. Some initial questions that come to mind include: how much of the business is conducted internationally? And how much of the business comes from new auto manufacturers versus used vehicle replacement parts?

Do you have a question or a company you would like us to take a look at?
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