BorgWarner, Inc. (BWA) Q4 2018 Earnings Conference Call Transcript

BWA earnings call for the period ending December 31, 2018.

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BorgWarner Inc (NYSE:BWA)
Q4 2018 Earnings Conference Call
Feb. 14, 2019, 9:30 a.m. ET

Contents:

Prepared Remarks:

Operator

Good morning. My name is Sharon, and I will be your conference facilitator. At this time, I would like to welcome everyone to the BorgWarner 2018 Fourth Quarter and Full Year Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press *1 on your telephone keypad. If you would like to withdraw your question, press the # key. If you are using a speakerphone, please pick up the handset before asking your question.

I would now like to turn the call over to Patrick Nolan, Vice President of Investor Relations. Mr. Nolan, you may begin your conference.

Patrick Nolan -- Vice President of Investor Relations

Thank you, Sharon. Good morning, everyone, and thank you for joining us. We issued our earning and backlog releases at 06:30 AM Eastern Time. They're posted on our website, borgwarner.com, on our homepage, and on our Investor Relations homepage. A replay of today's call will be available through March 1st. The dial-in number is 855-859-2056 and the conference ID is 6778077 or you can simply listen to the reply on our website. With regard to our Investor Relations calendar, we will be attending multiple conferences between now and our next earnings release. Please see the Events section of our IR page for a full list.

Before we begin, I need to inform you that during this call, we may make forward-looking statements which involves risks and uncertainties as detailed in our 10-K/A. Our actual results may differ significantly from the matters discussed today. Also, during today's presentation, we'll highlight certain non-GAAP measures in order to provide a clearer picture of how the core business performed for comparison purposes with prior periods. When you hear us say on a comparable basis, that means excluding the impact of FX, net M&A, and other non-comparable items. When you hear us say adjusted, that means excluding non-comparable items. When you hear us say on a reported basis, that means U.S. GAAP. We will also refer to our growth compared to our market. When you hear us say market, that means the change in light vehicle production weighted for our geographic exposure. Our outgrowth is defined as our organic revenue change versus our market.

Now, back to today's call. First, Fred Lissalde, our President and CEO, will discuss our achievements of 2018. Fred will then comment on the industry outlook. This will be followed by a high-level overview of our Q4 results, as well as our 2019 outlook. Fred will then conclude with highlights of our three-year net-new business backlog. Then, Tom McGill, our interim CFO and treasurer will discuss the details of our results as well as our guidance. Please note that we posted an earnings call presentation to the IR page of our website. We encourage you to follow along with these slides during our discussion.

With that, I'm happy to turn it over to Fred

Fred Lissalde -- President and Chief Executive Officer

Thanks, Pat, and good morning, everyone. Today, we're pleased to share our results for 2018, our initial guidance for 2019, and our three-year backlog.

I'd like to start by sharing a few thoughts on 2018 on Slide 6. 2018 was a year of strong execution for BorgWarner. Despite the industry volatility, we delivered more than 600 basis points of outgrowth. This is an amazing performance. We had significant launches and wins across combustion, hybrid, and electric vehicles. Specifically, wins in hybrid and electric included multiple P2 programs, including three complete modular awards, multiple high voltage coolant heater awards for battery electric vehicles, and continued electric motor and electric drive module bookings,

At our investor day, we shared a 2023 revenue outlook of 14 billion before any M&A and a free cash flow outlook of $1 billion. As you will see later, our backlog supports the necessary outgrowth to reach these goals. We continue to approach our customers as a balanced proportion partner. Looking at the wind flows, we expect to be overweight in hybrid and electric by 2023.

Turning to the industry on Slide 7 and starting with Q4, the global light vehicle production came down about 3% versus our expectation of about 1% decline going into the quarter, so this was a 200 basis point headwind versus our expectation. However, I'm very proud to say that our outgrowth in Q4 was slightly stronger than what we expected, which allowed us to achieve our growth guidance. The biggest impact to industry volume expectations were once again Europe and China. European light vehicle production was down 6% year-over-year as our customers continued to work through WLTP certification. China light vehicle production was down 15% year-over-year and nearly 20% in December.

Now, for 2019, we expect that the challenging conditions in China and Europe will continue into 2019. In Europe, we still expect first half industry volume to decline as customers work through the final WLTP impacts. In China, we expect double-digit industry declines in Q1 as customers reduce inventory. As a result, this is also impacting the launch of some of our backlog. As we look to the full year, we expect a market decline in the -2% to -5% range. At the midpoint of our guide, we're factoring in China down 10%, Europe down 3%, and North America down 2%, but the key is that we expect to continue to outgrow the market in 2019 based on continued strong demand for our product.

Let me now move to Slide 8. First, a brief summary of the Q4 results. Overall, we're very pleased with the way the teams reacted to the weaker industry backdrop. With 2.6 billion in sales, we are up 2% organically. This compares to our market being down approximately 3%, so our outgrowth was very strong in the quarter at approximately 500 basis points. Looking at our regional light vehicle growth, our North America revenue grew high single-digits. We saw a low single-digit revenue decline in China, more than 10% better than the industry decline. Europe, revenue declined low single-digits. This slight vehicle growth was supplemented by positive revenue trends in commercial vehicle and off road. We reached our goal of a double-digit incremental margin despite the industry volume volatility. Out earnings per share is at $1.21 and was above our guidance range due to a year-end tax thrown up.

Now, for the full year 2019, we expect revenue to be down 2.5% to up 2% organically. This represents an outgrowth of 250 basis points to 400 basis points over our expected market decline. Excluding the first quarter, which is being impacted by launch timing and customer inventory adjustments, our outgrowth is expected to be 400 basis points to 550 basis points above market. We expect our earnings per share to be at $4.00 to $4.35 with a wider than typical range reflecting the end market uncertainty. While we continue to deliver strong outgrowth in 2019, we will also look at ways to adjust our cost structure to adapt to the current environment without compromising our longer-term aspirations.

Now, let's look at this exciting longer-term view for BorgWarner with a snapshot of our updated backlog. Starting on Slide 10, from a product perspective, we see growth across the portfolio. 20% of our backlog will be related to vehicles with combustion propulsion systems, 70% of our backlog will be related to hybrid, and 10% of our backlog will be related to battery electric vehicles, so 80% of our backlog is from a hybrid electric. This is a great example of how we are executing our propulsion growth strategy with overweight, hybrid, and electric.

Turning to Slide 11, from the regional perspective, we see outgrowth in all our major markets. 25% of the backlog is in the Americas. 15% is in Europe as continue diesel declines impact the net-new business backlog. 60% of the backlog is in Asia. Within this, China accounts for 50%. China is where the music is being played for hybrid and electrics and we're doing very, very well there. This is playing an increased factor in outgrowth. From a customer perspective, our very diverse customer base is increasingly important. This gives us great insight to what's happening across the entire propulsion landscape.

Wrapping up on Slide 12, our '19 to '21 backlog is expected to be within the range of $2 billion to $2.4 billion. You'll notice that the 2019 backlog is down from last year's disclosure due to obvious lower industry volumes and launch timing impact in 2019. However, you'll notice strong backlogs for 2020 and 2021. Importantly, this backlog will support an average outgrowth of 500 to 600 basis points for the next three years and keep us on track to reach 14 billion of revenue by 2023. These targets are achievable because electrification accelerates the opportunities for BorgWarner.

With that, I will hand it over to Tom.

Tom McGill -- Treasurer and Chief Financial Officer

All right, thank you, Fred. Good morning, everyone. Before I review the financial details, I'd like to provide some of the highlights as I see them for the fourth quarter. First, our outgrowth remains strong at 500 basis points. This allowed us to deliver our guidance despite end markets that continued to weaken throughout Q4. Second, incremental margin performance was in line with our expectations due to strong performance in our drivetrain segment and corporate cost controls. Finally, free cash flow generation was better than expected due to lower working capital and capital spending requirements.

Let's turn to Slide 14. On a comparable basis, our organic sales were up 2%. This is solid performance compared our weighted average light vehicle industry production for the quarter, which was down approximately 3% year-over-year. We saw a 3% decline in China against a production market that was down more than 15%. Europe revenue was down 2% compared to the 6% industry production decline in the quarter. North America revenue was up high single-digits versus the 2% production growth in the quarter. Commercial vehicle was a benefit, contributing about 50 basis points to our growth.

Now, let's look at the year-over-year comparison for operating income, which can be found on Slide 15. Q4 adjusted operating profit was 323 million compared to 327 million in Q4 '17. Our operating margin of 12.6% was flat year-over-year. On a comparable basis, operating income was up 6 million on 52 million of higher sales. That gives us an incremental margin of 11% in the quarter, which was in line with our double-digit goal going into the quarter. However, this is below our long-term mid-teens target due to the rapid decline in industry volumes and tariff-related cost inflation. Earnings per share on a reported basis were $1.10 per diluted share, and on an adjusted basis, net earnings were $1.21 per diluted share.

Now let's take a closer look at our operating segments in the quarter beginning on Slide 16 of the deck. Reported engine segment net sales were 1.54 billion in the quarter. Sales growth for the engine segment on a comparable basis was 0.4% as growth in North America was offset by lower Europe and China volumes. Adjusted EBIT was 243 million for the engine segment or 15.7% of sales. On a comparable basis, the engine segment's adjusted EBIT was down 16 million on 6 million of higher sales. This week, incremental margin performance was driven by the rapid decline in industry volumes. We are not satisfied by this performance and are exploring additional cost actions within the engine segment.

Turning to Slide 17, the drivetrain segment net sales were 1.05 billion in the quarter. Sales growth for the drivetrain segment on a comparable basis with 4.4%, primarily due to strong DCT growth in China, as well as transmission components in all-wheel drive growth in North America. Growth was partially mitigated by lower volumes on European customers with higher than average drivetrain content. Adjusted EBIT was 131 million for the drivetrain segment or 12.5% of sales. On a comparable basis, the drivetrain segment's adjusted EBIT was up $9 million on 45 million of higher sales for an incremental margin of 20%. This strong performance was driven by the benefit of new programs.

Before I move on to our guidance, I would like to discuss our cash performance for Q4. Our annual free cash flow came in at $580 million, and that's ahead of our 550-575 million guidance and our expectations going into Q4. There are two factors driving this strong performance. No. 1 is that the working capital pressures that we expected in Q4 were not as bad as we originally feared, and No. 2 was due to the push out of some of our new programs. From first half '19 to second half '19, some of our planned Q4 capital spending was delayed into 2019.

Now I'd like to discuss our 2019 full year guidance. Turning to sales growth guidance for the full year in Slide 19, our guidance is based on a market assumption of down 2% to 5%. We expect our organic revenue change of -2.5% to +2%, or 250 to 400 basis points of outgrowth. The thermostat divestiture is expected to reduce sales by approximately $98 million in 2019. Currency is expected to be a $280 million headwind. Total revenue is expected to be in the range of 9.9 billion to 10.37 billion.

Our operating income walk is on Slide 20. Our consolidated operating income margin is expected to be flat to down in 2019. This margin performance is due to the relatively low organic growth combined with costs related to tariffs, supplier bankruptcy costs in Europe, and changes to launch timing throughout 2019.

To finish up or pull your guidance, please turn to Slide 21. Our EPS guidance range is in the $4.00 to $4.35 per diluted share range. Our guidance range is wider than typical. We're targeting a free cash flow of 550 to 600 million. The midpoint of this guidance implies flat free cash flow year-over-year as higher capex spending is expected be offset by lower working capital usage. The tax rate for 2019 is expected to be approximately 26%.

On Slide 23 is out first quarter guidance. First, sales, we expect an organic sales decline of 5.5% to 7.5%, and this is roughly in line with our market forecast as our outgrowth is impacted by the timing of launches in 2019 and customer inventories of programs launched during 2018. Our earnings per share is expected to be in the range of $0.92 to $0.96 per share, and this guidance is based on a 26% tax rate and incorporates a $130 million FX revenue headwind year-over-year.

In conclusion, let me summarize our Q4 and our outlook. Our overall execution was solid in light of the challenging industry volume. Our organic sales growth was 2% or 500 basis points of outgrowth. The Q4 incremental margin of 11% was in line with our expectations driven by strong performance in our drivetrain segment and corporate cost control. As we look into 2019, the environment will remain challenging. However, we are continuing to outgrow the industry and will take the necessary steps to adjust our costs to the changing industry volume outlook.

With that, I'd like to turn the call back over to Pat.

Patrick Nolan -- Vice President of Investor Relations

Thank you, Tom. Sharon, we're ready to open it up for questions.


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Questions and Answers:

Operator

At this time, I would like to remind everyone, if you would like to ask a question, press *1 on your telephone keypad. If you are using a speakerphone, please pick up the handset before asking your question. In the interest of time, please limit yourself to one question and one follow up. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Emmanuel Rosner with Deutsche Bank.

Emmanuel Rosner -- Deutsche Bank -- Analyst

Hi. Good morning, everybody.

Fred Lissalde -- President and Chief Executive Officer

Good morning, Emmanuel.

Tom McGill -- Treasurer and Chief Financial Officer

Good morning.

Emmanuel Rosner -- Deutsche Bank -- Analyst

First question around the first quarter factors, can you maybe highlight what your production assumption are, maybe by market, for the first quarter, and then just maybe a little bit more color around how some of these factors impact your backlog? It looks like you're -- I mean, you're essentially saying you won't really outperform the underlying markets in Q1, so I assume there's minimal amount of backlog, and so how do the production and dynamics around the various markets impact the backlog in Q1?

Fred Lissalde -- President and Chief Executive Officer

Yeah, if you want to focus on Q1, it's essentially Europe and China, and in China, we think that the run rate in Q1 is not going to be much better than the run rate we saw in December. It's below -20%, and in Europe, also, we see Europe around -5, -6, which also is pretty much the run rate that we saw in Q4 last year. Now, when it comes to the backlog, it impacts the backlog where actually, literally, there is no backlog in Q1. If you look at the backlog evolution and if you are removing Q1, we're pretty much absolutely in line with what we've announced and marching toward this 2.4 billion, and the outgrowth of the market, actually, if you take Q1 out, if you do the math on the outgrowth of the market in Q2 to Q4, we are around 400 basis points to 550 basis points, which supports our long-term view of 14 billion by 2023.

Emmanuel Rosner -- Deutsche Bank -- Analyst

Right, I realize that and that's helpful color. I'm just curious, on the ground, how does that actually translate in the first quarter because, obviously, the whole beauty of the backlog, it is gross above-market, so the markets are extremely weak in Q1 and I think it's a fair conservative assumption? I'm just curious what it is that is on the ground in your plants that drives the lack of backlogging in the first quarter.

Fred Lissalde -- President and Chief Executive Officer

Well, this doesn't show you the China volume of new programs that are lower rate, and it's because of the market being down so much. Also, we have -- and I think we talked about it before, some Europe and North America timing, but the majority of the impact is in China.

Emmanuel Rosner -- Deutsche Bank -- Analyst

Okay, that's very helpful. I guess my second question then is, you mentioned maybe three margin drivers for the 2019 guidance. Obviously, I understand the low organic growth piece of it, but then you also mention tariffs, supplier bankruptcies, and then changes in the launch timing. Can you maybe give a little more color on each of these buckets and any numbers you're able to share?

Fred Lissalde -- President and Chief Executive Officer

From a full year basis, at the high end of our guide, we have an incremental of single-digits. I think it's around 6% and that's essentially linked to the weaker Q1. At the low end of our guide, we have an incremental that is a little bit on the high side, and it's also linked in Q1 from a volume and conversion standpoint. Supplier bankruptcy is around 5 million, if I had to throw a number, and as you know, tariffs are also impacting us, and on the launch perspective, we're not slowing down on any R&D and launch support, and that has an impact of about 10 million.

Emmanuel Rosner -- Deutsche Bank -- Analyst

The tariffs?

Fred Lissalde -- President and Chief Executive Officer

The tariff impact is about 20 million, mostly in the first half.

Emmanuel Rosner -- Deutsche Bank -- Analyst

Very helpful, thank you.

Operator

Your next question comes from Joseph Spak with RBC Capital Markets.

Joseph Spak -- RBC Capital Markets -- Analyst

Good morning, everyone. I just wanted to maybe follow along some of that, and Fred, some of your comments, because if you look at the implied guidance beyond the first quarter on a total revenue basis, it looks like you're flat year-over-year, but then the outgrowth is 4%, which I think is the number you said. I know that's sort of just the math, so I was wondering if you could provide a little bit more texture to the cadence because it would seem like what you're basically saying is there are still some issues in the second quarter and then maybe a little bit stronger outgrowth in the back half. Is that fair?

Fred Lissalde -- President and Chief Executive Officer

Yeah, the outgrowth if you remove Q1 with inventory adjustment in China, launch timing is actually improving quarter-over-quarter, and the back half of 2019, the outgrowth is close to 500 basis points, which is in line with the outgrowth of last year and which is in line with the backlog and in line with the 14 billion by 2023, so that's the cadence and that's the sequence of that backlog and outgrowth of the market.

Joseph Spak -- RBC Capital Markets -- Analyst

Okay, and then on the backlog, I was wondering if you could just give a little bit more -- you mentioned the China number and that's where all the action is and a subsequent percentage of the backlog. Can you talk a little bit more about the type of business you're running there, who you're running it with, and then, also, maybe, if you care to add, how much of the backlog is turbochargers and maybe even how much of that is turbos for hybrid vehicles?

Fred Lissalde -- President and Chief Executive Officer

All right, I'll give you some color on the backlog. About 15% of the backlog is related to turbos, about 30% of the backlog is related to transmission products, including DCTs and including hybrid products, 20% of the backlog is all wheel drive, and 15% of the backlog is around rotating electric components and motors. In China, most of our backlog is advanced hybrid, battery electric vehicle, but we're also growing in some of our combustion products, so I would say it's pretty much across the board, 80% of the backlog being hybrid electric, and I think this is a great example on how we execute the strategy of being overweight hybrid and electric by 2023.

Joseph Spak -- RBC Capital Markets -- Analyst

Then, within China, is it the domestics? Is it the global OEMs? Any color there?

Fred Lissalde -- President and Chief Executive Officer

It's about 50/50. We are 50% working with the Chinese, the big ones, and we're doing well with them, and the other 50% are with the western JVs.

Joseph Spak -- RBC Capital Markets -- Analyst

Okay. Thank you very much.

Fred Lissalde -- President and Chief Executive Officer

You're welcome.

Operator

Your next question comes from Noah Kaye with Oppenheimer.

Noah Kaye -- Oppenheimer -- Analyst

Thanks and actually just a follow-up on Joe's question, it's really around and methodology and assumptions that you're making to de-risk that three-year backlog number. I think we have a sense that the number of new energy vehicle carmakers there is unsustainable, so what should investors know about your methodology and your conviction level in this three-year backlog number?

Fred Lissalde -- President and Chief Executive Officer

Noah, we incorporate risk factors and we put a lot of intelligence in the volume adjustments, and we've done that since a few years -- there is no change in what we do. We are taking all that into account when we look at the three-year backlog.

Noah Kaye -- Oppenheimer -- Analyst

Great, and then maybe switching gears, how should we think about priorities for cash in '19? You kept your dividend unchanged in 4Q. Could you get more aggressive on share buybacks considering where the stock is versus its prior peak, and then do you have any active conversations around the M&A pipeline that might materialize?

Tom McGill -- Treasurer and Chief Financial Officer

Yeah, sure, Noah, this is Tom. First of all, with dividends, we said before that we will grow dividends with our free cash flow growth, so we've kept them level this year. On the stock buyback, we guiding share repurchases of about 100 million versus about 150 million in 2018. Our 2019 guidance is similar to how we initiated 2018, as well. However, we're going to continue to buy back shares opportunistically. As has been our historical practice when we're producing excess cash and if there's no near-term M&A possibilities, we will consider buying back additional shares, so with that, again, we do continue to look at M&A with a focus on technology.

Fred Lissalde -- President and Chief Executive Officer

Right, so I'd like to give you some color. This technology is really what's driving our approach, and technology is what drives our focus and our decisions. We continue to be opportunistic, but very, very disciplined the way we look at M&A, and it's always been a focus. It will always be a focus. We're always very technology-driven.

Noah Kaye -- Oppenheimer -- Analyst

Okay, thank you very much.

Operator

Your next question comes from David Tamberrino with Goldman Sachs.

David Tamberrino -- Goldman Sachs -- Analyst

Good morning, gentlemen. I just wanted to ask about your regional production guidance because just looking at the different suppliers and forecasts that are out there, I think you have the most conservative that we've seen so far, so just curious if this is more a reflection of what you're seeing from your customers or really just your beliefs in the market given it is a little bit lower than I think everybody else is baking into their number.

Fred Lissalde -- President and Chief Executive Officer

I think it's early in the year. We feel that we need to be a little bit prudent in the market assumptions. From what we see, we see Q1 with inventory adjustment and some volume delays, so what we're focusing on is what we can control and focusing our strategy to outgrow the market around 500 basis points year-over-year. You're going to have some years or quarters we're going to be a little bit lower than that like Q1 this year, but that's our focus and I think it's the right thing to do, to be prudent looking at the volatility of all those market dynamics right now.

David Tamberrino -- Goldman Sachs -- Analyst

Okay, so it's not necessarily anything you're seeing from a specific program. It's more of just where we've left 2018 that's the best place to start given the chop.

Fred Lissalde -- President and Chief Executive Officer

I think, yeah, I would agree with that.

David Tamberrino -- Goldman Sachs -- Analyst

Okay, and then my follow-up is Bosch recently bought out their partner Daimler's stake in this electric EM-Motive JV that they used to have. Is that competitor taking full control of an e-motor's business -- is that going to create more of a competitive market? On the back of this, maybe, what are you seeing in terms of competition for some of those complete module awards that you've been getting and you've been winning? Thank you.

Fred Lissalde -- President and Chief Executive Officer

We're very, very happy with the motor that we have. We have a great motor. We have a great technology with a PACE Award. We're very happy with the booking flow that we see, and as we mentioned before, we don't see any differences from a competition intensity in this field than what we see in other fields in other product lines.

David Tamberrino -- Goldman Sachs -- Analyst

Okay. All right, thank you.

Operator

Your next question comes from Rod Lache with Wolfe Research.

Rod Lache -- Wolfe Research -- Analyst

Good morning, everybody.

Tom McGill -- Treasurer and Chief Financial Officer

Good morning, Rod.

Rod Lache -- Wolfe Research -- Analyst

I was hoping you can just clarify some things for us on the backlog. If I looked at the midpoint of your backlog breakdown from last year, hybrid was $990 million and now it's a $1.5 billion. Over that, actually, a little bit. It looks like a $550 million increase. Combustion went from $1.1 billion down to 440. If I look at the regional breakdown, China has actually increased from 660 million to 1.1 billion. It looks like North America -- the Americas and Europe are down. Is the way that we should interpret this is that, basically, what you're winning is overwhelmingly in China and hybrid and that you're not winning as much in the western markets? If that's the case, why are there not that many awards in the western markets? What does the pipeline look like and what's been happening in these markets?

Fred Lissalde -- President and Chief Executive Officer

Two things that I would say, Rod. The first one is we strongly believe that China is where the music is played from a battery electric vehicle standpoint and we are doing very well there, and we're very proud about having 50% of our backlog being in China. In Europe, when you look at the backlog, you need to, I thin, factor back the fact that it's net of the diesel decline. If you factor that back in, I think you would increase that European backlog by about 10%, and in North America, even if customers are moving, I think customers are waiting on regulations that we hope are going to become published and real in the next weeks or months, so that's what I would say to give you some color on your question.

Rod Lache -- Wolfe Research -- Analyst

It's not so much that you've missed out or lost share, it's just that those contracts haven't been awarded? Can you give us any color on what the pipeline looks like as you look forward? Just lastly, obviously, there's been a lot of volatility in China production and from time to time you have some of those customers push out launches. With that in mind, could you just give us a feel for how you might have incorporated some conservatism in the China assumptions for backlog?

Fred Lissalde -- President and Chief Executive Officer

We don't see program cancellations. We see some delays and we see volumes of the backlog being impacted by the fact that the Chinese market is low and inventories are being managed. I would say that what I see is that the backlog is well balanced across the three regions when I look at the intensity of what people are doing from a hybrid-electric standpoint, and we're very confident that the booking that we see coming our way is supporting a constant 500 basis points outgrowth and confirming that 14 billion by 2023.

Rod Lache -- Wolfe Research -- Analyst

Just to clarify, Fred, going forward, is the opportunity accelerating in Europe or is it still that most of the activity, not just hybrid, but just in general, net new business opportunity? Obviously, it's hard for us to see what's been happening net of the diesel decline.

Fred Lissalde -- President and Chief Executive Officer

I would say China is still a significant portion of the backlog. China is remaining significant and Europe is going to Europe. The good thing and what we really like where we are is that, from a hybrid and electric standpoint, we're going to get scale in China, and getting scale is what's important. Once we are at scale, it's going to be really, really an enabler for us to be booking business in Europe and in North America.

Rod Lache -- Wolfe Research -- Analyst

Okay. Great, thank you.

Operator

Your next question comes from John Murphy with Bank of America Merrill Lynch.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Good morning, guys. I just want to follow on Rod's question because I think it's probably one of the most important things we learned today here in these backlog shifts. When you look at the extreme shifts that Rod highlighted, how much of that is being driven by program winds and maybe delays, and is there any component of it that's based on changes in volume assumptions, and how confident are you with these numbers? Obviously, things can shift around.

Fred Lissalde -- President and Chief Executive Officer

As I mentioned, we are incorporating a certain level of risk and volume adjustment in the backlog, and we are used to -- since we talk to everyone and since we have a very broad customer base, we used to discount what customers tell us, but we feel good about where we are. The backlog to 2021 is 100% booked and 2023 is about 80% booked, so the biggest risk that you would have between now and 2021 would be industry volume.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Fred, maybe just a follow-up, the preponderance of the shift is a result of programs, not industry or program volume assumptions? I mean, this is really a shift in program wins for you. Is that correct?

Fred Lissalde -- President and Chief Executive Officer

I would say that there is a timing effect in 2018. If you didn't have Q1 the way we look at it, you would see a backlog that would be absolutely in line with what we announced last year, which was 700-800 million, so if you remove Q1, the 2019 backlog would be flat versus the prior announcement. Nevertheless, or in addition, I would say that what's important for us to do is to really focus on what we can control, which is the outgrowth of the market, and which is announcing the products and booking the new businesses. If you remove that timing effect of Q1, we are actually absolutely in line with what we've announced before.

John Murphy -- Bank of America Merrill Lynch -- Analyst

I apologize, Fred. I might be asking the question in a confusing manner. The shift between combustion, hybrid, and EVs, and the big shift toward hybrids away from combustions, that is really a result of program wins and maybe other programs rolling off and being smaller on the combustion side. Is that a fair statement?

Fred Lissalde -- President and Chief Executive Officer

I think it is fair statement. We see an acceleration in the flow of products that we win in hybrids, and also, you need to factor in the diesel decline that impacts the volume on the production stand -- on the combustion segment.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Got it, that's very help. Then just the follow up and lastly, the margins and return implications for these kinds of shifts, I mean, as we think about the next three years -- and maybe, Tom, this is a question for you -- will that have a big implication for margins and returns as we see this shift away from combustion toward hybrids and EVs as you have to put maybe more capacity into play? As Fred alluded, you need to build scale in China so that you can compete back in North America and Europe. I'm just trying to understand the margin return implications.

Tom McGill -- Treasurer and Chief Financial Officer

Right, we don't anticipate any changes in margins and returns. When we quote business, we -- and this is out on our investor presentation, yeah, we have certain return on invested capital hurdles and those hurdles are the same no matter the region or the type of product. We have that minimum hurdle rate. We can always go above that, but what we're seeing on our business wins in hybrid and electric is kind of an average return on invested capital that's very consistent with what we have on combustion. Our capex, we intend to have that still be within that same 5.5-6.5% range long-term. Again, we're hoping to drive that to the lower end of the range, maybe even go lower, but it factors that in, as well.

John Murphy -- Bank of America Merrill Lynch -- Analyst

Great. Thank you very much, guys.

Tom McGill -- Treasurer and Chief Financial Officer

Thanks, John.

Operator

Your next question comes from Colin Langan with UBS.

Colin Langan -- UBS -- Analyst

Oh, great. Thanks for taking my question. Any color on the margin outlook, how we should think about it between the two different segments? It seems like engine, particularly this quarter, is under a lot of pressure. Should we expect that to continue or accelerate or is there going to be some stabilization there?

Tom McGill -- Treasurer and Chief Financial Officer

Yeah, I'd say a couple things. One is, and we've talked about this, for us to get our mid-teen incremental goal, we're looking for some minimum amount of growth of at least 2% because that growth will help us drive that incremental margin, and we had missed that on the engine side. Separately, and I talked about it, we're not really happy with the incremental and decremental on engine right now, so we're going to take a closer look at that and see if there are some cost actions that we can take to get that more in line with our long-term expectations.

Colin Langan -- UBS -- Analyst

Got it. You mentioned earlier, the tariff headwind was, I think you said, 20 million. Is that an incremental impact of tariffs? I thought there was a big hit already. Then, is that assuming a 25% tariff, which obviously is not imposed yet?

Fred Lissalde -- President and Chief Executive Officer

The tariff is 20 million incremental in first half.

Colin Langan -- UBS -- Analyst

It assumes the 25% rate in there?

Tom McGill -- Treasurer and Chief Financial Officer

It's for the tariffs that are currently in place. We have not made any assumption for any tariffs that have not been decided on, so this three has very little impact.

Colin Langan -- UBS -- Analyst

Okay, got it. All right, thank you very much for taking my question.

Operator

Your next question comes from Brian Johnson with Barclays.

Brian Johnson -- Barclays -- Analyst

Yes, I appreciate your conservative end market guide, and you're not spending on macro to bounce back, but I'm struck by the slowdown in above market growth; that 250 to 400 basis point range, versus the strong 4Q and '18 as a whole was over 600. Could you maybe break down how much of that is due to just the delay of the Q1 backlog and how much is conservatism around other factors?

Fred Lissalde -- President and Chief Executive Officer

It's almost all around the Q1 backlog. As I mentioned before, if you remove the no-backlog in Q1, we're in line with the 500 basis points at midpoint.

Brian Johnson -- Barclays -- Analyst

That backlog, the programs that would have been launched in Q1, why aren't they just launched later in the year? Do they just kind of roll into '19 given everything is pushed out a quarter?

Fred Lissalde -- President and Chief Executive Officer

Yes.

Brian Johnson -- Barclays -- Analyst

I mean roll into 2020, I'm sorry, one year out.

Fred Lissalde -- President and Chief Executive Officer

Yes, they are -- you have some delays in launch. You have, also, some lower volume in launch due to the Q1 market situation, especially in China, and this is going to roll out in the future years. As you've seen, the 2020 and '21 backlog is strong, so it's timing, essentially linked to Q1.

Brian Johnson -- Barclays -- Analyst

How much of the '20 backlog nearly doubling versus '19 is program delays versus fresh programs?

Fred Lissalde -- President and Chief Executive Officer

I'm not sure I can give you that granularity at this point in time, Brian.

Brian Johnson -- Barclays -- Analyst

Okay, and then, final question around the backlog, could you give us more color on not just the -- you've talked about the end propulsion mix in the China backlog, but the mix of OEMs between the global JVs, the strong local players, e.g. Geely, Great Wall, and others, and then the more regional smaller tier, lower tier OWMS who have to catch up on powertrain, but also are in the most macro impacted regions?

Fred Lissalde -- President and Chief Executive Officer

We're strong with the big Chinese OEMs. That's really the punchline, Brian. We will follow up with you on your prior question. I apologize I could not give you that granularity. On China, it's the big ones.

Brian Johnson -- Barclays -- Analyst

Okay, thank you.

Fred Lissalde -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Rich Cross with Wells Fargo.

Deepa Raghavan -- Wells Fargo -- Analyst

Good morning. This is Deepa Raghavan for Rich Cross. A couple questions from me, a medium-term question first. What are some of the production assumptions in the backlog for your 2020-2021 target, particularly in China, but also others, too?

Fred Lissalde -- President and Chief Executive Officer

The industry assumption that we have in 2020 and 2021 is a growth of 1%, which is the baseline assumption that we have built up our 14 billion by 2023.

Deepa Raghavan -- Wells Fargo -- Analyst

Is there a split between China versus Europe of North America production assumptions?

Fred Lissalde -- President and Chief Executive Officer

I would say that we're incorporating a slower growth in China that we've seen in the past with maybe low single-digit growth in that market going forward.

Deepa Raghavan -- Wells Fargo -- Analyst

Okay, my second question would be, can you discuss some of the restructuring that you mentioned and if there are any other actions you're undertaking to offset some of the negative volume impacts? We heard you on some of the additional actions on the engine segment, but is there going to be more on the drivetrain, too, just given you need to offset negative volume impact across your firm? Thank you.

Fred Lissalde -- President and Chief Executive Officer

We're exploring a lot of different options and we'll give you more details and color in the Q2 call. I mean, in the next quarter call.

Deepa Raghavan -- Wells Fargo -- Analyst

Great, thank you.

Fred Lissalde -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Armintas Sinkevicius with Morgan Stanley.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Good morning, thank you for taking the question. Can you remind us how much diesel headwind you are incorporating? Is it the usual sort of 500 BPs of headwind, and how we should be thinking about diesel beyond this year?

Fred Lissalde -- President and Chief Executive Officer

Yeah. We are incorporating a 300 basis point to 400 basis point shift between last year and this year down. Two things that I would add; we see a little bit of a decrease in the slowing down rate in the past two months, and also, as far as we're concerned, as you know, by the end of 2020, we'll be totally agnostic to the diesel penetration take rate.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Okay, and then there was some commentary at the investor day around M&A. I'm just curious to get your thoughts, updated thoughts here, particularly given the environment, and if the environment presents any opportunities.

Fred Lissalde -- President and Chief Executive Officer

Yeah, it has not changed. As I mentioned before, it's all around technology. It's a technology-driven approach. We're focused on M&A. We're focused on building system capabilities for complete solutions and technology. Product leadership drives the focus.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Okay, and then my last one here, during that the quarter, you announced the launch of I believe it's the IDM. Have you noticed any change in conversation since the official launch?

Fred Lissalde -- President and Chief Executive Officer

No. We are absolutely not seeing any change. We're seeing a strong pool for IDM products for battery electric vehicles. We're also seeing a strong pool as you've seen in some of the announcements for our liquid heaters, and today, most of what we sell is EDM, so it's transmission and motor, and in focus and in the near future, we'll sell IDM, which is transmission motor and power electronics.

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Okay. Thank you for taking the question.

Operator

Your next question comes from Ryan Brinkman with JP Morgan.

Ryan Brinkman -- JP Morgan -- Analyst

Great, thanks for taking my question, which is really just exploring a little bit more around the push out of some of the backlog from 1Q further in the year. You talked earlier in the call about softness in China and Europe and maybe that's created an oversupply of some of the vehicles that were recently launched in 2018. I think there's more publicly available data that we can look at in Europe and I was just hoping you could shed a little bit of light on the inventory situation in China. Is it concentrated at certain automakers or in certain product segments, and then, if the environment persists in being softer, as you seem to assume the outlook for 10% lower LDP there at this year, is there any risk that more programs or more launches could be pushed out or elongated, or is that already factored into your guidance at this point?

Fred Lissalde -- President and Chief Executive Officer

We're seeing this inventory adjustment across the customer base, it's already factored into the backlog, and we're not planning for -- we're planning for China's run rate to be stable to today's run rate, so we're not planning for deterioration of the China market. We're planning for a -- we're not planning for an improvement as the year advances. Also, we're not seeing any slowdown in intensity of programs and awards that we see form those key customers that we have in China, which is really encouraging.

Ryan Brinkman -- JP Morgan -- Analyst

Yeah, that is good to hear, and then, I know it's only a small -- last question -- a small minority of your business, but I'm just curious if you could provide us an update on your commercial vehicle business. It seems the trends impacting that market were still very strong in the fourth quarter, and yet there's sort of some anecdotal signs in the US that there might be some potential slowing. If you've got some insight into that market, I just was curious what your thoughts are.

Fred Lissalde -- President and Chief Executive Officer

Yeah, we benefited in Q4 from a strong commercial vehicle market. In our backlog, we assumed flat going forward, and again, when you think about commercial vehicle and BorgWarner, the North American Class 8 is small. 12% of our businesses is what we call commercial vehicle, but it's pretty much a third, a third, a third, a third North America, a third, Europe, and a third China and the rest of the world, and we are in off road and agricultural construction, so don't associate North America Class 8 to the BorgWarner commercial vehicle portfolio.

Ryan Brinkman -- JP Morgan -- Analyst

That's really helpful, thank you.

Fred Lissalde -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Chris McNally with Evercore.

Chris McNally -- Evercore -- Analyst

Thanks so much, team. Just two quick ones. I think we've asked a lot about the core markets, but just the math on getting to the bottom end of that -5% market range, I think you're talking about China being flat where it was December, but should we take that as essentially the market would have to be 15% in 2019, and Europe would be down a couple percent as well, to hit sort of the worst low end of that market range?

Fred Lissalde -- President and Chief Executive Officer

Yeah, so if you're talking about the low end of the market range, that would put China at -12 year-over-year, Europe around -5, and North America around three to four.

Chris McNally -- Evercore -- Analyst

Down three to four.

Fred Lissalde -- President and Chief Executive Officer

Correct. That would be the low end.

Chris McNally -- Evercore -- Analyst

Okay, and that's based on December run rates.

Fred Lissalde -- President and Chief Executive Officer

That is based on average last year run rate. It's the year-over-year run rate.

Chris McNally -- Evercore -- Analyst

Okay, but you're coming to those numbers based on essentially if we would have a run rate the worst levels that we saw in Q4, particularly in China and Europe as you come up with those assumptions.

Fred Lissalde -- President and Chief Executive Officer

Yes.

Chris McNally -- Evercore -- Analyst

Okay.

Fred Lissalde -- President and Chief Executive Officer

Plus, North America weakening just a little bit from that 17.2.

Chris McNally -- Evercore -- Analyst

Okay, great, and the second part is I really just wanted to hone in on Europe, which we saw some of the weakness in the second half, but we're sort of following the weakness in consumer confidence and some of the estimates in the first half. It's probably going to be down that -5%. The unknown is sort of the second half of the year, and we do have more tests, particularly on the RDE. Could you talk about, from the supplier perspective, what you know about Q3 from speaking with the OEMs? Is this another situation where we could have a production issue associated with bottlenecks like we did with WLTP? What sort of visibility are you getting and how are you preparing for what will be another -- it should be a less onerous test, but how do you think about that as you prepare for your business?

Fred Lissalde -- President and Chief Executive Officer

Our assumption is that Europe for the second half will be flat versus the second half of '18. I think our customers have done a great job getting lessons learned from WLTP, but really, RDEs are coming and it's not going to be done with no effort. IT's going to require a lot of work.

Chris McNally -- Evercore -- Analyst

Okay, and in terms of specific OEMs or variances, is there -- obviously, everyone had their eye on Volkswagen for WLTP. Should we just think about it as the same big guys are going to have the same issues when it comes to RDE? We should focus on middle of the year, seeing how well they execute it?

Fred Lissalde -- President and Chief Executive Officer

I think you should ask them directly. I would not want to comment specifically for our customers.

Chris McNally -- Evercore -- Analyst

Understood. Thank you so much.

Fred Lissalde -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from David Kelley with Jefferies.

David Kelley -- Jefferies -- Analyst

Good morning. Thanks for taking my questions. Just a quick follow up on the 80% backlog tied to hybrids and EVs, are you seeing increased customer bias to go with your full hybrid and electric drive module solutions? I guess I was just hoping to get a feel for full module versus the component mix within the electrification backlog and maybe potential impact of that higher dollar content on the backlog growth.

Fred Lissalde -- President and Chief Executive Officer

Yeah, we have a pool for a system from a hybrid and electric standpoint, but it's the mix. As I mentioned before, we're also very open to support the customer with components, and sometimes we do, and we are happy to serve them we all the products that we have in this propulsion side of the market and other technology.

David Kelley -- Jefferies -- Analyst

Okay, so you're not seeing a substantial shift in how your customers are approaching components versus modules, say, versus last year.

Fred Lissalde -- President and Chief Executive Officer

I think it was also mentioned in my prepared remarks. In China, we see a little bit more interest on modules than in the rest of the world, but it's the mix and we are happy to support them in any different shape or form.

David Kelley -- Jefferies -- Analyst

Okay, great. Thanks, and then just a quick housekeeping on FX, I think you referenced a first quarter assumption of $1.13. Could you also provide you assumption, I guess, baked into the full-year outlook?

Tom McGill -- Treasurer and Chief Financial Officer

Yeah, I think it's about the same. Yeah, it's $1.13 for the full year.

David Kelley -- Jefferies -- Analyst

All right, perfect. Thank you.

Operator

We have time for one final question and that question comes from James Picariello with KeyBanc Capital Markets.

James Picariello -- KeyBanc Capital Markets -- Analyst

Hey, good morning, guys. Just on your portfolio, you completed the sale of your thermostats business. I believe you still have the EGR pipes and tubing business that you intend to sell, as well. Any update there, can you confirm the remaining size of that business, and just a follow on, do you have any other businesses within your portfolio that you'd be looking to prune, as well? Thanks.

Tom McGill -- Treasurer and Chief Financial Officer

Yes, so with that thermostat business, we've entered into an agreement. We're waiting for final signing and everything, which should be happening in the next few weeks, if all goes according to plan. Your other question on portfolio for some of the other products, that's an ongoing process for us. We're looking at that at all times, looking at what makes sense for us, and there are lots of different factors that go into that, where we see the market, where we see our strengths, and our position in the market, so that's something that's an ongoing discussion with us.

James Picariello -- KeyBanc Capital Markets -- Analyst

Okay, thanks, and you just regarding your 2023 targets, you specifically called out in the prepared remarks that revenue and free each flow is strongly intact, the 14 billion and 1 billion, not to read too much into it, but do you still regard the low 13% EBIT margin target as intact, as well?

Fred Lissalde -- President and Chief Executive Officer

Yes.

Tom McGill -- Treasurer and Chief Financial Officer

Yes.

James Picariello -- KeyBanc Capital Markets -- Analyst

All right, thank you.

Patrick Nolan -- Vice President of Investor Relations

With that, I'd like to thank you all for your questions today. If you have any follow-ups, feel free to reach out to me. Sharon, you can close the call.

Operator

That does conclude the BorgWarner 2018 Fourth Quarter and Full Year Results Conference Call. You may now disconnect.

Duration: 64 minutes

Patrick Nolan -- Vice President of Investor Relations

Fred Lissalde -- President and Chief Executive Officer

Tom McGill -- Treasurer and Chief Financial Officer

Emmanuel Rosner -- Deutsche Bank -- Analyst

Joseph Spak -- RBC Capital Markets -- Analyst

Noah Kaye -- Oppenheimer -- Analyst

David Tamberrino -- Goldman Sachs -- Analyst

Rod Lache -- Wolfe Research -- Analyst

John Murphy -- Bank of America Merrill Lynch -- Analyst

Colin Langan -- UBS -- Analyst

Brian Johnson -- Barclays -- Analyst

Deepa Raghavan -- Wells Fargo -- Analyst

Armintas Sinkevicius -- Morgan Stanley -- Analyst

Ryan Brinkman -- JP Morgan -- Analyst

Chris McNally -- Evercore -- Analyst

David Kelley -- Jefferies -- Analyst

James Picariello -- KeyBanc Capital Markets -- Analyst

More BWA analysis

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