In a somewhat familiar refrain, vehicle technology company BorgWarner (NYSE:BWA) found itself outperforming difficult end markets in the third quarter. Having already lowered full-year sales and earnings guidance during its investor day presentation in September, the company was always set to face a difficult third quarter. BorgWarner managed to steady the ship by delivering numbers within the revised (reduction) guidance ranges, but there were some cautionary statements from management. Let's take a look at an eventful quarter.
BorgWarner third-quarter earnings: The raw numbers
Starting with the headline numbers from the third quarter, and putting them in the context of the second quarter and the revised guidance given mid-quarter in September:
- Organic net sales growth of 3.6% came in ahead of the revised guidance range of 3% to 3.5%, but below the 4.5% to 6.5% guidance range given in the second quarter.
- Adjusted net earnings per share (EPS) of $1 came in at the high end of revised guidance of $0.98 to $1, but below the $1.03 to $1.06 range given in the second-quarter call.
In terms of the revised guidance, BorgWarner did well, but since the mid-September update it saw a cut in guidance due to automobile production cuts in China and what management described as "short-term production issues in Europe related to WLTP."
For reference, WLTP stands for Worldwide harmonized Light vehicle Test Procedure, a new set of emissions tests being applied in the vehicle industry. Unfortunately, there have been widely publicized production cuts in Europe as a consequence of delays in getting models certified under the new tests.
Outperforming end markets
Management cut guidance in September due to the issues in China and Europe, and the quarter proved every bit as difficult as expected. However, BorgWarner is used to dealing with difficult conditions and -- just as it did in the first quarter and the second quarter -- managed to outgrow its end markets.
CEO Frederic Lissalde began the earnings call by outlining that global light-vehicle production was down 3% in the quarter compared to BorgWarner's expectation for growth of 2%. CFO Ron Hundzinski went on to give the granular detail of how the company outperformed its end markets:
- BorgWarner grew 4% in China, compared to a production market down 4% -- management had expected industry growth of more than 10% in China.
- Europe revenue declined 2% for BorgWarner, compared to a 6% decline in the production market.
- North America revenue increased "double digits versus the 2% production growth in the quarter," according to Hundzinski.
All told, it's an impressive performance given the circumstances, and Lissalde highlighted the strength of demand for BorgWarner's products and ongoing award wins with some leading China automakers.
Management's guidance and commentary
It's somewhat ironic that China and Europe were the problem areas in the quarter, because at the start of the year the maturing cycle in North America appeared to be the biggest source of worry for the industry.
The inevitable question now is, what direction will BorgWarner's end markets take? Lissalde argued that industry headwinds would remain for the rest of 2018, and that "We expect that the short-term production issues in Europe related to WLTP will continue into Q4. Also in China, we're expecting industry volumes to remain under pressure through year-end."
Indeed, the guidance for the fourth quarter -- organic growth of 1% to 4.5% and EPS in the range of $1.07 to $1.12 -- is wider than might be expected as a reflection of "the continued industry volume uncertainty we see through year-end," according to Hundzinski. Moreover, the full-year free cash flow target of $550 million to $575 million was maintained, but Hundzinski said the company could be challenged in meeting it.
Management's outlook suggests some caution about the fourth quarter, understandable given the uncertainty around vehicle production.
That said, BorgWarner has a consistent history of outperforming its end markets; investors will be hoping the WLTP issue in Europe proves a temporary setback, while the resolution of trade disagreements between the U.S. and China would possibly lead to a resumption of expected growth in China.