Engine and powertrain company BorgWarner (BWA +1.54%) released its second-quarter earnings today, and disappointed the market by missing analyst estimates and reducing its full-year guidance. If there's one thing you can conclude from the recent spate of earnings in the industrial sector, it's that China's automotive sector is slowing.
In truth, after missing analyst estimates in its first quarter, the pressure was on BorgWarner to come up with a good set of results this time around. Unfortunately, a combination of factors conspired to disappoint such hopes. Let's take a closer look at what happened.
BorgWarner second-quarter results
The headline numbers:
- Second-quarter net sales of $2.03 billion compared to analyst estimates for $2.08 billion
- Non-GAAP adjusted EPS 0f $0.75 compared to analyst estimates for $0.83
And now the guidance:
- Full-year net sales growth now expected to be -5.5% to -2.5% year on year, compared with a previous estimate for -4% to 0%. At the start of its fiscal year, the estimate was for growth of 2% to 6%.
- Full-year diluted EPS guidance of $2.95 to $3.10 compared to a previous estimate of $3.10 to $3.20. BorgWarner started the year estimating $3.35 to $3.55.
- Full-year organic base revenue growth in constant currency now expected to be 7% to 8%, compared to a previous estimate of 9.5% to 12%
What went wrong?
Foreign currency movements obviously played a part in the second quarter; after all, reported sales declined 7%, but were actually up 4% on a constant-currency basis. However, on the earnings release, management laid blame on other factors. Here is how CEO James Verrier put it: "Our growth was affected by an unfavorable mix of light vehicle production in North America, slower light vehicle production growth in China and weak commercial vehicle markets around the world."
Indeed, in the first-quarter earnings release, management mentioned the negative effect of "unfavorable mix of light vehicle production in North America and launch delays in Asia," but concluded that, "We believe these issues are short term and should not impact our full year growth expectations."
Unfortunately, these issues proved to be more long lasting, and BorgWarner isn't alone in seeing weaker conditions in China. For example, on the earnings call for paintings and industrial coatings company PPG Industries, CEO Charles Bunch had this to say on China's auto market: "So now, as we look at some of the forecast for the full year, we're still looking for solid volume growth in builds in China, but more in the area of 3% to 5%, maybe not at that 7% level that we came into the year with."
Given this kind of drop-off in end-market conditions, is it surprising that BorgWarner disappointed in China?
Segmental sales
Turning to the earnings by segment, once again it's the Drivetrain segment that saw the bulk of the impact in the quarter. As you can see in the table below -- where the starred data represents constant-currency figures -- both segments were negatively affected by the stronger U.S. Dollar.
|
Reported Sales ($million) |
Reported Sales Growth |
*Adjusted Sales Growth |
Adjusted EBIT ($million) |
*Adjusted EBIT ($million) | |
|---|---|---|---|---|---|
|
Engine |
1413 |
-5.6% |
7% |
228 |
252 |
|
Drivetrain |
627 |
-11.5% |
-3% |
72 |
76 |
SOURCE: BORGWARNER PRESENTATIONS.
On a more positive note, there was some positive news on sales to a major Drivetrain customer. As discussed previously, the company has been suffering from a "slow ramp up" in production by a major North American customer. However, on the earnings call, management affirmed its belief that the issue would improve in the second half -- somewhat de-risking the company's sales outlook.
The takeaway
All told, the reasons given for the earnings miss and guidance reduction seem to be end-market issues rather than anything to do with BorgWarner's execution. If this is the case, investors should watch macro-economic developments closely, particularly in China. BorgWarner's prospects are always going to be tied to the automotive sector, and there's no doubt that industry conditions weakened in the quarter.
