Stock Mart: Borg Warner Automotive

Resistance is futile.

Borg Warner Automotive (BWA), a major auto parts supplier, is rumbling toward recovery, and once something like that gets going, it's not easy to stop.

The Borg had a rocky 1998, primarily due to weakness in Asia, strikes at General Motors (GM) and a temporary shortage of V-8 engines at Ford (F). Those problems are mostly behind it now, as Asia has stabilized and Ford has begun to increase V-8 capacity, analysts and investors say.

Borg Warner, based in Chicago, supplies parts to every major carmaker in the world and has three main businesses. All "have good underlying trends," says portfolio manager Bruce Geller of New York institutional money manager Dalton Greiner Hartman & Maher, which owned 165,000 shares at the first quarter's end.

The company's main business is supplying parts that help improve fuel efficiency and reduce emissions. Governments around the world continue to tighten emissions standards and there will continue to be growing demand for increased fuel efficiency.

"That's the concept behind the stock. That's why you want to buy this stock, rather than others in the group," says Matt Stover, an analyst at PaineWebber. (PaineWebber rates the stock an attractive and hasn't done banking for the company.)

Borg Warner's other businesses include automatic transmissions, as well as transfer cases that help cars switch from two-wheel to four-wheel drive.

Trucks with four-wheel drive capability continue to be popular (although growth in that area may be slowing a bit), and automatic transmission hasn't yet fully penetrated many markets, especially Europe.

U.S. carmakers are flush these days with the strong economy fueling consumer confidence. Car economists estimate now that the industry will sell roughly between 15.5 million and 16 million cars and light trucks this year, compared with the 15.6 million sold last year. April sales were particularly strong. Automakers across the world are expanding their plants and offerings.

As with many cyclical stocks, Borg Warner's tough times last year were reflected in its stock. It fell from its high of 68 in April 1998 to close the year at 55 13/16; it's flat overall this year. But signs of perkiness abound. It's recovered 18% since February and closed Friday up 1 11/16, or 3%, at 55 7/16. Analysts think it has further to go. Since late April, seven analysts have raised their 1999 earnings estimates. Wasserstein Perella upgraded the stock to a buy in late March and BT Alex. Brown followed in late April. Neither has participated in recent offerings for the company.

The Borg is expected to pull in $2.37 billion in revenue this year, up from $1.84 billion in 1998. With its market capitalization of $1.4 billion, the company is trading at a price-to-sales ratio of 0.59. Value managers typically look for a ratio of less than one. Dalton Greiner's Geller says that while the company is trading at around 11 times 1999 earnings, a price-to-earnings ratio of 14 is more reasonable. "Given that the S&P is at 30 times, it's not much of a stretch," says Geller.

Geller's not alone in that belief that multiple expansion is at hand. In a note earlier this month on the auto parts suppliers, PaineWebber's Stover noted that the auto parts companies are trading at discounts to their historic levels. Typically, the stocks trade at a 10% to 30% discount to the S&P 500; now the auto supply group is trading at around a 60% discount. Among his top three picks is Borg Warner.

According to First Call, the company is expected to earn $5.02 a share this year, up from $4 last year. That reflected a drop from $4.31 in 1997. But over the last five years, EPS growth has averaged 12%. Earnings are expected to grow to $5.69 a share in 2001, a 13% growth over the 2000 estimates.

Geller is impressed with the company's management. "The management team is strong. They are very smart guys." He's particularly pleased that the company's cash flow margins are above the industry average. The acquisition of cooling systems turbocharger maker Kuhlman, which closed in March, has boosted margins and helped position the company for the expected business boom from raised emissions standards.

Stover says management is "very aggressive on the cost side. You can't go into a [Borg Warner] manufacturing plant and find a receptionist. That's just an example, but it shows a cost-control culture."

Geller says the fact that the industry is consolidating bodes well for the Borg, too. "There's lots of opportunities in a consolidating industry. They could be a buyer or be bought themselves," he says.

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