DBRS Confirms BorgWarner at BBB (high), Trend Changed to Stable

DBRS has today confirmed the senior unsecured debt rating of BorgWarner Inc. (BWA or the Company) at BBB (high). DBRS has, however, changed the trend from Positive to Stable. The trend change reflects sharply deteriorating market conditions worldwide that have reduced the Company’s earnings prospects over the near to medium term. The ratings confirmation, in turn, reflects BWA’s ongoing strong business profile, with the Company’s core products very well positioned in light of the global trend toward more fuel-efficient vehicles driven by volatile fuel prices and tightening emissions regulations across major markets.

BWA recently announced a revised downward profit outlook for 2008. The Company stated that it now expects net profit before special items for 2008 to be in the range of $215 million to $230 million; this would represent a decline in net earnings of up to 25% over 2007 levels. The profit warning is a function of weak automotive markets that prevailed throughout 2008, but which have become much worse in recent months as aggregate demand has contracted sharply from already poor levels, given restricted access to credit and much lower consumer confidence. These factors have also led to significant sales decreases in Europe as the American economic crisis has proliferated globally. Emerging automotive markets have been adversely impacted as well, with lower growth rates achieved in 2008.

In response to the weakening demand and automotive production, BWA has slowed production across its operations, with facilities in North America and Europe subject to extended holiday shutdowns. Additionally, many European plants have also switched to a four-day work week for an indefinite period of time. By year-end 2008, the Company had reduced its global workforce by approximately 2,900 people.

Despite the current severe market downturn, DBRS notes that BWA’s fundamental business profile remains strong and that, over the long term, the global automotive market will continue to grow. While the Company is not immune to the well-documented challenges of the Detroit 3, BWA’s exposure is relatively modest with the North American operations of the Detroit 3 representing approximately 12% of total 2008 sales. Additionally, the Company’s leading technology positions enable it to defend margins much better than its automotive supplier competitors.

The Company’s two primary products, turbochargers (which increase the performance of smaller displacement engines), and dual-clutch transmissions (automatic transmissions based on the fuel efficient architecture of a manual transmission) have very good growth prospects going forward, given increasing emission regulations across mature automotive markets. Volatile fuel prices have also contributed to a shift in segmentation away from large SUVs and pick-up trucks toward smaller, more efficient vehicles, further boosting demand for BWA’s products. The Company recently announced net new business volumes in the amount of $2.1 billion from 2009 through 2011. Of the new business, only 10% is sourced from the Detroit 3; geographically, 50% is to be sourced from Europe, with Asia and the Americas representing 30% and 20% respectively.

DBRS also notes that BWA’s financial profile remains well commensurate with the assigned rating. As of September 30, 2008, the Company’s total debt-to-capitalization ratio stood at 24%. Coverage measures were also solid with EBITDA-to-interest and cash flow-to-total debt levels of 19.2 times and 0.83 times respectively. BWA’s liquidity is also strong with $136 million in cash balances and a $600 million unsecured revolver that remained unutilized as of September 30, 2008, which combined are readily sufficient to cover the Company’s $137 million bond due in February, 2009.

BWA should prove relatively resilient to the automotive downturn. Despite the revised profit outlook, DBRS notes that the Company is expected to remain free cash flow positive (before working capital items) and generate operating margins for 2008 above 6%; which remains very favourable among automotive suppliers. While earnings in 2009 will likely also be below historical levels, the Company remains very well positioned to benefit from the long-term growth prospects of the automotive industry, particularly where smaller, more fuel-efficient vehicles are concerned. BWA remains acquisitive and a large debt-financed acquisition would trigger an event-driven revision of the rating. Absent such an acquisition, DBRS expects the rating to remain constant over the near to medium term, with a positive rating action remaining possible over the long term once the current crises in mature automotive markets subside and the global automotive industry resumes a steady growth rate, fuelled primarily by continued gains in emerging markets. However, in the event that protracted production declines in the near term result in significantly weaker results that would adversely impact BorgWarner’s financial profile, a negative rating action would be considered.

Notes:
All figures are in U.S. dollars unless otherwise noted.
The applicable methodology is Rating Automotive Suppliers, which can be found on our web site under Methodologies.
This is a Corporate (Autos and Auto Parts) rating.