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

DBRS has today confirmed the rating of the Senior Notes of BorgWarner Inc. (BWA or the Company) at BBB (high), while changing the trend to Positive from Stable. The trend change reflects the Company’s strengthening business profile, as tightening emissions regulations and sharply increasing oil and fuel prices have created a structural shift toward more fuel-efficient vehicles, thereby increasing demand for BWA’s core products. The ratings continue to incorporate the Company’s steadily improving financial profile, as demonstrated by its consistent growth and profitability, with solid cash generation enabling BWA to significantly de-leverage its balance sheet in recent years, resulting in credit metrics well commensurate with the rating.

Continuously increasing emission regulations across global automotive markets have resulted in steady demand growth for 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). This has been supplemented by recent sharp increases in oil and fuel prices, which have resulted in a rapid shift in segmentation away from large SUVs and pick-up trucks toward smaller, more-efficient vehicles, further boosting demand for BWA’s products. Additionally, the Company’s products are of a high technological content, affording BWA considerable pricing power, with margins consistently well above industry averages.

BWA has also benefited from increasing geographic diversification. Sales to Europe and Asia, which together represented approximately 34% of total revenues in 2000, are expected to account for close to 70% of projected 2008 sales. Similarly, customer diversification has also improved as sales to the Detroit Three have dropped significantly over this time period, from a level of 47% to a forecasted 12%. This has considerably mitigated the Company’s exposure to these OEMs’ SUV and light-truck platforms, whose production volumes has dropped considerably, in line with decreasing demand.

Despite the above, BWA does face some challenges. Margins remain constrained by the continuously increasing costs of raw materials, namely nickel, steel, copper, aluminum and resin. While the Company was successful last year in passing through the majority of nickel price movements to customers, BWA is currently faced with surcharges associated with sharply higher steel prices. Additionally, despite the aforementioned improvement in its geographic diversification, the Company remains materially exposed to the Detroit Three and the North American automotive industry, which has been subject to significant contraction in sales and production volumes owing to the well-documented economic challenges in the United States. However, these challenges are amply offset by the Company’s positive business prospects, with BWA well-positioned to capitalize from very strong growth rates in emerging automotive markets. Should the Company’s results prove resilient to the difficult North American market over the near term and continue to improve, a rating upgrade would be likely.

DBRS notes that BWA remains acquisitive, which combined with a newly authorized share repurchase program, could adversely affect the Company’s financial profile. However, DBRS expects the Company to be financially prudent in these endeavors. While a large debt-financed acquisition would trigger an event-driven revision to the rating, DBRS expects any associated transaction to be structured such that the Company’s credit metrics remain well within investment grade territory.