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We recently downgraded our recommendation on BorgWarner Inc. (BWA">BWA) to Neutral from Outperform. Headquartered in Michigan, BorgWarner is a leading manufacturer of powertrain products for the world's major automakers including Volkswagen AG (VLKAY">VLKAY) and Ford Motor Co. (F - Analyst Report).

Its products include four-wheel-drive and all-wheel-drive transfer cases (primarily for light trucks and sport utility vehicles or SUVs), as well as automatic transmission and timing chain systems.

The company released its third quarter 2011 earnings on October 28, 2011. BorgWarner realized a profit of $1.15 per share, up 64% from 70 cents per share (excluding non-recurring item) in the year-ago quarter.

Net sales surged 27% to $1.79 billion from $1.41 billion in the year-ago quarter on the back of strong demand for the company’s products, which are amenable to improved fuel economy and ensure emission standards.

Operating margin income rose to $198.8 million from $123.0 million in the prior-year quarter. Consequently, operating margin improved to 11% from 9% in the year-ago quarter. The increase was attributable to the company’s cost management measures.

BorgWarner expects net new powertrain business of $2.5 billion from 2012 till 2014, reflecting a 9% increase from its previous three-year net new business. About 80% of the new business is expected to come from engine-related products including turbochargers, ignition systems, emissions products, engine timing systems, variable cam timing modules and thermal systems.

The remaining 20% of the business is expected to emanate from drivetrain-related products such as the company’s fuel-efficient DualTronic transmission technology, traditional automatic transmission and all-wheel drive technologies.

However, BorgWarner faces continued pricing pressure from the OEMs to reduce costs. Annual price reductions to OEM customers have become a permanent feature of its business. The company’s ability to pass through increased raw material costs to its OEM customers is limited, with cost recovery often less than 100% and often on a delayed basis.

Moreover, the company’s high concentration of sales to its major customers such as Volkswagen and Ford also makes it more vulnerable to risks.

Considering all these factors, the shares of BorgWarner are also maintaining a Zacks #3 Rank reflecting a short-term “Hold” rating.

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