Dowlais Group — Powder Metallurgy in the spotlight

Dowlais Group (LSE: DWL)

Last close As at 23/08/2024

GBP0.65

−0.10 (−0.15%)

Market capitalisation

GBP887m

More on this equity

Research: Industrials

Dowlais Group — Powder Metallurgy in the spotlight

Weaker global automotive production in 2024 is proving a challenge for Dowlais Group. Benefits from the restructuring programme and market recovery in 2025/26 should still see target double-digit margins achieved, driving earnings and cash generation. More important in the short term is the announced strategic review of Powder Metallurgy (PM). This could offer a step change in the market’s appreciation of the value of the company’s portfolio of assets.

David Larkam

Written by

David Larkam

Analyst, Industrials

Industrials

Dowlais Group

Powder Metallurgy in the spotlight

Interim results

Automobiles and parts

19 August 2024

Price

64p

Market cap

£885m

Net debt (£m) at 30 June 2024

915

Shares in issue

1,375m

Free float

98.2%

Code

DWL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(5.4)

(17.7)

(42.6)

Rel (local)

(6.7)

(16.8)

(49.2)

52-week high/low

128.05p

58.7p

Business description

Dowlais Group is an automotive components group with two core divisions: GKN Automotive is the market leader in drive systems for both ICEs and EVs, and GKN Powder Metallurgy is the leader in sintered component manufacture and number two in metal powders.

Next events

Trading update

28 November 2024 (provisional)

Analyst

David Larkam

+44 (0)20 3077 5700

Dowlais Group is a research client of Edison Investment Research Limited

Weaker global automotive production in 2024 is proving a challenge for Dowlais Group. Benefits from the restructuring programme and market recovery in 2025/26 should still see target double-digit margins achieved, driving earnings and cash generation. More important in the short term is the announced strategic review of Powder Metallurgy (PM). This could offer a step change in the market’s appreciation of the value of the company’s portfolio of assets.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/22

5,246

212

(15.3)

0.0

N/A

N/A

12/23

5,489

264

13.8

4.2

4.6

6.5

12/24e

4,987

207

11.0

4.2

5.8

6.5

12/25e

5,107

247

13.4

4.2

4.9

6.5

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

H124 results

Underlying sales declined by 5.1% due to weakness in ePowertrain (c 25% of group sales), reflecting the disruptions being seen in the EV market as adoption growth rates have slowed. The other activities – Driveline (-1%), China (+7%) and PM (+0.2%) – outperformed their markets. Adjusted operating profit fell 9.0% to £151m, with margin declines limited to 30bp (5.9%) as management actions on costs and restructuring limited the drop through. These actions, including plant rationalisation in North America, are expected to improve the operating margin in H2. Adjusted PBT of £95m (down 26%) was further affected by financing costs following the demerger. EPS of 4.9p was down 30%. The dividend is held at 1.4p/share. Net debt increased to £915m, net debt/EBITDA 1.6x.

Corporate activity

Management has announced a strategic review of the PM business, with a disposal an obvious possibility in the array of options to be considered. The group has also sold its loss-making hydrogen storage business (£7m in H124), reflecting the investment required and significantly improving group cash flow.

Outlook and forecasts

Management is guiding to a ‘mid to high single-digit adjusted revenue decline and adjusted operating margin between 6.0% and 7.0%’ for FY24. We have also factored in an additional currency impact. We forecast adjusted PBT of £207m (from £247m) and adjusted EPS of 11.0p (from 13.1p) in FY24 and adjusted PBT of £247m (from £297m) and adjusted EPS of 13.4p (from 16.1p) in FY25.

Valuation: Discount to peers with potential catalyst

A combination of automotive share price weakness (the sector is down c 20% from its peak in April) and reduced expectations for Dowlais affects our peer-based valuation. Our drivetrain automotive peer group-derived valuation comes to 107p/share (from 143p) and our aspirational double-digit margin automotive peer group valuation comes to 138p/share (from 182p). Arguably more important is the potential catalyst of the PM strategic review in highlighting the value of the portfolio.

Interim results

Overview

Underlying sales declined by 5.1% due to weakness in the ePowertrain product line in the Automotive business (c 25% of group sales), reflecting the disruptions being seen in the EV market as adoption growth rates have fallen short of expectations. Driveline, China and PM outperformed their markets. Adjusted operating profit fell by 9.0%, with margins down 30bp from the lower volumes, although management actions and the restructuring limited the drop-through impact.

Exhibit 1: Adjusted headline results

£m

H123

H124

Change (constant FX)

Revenue

2,830

2,571

-5.1%

Adjusted operating profit

177

151

-9.0%

Adjusted operating margin

6.3%

5.9%

-30bp

PBT

139

95

-26%

Basic EPS (p)

7.2

4.9

-30%

DPS (p)

1.4

1.4

0%

Source: Dowlais Group

Automotive

Driveline, the core powertrain-agnostic business, outperformed the end-market with an underlying sales decline of 1% against a production rate decline of 2.4% in the light vehicle market excluding China. The longstanding China JV grew 7%, outperforming market growth of c 4%, with continued gains with local original equipment manufacturers (OEMs) and Dowlais supplying all of the top 10 largest manufacturers. ePowertrain declined by 20%, driven by a double-digit decline in All-Wheel Drive systems (AWD) largely due primarily to market disruptions from the lower EV volumes in Europe in three programmes and launch delays to a fourth in North America, highlighting the potential impact when value per vehicle can be more than £1,000 against £50–100 for Driveline. Management action limited the impact on profit, with drop through to 17% from the standard 30%, while the division also benefited from a strong profit performance in China.

Exhibit 2: Adjusted Automotive performance

£m

H123

H124

Change (constant FX)

Driveline

1,272

1,209

-1%

ePowertrain

714

538

-20%

China

258

259

7%

Other

39

38

3%

Total revenue

2,283

2,044

-6%

Operating profit

149

122

-13%

Operating margin

6.5%

6.0%

-50bps

Source: Dowlais Group

Order intake remains positive with an intake lifetime value of £2.4bn. This is below the £3bn in the previous year, reflecting lower wins in the EV business (53% of book in 2024 against 78% in 2023), in line with the future market but also reflecting the re-evaluation taking place by OEMs of the EV transition pathway.

Powder Metallurgy

Sales were broadly flat, outperforming automotive markets, which account for c 80% of sales. EV and powertrain-agnostic body and chassis components grew 3%, while the more internal combustion engine (ICE) orientated chassis and transmission business declined by 1%, in line with the market. Underlying operating margins pre-FX impact improved 50bp, benefiting from the resolution of some of the operational issues experienced in FY23.

Exhibit 3: Adjusted PM performance

£m

H123

H124

Change (constant FX)

Sinter

417

400

-0.5%

Additive

13

14

19.0%

Powder

115

113

0.9%

Total revenue

545

527

0.2%

Operating profit

50

50

6.0%

Operating margin

9.2%

9.5%

50bps

Source: Dowlais Group

Order intake grew 10%, with 53% to transmission-agnostic sectors. The nascent magnets business continues to generate interest with an increase in quotations from OEMs and tier one suppliers.

Cash flow

Cash flow witnessed the normal seasonality in working capital, which is expected to unwind in H2, strong dividend payments from the group’s Chinese JV of £70m and continued high restructuring spend (the programme is due for completion in FY25). Free cash generation was broadly flat with shareholder returns from dividends (£39m) and commencement of the share buyback programme (£9m) leading to net debt of £915m up from £849m at end FY23, with net debt/EBITDA of 1.6x.

Exhibit 4: Group cash flow

£m

H123

H124

Adjusted operating profit

177.0

151.0

Adjusted EBITDA

306.0

281.0

Equity accounted investments

(27.0)

(43.0)

Adjusted operating EBITDA

279.0

238.0

Net change in working capital

(55.0)

(50.0)

Restructuring & other

(82.0)

(71.0)

Pension etc

(11.0)

(9.0)

Operating cash flow

131.0

108.0

Net interest

(20.0)

(46.0)

Dividends received

33.0

70.0

Total tax paid

(28.0)

(26.0)

Net capex

(122.0)

(101.0)

Free cash flow

(6.0)

6.0

Equity dividends paid

0.0

(39.0)

Shares issued/(repurchased)

(7.0)

(9.0)

Net cash flow

29.0

(40.0)

Source: Dowlais, Edison Investment Research

Corporate activity

Management’s focus on shareholder value as a sole listed entity following the demerger from Melrose has led management to reassess the shape of the group. This has seen two significant actions in the year:

Strategic review of PM: Dowlais has announced a strategic review of the PM business, reflecting the Tier 2 nature of the business and limited fit against the Tier 1 nature of the Driveline business, and confirming a process it committed to at the time of demerger in 2023. Melrose first looked at selling the business in 2018, with the press reporting offers of c £1.6bn. Clearly, much has changed since then with returns lower, interest rates higher and the business having to navigate the ICE/EV transition. Indeed, in the H124 results the NAV for PM is £860m (assets: £1,251m, liabilities: £391m). This translates to an EBIT multiple of 9.0x and EBITDA multiple of 5.9x based on FY23 results. The strong market position of the business (market leader in sinter and number two in metal powders) suggests it is a premium asset that should attract broad interest. However, the strategic review will consider alternatives including the potential to being in partners to assist developing the nascent magnets business.

Disposal of hydrogen: as part of the demerger portfolio, Dowlais inherited an early-stage hydrogen storage technology business, using metal powders to effectively absorb hydrogen, which could then be released. As the business is at an early stage, it requires significant investment and incurs large losses (H124: £7m loss reported). The drain in terms of cost and cash, along with the inevitable uncertainties, arguably exacerbated by the slow adoption of hydrogen, has led management to dispose of the business to Langley Holdings for a nominal consideration. While the transaction will incur an asset impairment of £18m (£10m of which was accounted for in H1), it also eliminates the significant future cash drain.

Outlook

The shorter-term outlook is challenging, with automotive production now expected to be down c 2% in the year with the majority of this in the second half. The volatility being seen in the EV market appears set to continue, reflecting the slower growth in adoption rates. Management has limited profit drop through in the first half (automotive ePowertrain 17% versus the standard 30%) and will take further actions as end-markets necessitate.

The longer-term outlook remains more robust, with the market expected to show a CAGR of 2–3% in 2025–26, offering positive operational gearing. In addition, management remains confident that the current restructuring will offer 200bp of margin upside. Indeed, management retains its medium-term target of 10%+ operating margins.

Guidance and forecasts

Management has guided to a ‘mid to high single-digit adjusted revenue decline for 2024 and an adjusted operating margin between 6.0% and 7.0% in constant currency, as commercial recoveries, restructuring savings and ongoing performance initiatives limit the impact on operating profit from lower volumes’. This suggests a slight deterioration in end-markets, which S&P now forecasts to be down 2% for the year globally. We note that the slowdown in EV adoption in particular is now appreciated by OEMs, which should assist future scheduling in this segment, while the company will continue to benefit from the restructuring programmes.

In addition, we note the following:

Currency movements are currently negative for the group. Rates for the remainder of the year would affect revenue by £200m (£114m impact in H1) and EBIT by £17m (£10m impact in H1).

Hydrogen losses will be eliminated from the second half post disposal but the business will not be reclassified as a ‘loss on disposal’.

Central costs were lower than anticipated in H1 but guidance for the full year remains unchanged.

Exhibit 5: Changes to forecasts

£m

FY24e

FY25e

Old

New

Change

Old

New

Change

Revenues

5,350

4,987

(6.8%)

5,477

5,107

(6.8%)

Adjusted operating profit

356

314

(12.0%)

406

360

(11.3%)

Targeted operating profit margin (ex-central costs)

7.3%

7.1%

(0.2%)

8.2%

7.8%

(0.4%)

Adjusted operating profit margin

6.7%

6.3%

(0.4%)

7.4%

7.1%

(0.3%)

Adjusted PBT

247

207

(16.4%)

297

247

(16.7%)

Basic EPS (p)

13.1

11.0

(15.8%)

16.1

13.4

(16.9%)

Dividend per share (p)

4.2

4.2

0.0%

4.8

4.2

(13.1%)

Net cash/(debt)

(852)

(907)

6.5%

(794)

(899)

13.3%

Source: Edison Investment Research

Valuation

Our preferred method for valuing Dowlais is peer based. Peer group 1 has drivetrain/powertrain operations along with other predominantly automotive activities. Peer group 2 comprises automotive stocks generating double-digit EBIT margins, in line with the company management’s target.

Exhibit 6: Peer valuation

Market cap

EV/EBIT (x)

EV/EBITDA (x)

P/E (x)

£m

2024e

2025e

2024e

2025e

2024e

2025e

Dowlais

810

5.5

4.8

2.9

2.7

5.4

4.5

Peer group 1

American Axle

600

13.6

12.8

4.5

4.4

20.7

11.8

Dana

1,179

7.7

6.5

3.9

3.6

10.8

6.6

Linamar

2,202

4.4

4.2

2.8

2.7

6.1

5.8

Magna

8,740

7.7

6.7

4.6

4.1

9.7

8.2

Valeo

1,972

7.3

5.4

2.3

2.0

7.7

4.1

Vitesco

1,784

5.3

3.6

2.0

1.7

9.7

6.8

Median

7.7

6.5

3.3

3.1

10.8

7.2

Peer group 2

Autoliv

5,963

8.6

7.1

6.2

5.3

11.1

8.8

Borg Warner

2,753

9.0

8.1

5.5

5.1

11.0

9.7

Brembo

5,675

7.5

6.9

5.3

4.9

7.8

6.8

Median

8.4

7.3

5.7

5.1

10.0

8.4

Dowlais financials (EBIT (£m), EBITDA (£m), EPS (p))

314

360

589

640

11.0

13.4

Peer group 1 valuation (p/share)

120

122

89

91

119

97

Peer group 2 valuation (p/share)

128

125

179

170

110

113

Source: Edison Investment Research, LSEG Data & Analytics. Note: Priced at 15 August 2024.

A combination of sector weakness (the auto sector is down c 20% from its peak in April) and reduced expectations for Dowlais inevitably affects these relatively short-term valuation metrics. Our average peer group 1 valuation comes to 107p/share (down from 143p/share) and our average peer group 2 valuation comes to 138p/share (down from 182p/share).

Exhibit 7: Financial summary

£m

2022

2023

2024e

2025e

2026e

Year to 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

5,246

5,489

4,987

5,107

5,280

Cost of Sales

(3,937)

(4,611)

(4,139)

(4,188)

(4,277)

Gross Profit

1,309

878

848

919

1,003

EBITDA

 

 

594

618

589

640

694

Operating profit (before amort. and excepts.)

 

333

355

314

360

360

Amortisation of acquired intangibles

(198)

(197)

(197)

(197)

(197)

Exceptionals

(48)

(578)

(169)

(40)

(10)

Associate adjustment

(29)

(30)

(26)

(27)

(27)

Reported operating profit

58

(450)

(79)

97

179

Net Interest

(121)

(91)

(107)

(113)

(112)

Finance exceptionals

19

Profit Before Tax (norm)

 

 

212

264

207

247

301

Profit Before Tax (reported)

 

 

(63)

(522)

(185)

(16)

67

Reported tax

(14)

27

40

(3)

(24)

Profit After Tax (norm)

152

198

155

186

226

Profit After Tax (reported)

(77)

(495)

(145)

(19)

43

Minority interests

(5)

(6)

(6)

(7)

(8)

Net income (normalised)

147

192

149

179

218

Net income (reported)

(82)

(501)

(151)

(26)

35

Average Number of Shares Outstanding (m)

0

1,393

1,353

1,333

1,333

EPS - normalised (p)

 

 

(15.3)

13.8

11.0

13.4

16.3

EPS - normalised fully diluted (p)

 

 

(15.3)

13.8

11.0

13.4

16.3

EPS - basic reported (p)

 

 

N/A

(36.0)

(11.2)

(1.9)

2.6

Dividend (p)

0.0

4.2

4.2

4.2

4.9

Revenue growth (%)

0.0

6.3

(6.7)

2.0

3.2

Gross Margin (%)

25.0

16.0

17.0

18.0

19.0

EBITDA Margin (%)

11.3

11.3

11.8

12.5

13.1

Normalised Operating Margin (%)

6.3

6.5

6.3

7.1

7.8

BALANCE SHEET

Fixed Assets

 

 

5,483

4,717

4,572

4,442

4,322

Intangible Assets

3,075

2,365

2,255

2,145

2,035

Tangible Assets

1,813

1,751

1,716

1,696

1,686

Investments & other

595

601

601

601

601

Current Assets

 

 

1,450

1,517

1,441

1,462

1,497

Stocks

498

510

476

486

501

Debtors

638

628

586

598

617

Cash & cash equivalents

270

313

313

313

313

Other

44

66

66

66

66

Current Liabilities

 

 

(1,472)

(1,446)

(1,490)

(1,514)

(1,561)

Creditors

(1,188)

(1,179)

(1,101)

(1,123)

(1,158)

Tax and social security

(109)

(100)

(100)

(100)

(100)

Short term borrowings

0

(2)

(100)

(100)

(100)

Other

(175)

(165)

(190)

(192)

(202)

Long-term Liabilities

 

 

(2,250)

(2,222)

(2,040)

(1,959)

(1,860)

Long-term borrowings

(1,104)

(1,158)

(1,120)

(1,112)

(1,057)

Other long-term liabilities

(1,146)

(1,064)

(920)

(847)

(803)

Net Assets

 

 

3,211

2,566

2,482

2,432

2,399

Minority interests

39

36

34

32

31

Shareholders' equity

 

 

3,172

2,530

2,449

2,399

2,367

CASH FLOW

Operating Cash Flow

516

537

518

569

620

Working capital

(32)

18

10

(4)

(7)

Exceptional, pension & other

(187)

(168)

(155)

(95)

(85)

Tax

(72)

(61)

(52)

(62)

(75)

Net operating cash flow

 

 

225

326

321

407

452

Capex

(219)

(262)

(260)

(282)

(294)

Acquisitions/disposals

(3)

0

0

0

0

Dividends received from JV

59

63

70

56

58

Net interest

(9)

(63)

(94)

(98)

(97)

Free cash flow

 

 

53

64

38

83

118

Equity financing/buy-back

0

(7)

(35)

(15)

0

Dividends paid

0

(26)

(61)

(60)

(63)

Other

(1,971)

0

0

0

0

Net Cash Flow

1,038

31

(58)

8

55

Opening net debt/(cash)

 

 

(1,918)

880

849

907

899

Closing net debt/(cash)

 

 

880

849

907

899

844

Source: Dowlais Group, Edison Investment Research

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United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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SIGA Technologies — PALM 007 data warrant a closer look in mpox

Although the topline results of PALM 007 (studying SIGA’s tecovirimat in the treatment of mpox) did not meet the statistical significance for the full population (primary endpoint), we are encouraged by the clinically meaningful benefit reported over placebo in early-treated patients and in those with severe disease. The data highlight an opportunity to establish an effective regime for these key populations, given the lack of effective treatment options and the overall importance of early treatment in infectious diseases. PALM 007 was not a registrational study, and SIGA’s priorities in mpox are the four remaining ongoing studies targeting this indication, which may potentially support a mpox label in the US. Currently, tecovirimat is approved for mpox treatment in the EU and UK.

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