Dowlais Group — Automotive production outlook softer

Dowlais Group (LSE: DWL)

Last close As at 20/06/2024

GBP0.72

−0.15 (−0.21%)

Market capitalisation

GBP998m

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Research: Industrials

Dowlais Group — Automotive production outlook softer

Dowlais Group’s shares trade at a significant discount to our fair value. We have lowered our forecasts due to reduced expectations for automotive production and currency impact, but the key to unlocking value remains the group’s margin trajectory. We expect management to confirm that these targets (pre-central cost operating margin over 10% against 7.1% forecast for FY23) remain on track with the impending maiden set of results.

David Larkam

Written by

David Larkam

Analyst, Industrials

Industrials

Dowlais Group

Automotive production outlook softer

Forecast update

Automobiles and parts

26 January 2024

Price

91p

Market cap

£1,267m

Net debt (£m) at 30 June 2023

849

Shares in issue

1,393m

Free float

97%

Code

DWL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(10.7)

(0.2)

N/A

Rel (local)

(8.7)

(3.5)

N/A

52-week high/low

144p

89p

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

2023 preliminary results

21 March 2024

Analyst

David Larkam

+44 (0)20 3077 5700

Dowlais Group is a research client of Edison Investment Research Limited

Dowlais Group’s shares trade at a significant discount to our fair value. We have lowered our forecasts due to reduced expectations for automotive production and currency impact, but the key to unlocking value remains the group’s margin trajectory. We expect management to confirm that these targets (pre-central cost operating margin over 10% against 7.1% forecast for FY23) remain on track with the impending maiden set of results.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/22

5,246

212

N/A

N/A

N/A

N/A

12/23e

5,487

259

13.3

6.8

4.4

4.4

12/24e

5,453

292

14.8

6.0

5.0

4.8

12/25e

5,572

357

18.3

4.9

6.2

6.0

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. FY22 EPS and DPS are unavailable as that period is prior to the demerger from Melrose.

Changes to underlying assumptions and forecasts

The automotive market performed well in 2023 with global sales growth of c 9%. Production was also up strongly as supply chain issues and chip shortages abated. This has led inventories to rise, which is likely to lead manufacturers to adjust production levels in 2024. In addition, there is potential disruption from the current Red Sea shipping issues, as Tesla and Volvo have already reported. Hence, we now expect Dowlais’s automotive business to grow 1%, down from 4%, in FY24, still posting market outperformance. Currencies tend to be volatile. Since mid-2023 the Chinese renminbi has weakened, with the US dollar also softer against sterling of late. We estimate that current foreign exchange levels will have a 2–3% impact on Dowlais’ FY24 sterling reported profits. Our FY23 expectations are unchanged, but we have reduced our more forward-looking forecast; for FY24 we now expect PBT of £292m (down 13% from £337m previously), EPS of 14.8p (down 15% from 17.4p) and DPS of 4.4p (down 15% from 5.2p), and for FY25 we now expect PBT of £357m (down 16% from £427m previously), EPS of 18.3p (down 18% from 22.4p) and DPS of 5.5p (down 18% from 6.7p).

Valuation: Undervaluation continues

We use a discounted cash flow (DCF) and peer group comparison to value Dowlais. Rolling our DCF forward as we enter a new financial year offsets the negative impact from short-term numbers (management’s medium-term margin targets are not expected to change) with a valuation of 187p a share. Our peer group derived valuation is inevitably more affected as it is based on near-term forecasts. Our more generic automotive peer group sees a reduction of 9% to 154p a share. Our higher-quality automotive peer group, the financials of which management’s margin targets and group market shares suggests Dowlais should be able to emulate, has been more severely derated of late, leading to a greater impact on our valuation, which reduces by 29% to 186p. All are significantly ahead of the current share price.

FY24 and FY25 expectations recast

We have reviewed our forecasts in light of two particular changes to external assumptions.

Automotive production now expected to be flat

2023 global automotive sales are expected to be around 86m units, an increase of approximately 9%. However, auto production is expected to have increased to around 90m units as chip and supply chain issues seen in 2022 abated. This has led to a rise in inventories, as highlighted by US auto inventory in Exhibit 1, albeit some way down on pre-pandemic levels, with inventory to sales ratios also on the rise. As a consequence, S&P Global Mobility forecasts 88.3m new vehicle sales worldwide in 2024, representing 2.8% growth, but expects production to be flat at 89.8m units. There is also potential disruption from the current Red Sea shipping issues, with Tesla and Volvo having already reported shutdowns due to component shortages. As a result, we have reduced our expectation for growth from 4% to 1% in 2024. Note that we still expect Dowlais to perform ahead of the end market, continuing the trend reported in the latest trading update.

Exhibit 1: US auto inventory

Source: US Bureau of Economic Analysis

Currency headwind emerging

In FY23, the currency impact was limited, with a small benefit from the euro expected to be offset by weakness in the Chinese renminbi. While it is still early days in FY24, the group’s largest territory, North America (at c 36% of sales in FY22), and the highest margin territory, China (c 12% of group EBIT in FY22), are both facing headwinds. We estimate that if current rates are maintained for the full year there will be a 2–3% translation impact in sterling terms.

Exhibit 2: Key currency movements against sterling (GBP)

Euro

US dollar

Chinese renminbi

FY23 to FY22

(1.0%)

0.1%

3.0%

Current to FY23

0.7%

2.8%

6.6%

Source: Refinitiv

Exhibit 3: GBP per US dollar

Exhibit 4: GBP per Chinese renminbi

Source: Refinitiv

Source: Refinitiv

Exhibit 3: GBP per US dollar

Source: Refinitiv

Exhibit 4: GBP per Chinese renminbi

Source: Refinitiv

Forecast changes

In light of these two issues, we are lowering FY24 and FY25 expectations while leaving FY23 unchanged (full year results are due on 21 March). Note that we do not expect these issues to alter management’s stated medium-term margin targets (Automotive at least 10%, Powder Metallurgy around 14%, translating to c 11% for group).

Exhibit 5: Forecast changes

£m

2024e

2025e

Old

New

Change

Old

New

Change

Revenues

5,799

5,453

(6.0%)

5,939

5,572

(6.2%)

EBITDA

713

679

(4.8%)

800

743

(7.2%)

Normalised operating profit

423

389

(8.0%)

510

453

(11.3%)

Targeted operating profit margin (ex-central costs)

7.6%

7.4%

(0.2%)

8.7%

8.2%

(0.4%)

Normalised PBT

337

292

(13.5%)

427

357

(16.4%)

Normalised basic EPS (p)

17.4

14.8

(14.7%)

22.4

18.3

(18.1%)

Dividend per share (p)

5.2

4.4

(14.7%)

6.7

5.5

(17.9%)

Net cash/(debt) pre IFRS

(854)

(851)

(0.3%)

(748)

(755)

1.0%

Source: Edison Investment Research

Valuation

Here we provide a summary valuation for Dowlais. Our full methodology is available in our 2023 initiation note.

Discounted cashflow valuation

Exhibit 7 flexes our DCF valuation relative to two key variables, the terminal growth rate and the discount rate. Our expectation is for long-term auto growth of 1–2%, while we assume a discount rate at present of 10%.. This would suggest a valuation of 186p a share.

Exhibit 6: DCF valuation per share (p)

Terminal growth rate

Discount rate

0.0%

1.0%

2.0%

3.0%

4.0%

12.0%

128

135

143

153

166

11.0%

146

155

166

180

198

10.0%

168

180

195

214

240

9.0%

195

211

232

260

300

8.0%

229

252

282

325

389

Source: Edison Investment Research

Peer group valuation

Exhibit 8 provides a valuation matrix based on two automotive peer groups. Peer group 1 uses companies with similar operating activities, while Peer group 2 is based on ‘best in class’ companies, generating higher operating margins but in line with Dowlais management’s stated targets (underlying pre-central cost operating margin over 10% against 7.1% forecast for FY23). The average valuation for Peer group 1 is 154p and for Peer group 2 is 186p.

Exhibit 7: Peer group valuation

EV/EBIT (x)

EV/EBITDA (x)

P/E (x)

2023

2024

2025

2023

2024

2025

2023

2024

2025

Peer group 1

American Axle

23.3

16.3

14.7

5.4

4.9

4.9

N/A

28.3

15.9

Borg Warner

7.5

6.9

6.2

5.3

5.0

4.7

8.7

7.8

6.9

Dana

9.7

8.3

7.1

4.8

4.4

4.0

15.6

10.5

7.2

Linamar

5.0

4.5

4.1

3.1

2.7

2.6

7.6

6.8

6.1

Magna

10.3

8.4

7.0

6.1

5.2

4.6

13.6

11.1

9.1

Valeo

8.0

6.2

4.8

2.3

2.1

1.9

9.0

6.1

4.0

Vitesco

10.6

6.2

4.7

3.7

2.8

2.4

17.9

10.6

8.1

Average

10.6

8.1

7.0

4.4

3.9

3.6

12.1

11.6

8.2

Peer group 2

Autoliv

10.8

8.0

6.9

7.5

6.0

5.3

13.6

10.5

8.7

Brembo

9.4

8.8

8.0

5.9

5.6

5.1

11.6

10.8

9.6

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

341

389

453

621

679

743

13.3

14.5

18.3

Peer group 1 valuation (p/share)

193

161

165

127

124

129

161

168

150

Peer group 2 valuation (p/share)

177

166

177

229

212

211

168

154

168

Source: Refinitiv (at 25 January 2024), Edison Investment Research

Overall

The reduction in short-term expectations inevitably has an impact on our peer group-based valuation, a c 8% reduction from our Peer group 1 but a c 29% reduction on Peer group 2, the higher impact reflecting the greater derated of the stocks in light of softer automotive market expectations. Our DCF valuation has been rolled over to 2024. This improves the cash profile given the low margins and restructuring cash spend in 2023, hence our DCF valuation is unchanged at 186p.


Exhibit 8: Financial summary

£m

2022

2023e

2024e

2025e

Year to 31 December

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

5,246.0

5,486.6

5,453.5

5,572.3

Cost of Sales

(3,937.0)

(4,590.6)

(4,526.4)

(4,569.3)

Gross Profit

1,309.0

874.4

927.1

1,003.0

EBITDA

 

594.0

621.3

679.0

742.6

Normalised operating profit

 

333.0

341.3

389.0

452.6

Amortisation of acquired intangibles

(198.0)

(198.0)

(198.0)

(198.0)

Exceptionals

(48.0)

(90.0)

(100.0)

(70.0)

Associate adjustment

(29.0)

(25.8)

(24.6)

(25.1)

Reported operating profit

58.0

27.5

66.4

159.5

Net Interest

(121.0)

(82.0)

(97.4)

(95.6)

Profit Before Tax (norm)

 

212.0

259.3

291.6

356.9

Profit Before Tax (reported)

 

(63.0)

(54.5)

(31.0)

63.8

Reported tax

(14.0)

6.9

1.6

(22.2)

Profit After Tax (norm)

151.8

190.9

212.5

261.4

Profit After Tax (reported)

(77.0)

(47.6)

(29.4)

41.6

Minority interests

0.0

(5.0)

(6.0)

(6.0)

Discontinued operations

0.0

0.0

0.0

0.0

Net income (normalised)

151.8

185.9

206.5

255.4

Net income (reported)

(77.0)

(52.6)

(35.4)

35.6

Basic average number of shares (m)

0

1,393

1,393

1,393

EPS - basic normalised (p)

 

N/A

13.35

14.83

18.34

EPS - diluted normalised (p)

 

N/A

13.35

14.83

18.34

EPS - basic reported (p)

 

N/A

(3.77)

(2.54)

2.56

Dividend (p)

0.00

4.00

4.40

5.50

Revenue growth (%)

0.0

6.8

0.6

2.0

Gross Margin (%)

25.0

16.0

17.0

18.0

EBITDA Margin (%)

11.3

11.4

12.5

13.3

Normalised Operating Margin (%)

6.3

6.2

7.1

8.1

BALANCE SHEET

Fixed Assets

 

5,483.0

5,403.0

5,263.0

5,128.0

Intangible Assets

3,075.0

2,965.0

2,855.0

2,745.0

Tangible Assets

1,813.0

1,843.0

1,813.0

1,788.0

Investments & other

595.0

595.0

595.0

595.0

Current Assets

 

1,450.0

1,527.6

1,535.2

1,559.6

Stocks

498.0

532.0

535.3

546.0

Debtors

638.0

681.6

685.8

699.5

Cash & cash equivalents

270.0

270.0

270.0

270.0

Other

44.0

44.0

44.0

44.0

Current Liabilities

 

(1,472.0)

(1,665.3)

(1,678.2)

(1,716.0)

Creditors

(1,188.0)

(1,269.1)

(1,277.1)

(1,302.6)

Tax and social security

(109.0)

(109.0)

(109.0)

(109.0)

Short term borrowings

0.0

(100.0)

(100.0)

(100.0)

Other

(175.0)

(187.2)

(192.1)

(204.4)

Long Term Liabilities

 

(2,250.0)

(2,190.2)

(2,034.1)

(1,870.2)

Long term borrowings

(1,104.0)

(1,160.5)

(1,130.6)

(1,063.0)

Other long term liabilities

(1,146.0)

(1,029.8)

(903.5)

(807.3)

Net Assets

 

3,211.0

3,075.1

3,085.9

3,101.4

Minority interests

39.0

35.7

36.0

36.3

Shareholders' equity

 

3,172.0

3,039.4

3,050.0

3,065.1

CASH FLOW

Op Cash Flow before WC and tax

516.0

564.6

624.9

687.3

Working capital

(32.0)

34.3

(1.5)

(4.9)

Exceptional & other

(187.0)

(155.0)

(105.0)

(95.0)

Tax

(72.0)

(75.3)

(88.8)

(106.9)

Net operating cash flow

 

225.0

368.6

429.5

480.6

Capex

(219.0)

(290.0)

(310.0)

(282.0)

Acquisitions/disposals

(3.0)

0.0

0.0

0.0

Net interest

50.0

(13.0)

(33.8)

(31.4)

Equity financing

0.0

0.0

0.0

0.0

Dividends

0.0

(21.1)

(61.3)

(71.4)

Other

(2,011.0)

0.0

0.0

0.0

Net Cash Flow

(1,958.0)

44.5

24.4

95.8

Opening net debt/(cash) pre IFRS16

 

(1,038.0)

920.0

875.5

851.1

Closing net debt/(cash) pre IFRS16

 

920.0

875.5

851.1

755.3

Source: Dowlais Group accounts, Edison Investment Research

General disclaimer and copyright

This report has been commissioned by Dowlais Group and prepared and issued by Edison, in consideration of a fee payable by Dowlais Group. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2024 Edison Investment Research Limited (Edison).

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General disclaimer and copyright

This report has been commissioned by Dowlais Group and prepared and issued by Edison, in consideration of a fee payable by Dowlais Group. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2024 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

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Research: Healthcare

Basilea Pharmaceutica — Strong close to FY23 with another milestone payment

Basilea has announced receipt of its first sales-related milestone (for an undisclosed amount) from distribution partner Knight Therapeutics. The payment was triggered by combined Cresemba sales in Latin America exceeding a pre-defined sales threshold. Cresemba continues to see strong market traction for the treatment of invasive aspergillosis and mucormycosis, with the drug reporting in-market sales of US$445m in the 12 months ending September 2023 (+22% y-o-y), reflecting a growing market share in value terms (15% globally and 38% in the US among best-in-class antifungals). In FY23 Basilea recorded around CHF30m in milestone payments for lead product Cresemba, including CHF25m from Pfizer in Europe (>CHF355m in upfront and milestone payments received to date). In December 2023, Cresemba was granted a paediatric label expansion in the US, extending market exclusivity to September 2027 (EU decision anticipated in Q124), by which time we estimate sales to peak at c US$700m.

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