Dowlais Group — Vigo: The benefits of restructuring and investment

Dowlais Group (LSE: DWL)

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Research: Industrials

Dowlais Group — Vigo: The benefits of restructuring and investment

A visit to the Vigo plant provided tangible evidence of the restructuring and investment undertaken to improve the cost base required to deliver management’s margin targets as automotive markets recover. The shift to electric vehicles (EVs) is also key. Management expectation is for the business to be drivetrain agnostic with upside potential from complete eDrive systems. Details of contract wins will be key to confirming this. Delivery of margins and the EV transition will promote Dowlais as a premium automotive company offering the potential for valuation enhancement.

David Larkam

Written by

David Larkam

Analyst, Industrials

Industrials

Dowlais Group

Vigo: The benefits of restructuring and investment

Site visit

Automobiles and parts

19 June 2023

Price

127p

Market cap

£1,779m

Net debt (£m) at 31 December 2022

834

Shares in issue

1,393m

Free float

97%

Code

DWL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(0.9)

N/A

N/A

Rel (local)

0.4

N/A

N/A

52-week high/low

144p

117p

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

Interim results

12 September 2023

Analyst

David Larkam

+44 (0)20 3077 5700

Dowlais Group is a research client of Edison Investment Research Limited

A visit to the Vigo plant provided tangible evidence of the restructuring and investment undertaken to improve the cost base required to deliver management’s margin targets as automotive markets recover. The shift to electric vehicles (EVs) is also key. Management expectation is for the business to be drivetrain agnostic with upside potential from complete eDrive systems. Details of contract wins will be key to confirming this. Delivery of margins and the EV transition will promote Dowlais as a premium automotive company offering the potential for valuation enhancement.

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

4.0

9.5

3.1

12/24e

5,799

337

17.4

5.2

7.3

4.1

12/25e

5,939

427

22.4

6.7

5.7

5.3

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

Margin target pathway

The target operating margin for the group is 11% with the Automotive division 10%+ as volumes return to 2019 levels. The previous capital markets day in January provided an overall divisional perspective of the restructuring actions taken. The Vigo plant provides a microcosm of what is happening at the plant level. A significant increase in automation (over 140 robots are now in use) along with changes to material layout and flows and the use of automated guide vehicles, rather than traditional forklift trucks, have reduced costs by c 6% of sales as well as assisting in quality and health and safety.

Powertrain agnostic

The accelerating shift from internal combustion engines (ICEs) to EVs is critical for Dowlais. For the key Automotive division, management’s expectation is for the main sideshaft business to benefit from increasing penetration (more four-wheel drive) and increased size given the higher torque requirements, while the propshaft business is set to decline. The overall impact will therefore depend on the conversion from all-wheel drive (AWD) to electric offtake. The EV system will be less complex and lower value, but fitment rates are expected to be higher, leading to an overall benefit for the eDrive components business. Success in the eDrive systems offers upside potential. Evidence of this pathway will be critical in terms of eDrive bookings (note the recent trading update included ‘Bookings were healthy with the majority relating to BEV platforms’), with a detailed update likely with the interim results.

Valuation unchanged

The recent trading update suggested a positive start to the year with 9% growth in revenues at constant currency and operating margins similar to FY22 and 200bp up on the softer H122. Management expectations for the year are unchanged. Hence our forecasts and valuation remain unchanged from our initiation note.

Margin pathway and Vigo plant restructuring

Automotive restructuring overview

Dowlais management has previously provided guidance for 11% operating margins for the group, including 10%+ for the Automotive division and 14% for the Powder Metallurgy division when automotive markets recover to 2019 levels. Given that Automotive accounts for c 80% of revenue, improvement in the Automotive division will be the key driver. Actions undertaken include:

Operations: number of plants reduced from 54 to 47, with a shift from c 40% to c 50% of capacity in best cost locations.

Fixed costs: headcount has been reduced by 12% from 23,300 to 20,500 along with investment to improve internal efficiencies.

Purchasing: focus on lowest landed cost of components rather than lowest price.

This improved cost base delivered margins of 5.9% in 2022 (4.6% in 2021) against 7.7% in 2019, despite an 8% decrease in the overall automotive market (including even greater weakness in the key European and North American markets).

Vigo driveline plant

Dowlais hosted an analyst site visit to a key European manufacturing plant in Spain to demonstrate the strength of the business and the restructuring programme benefits.

Profile

Based in a free-trade zone in the city of Vigo in north-west Spain and next to a Stellantis OEM facility, the Vigo plant forms a core part of Automotive network of 18 manufacturing sites in Europe. Vigo manufactures complete sideshaft systems (50% of activity) and components for other group assembly plants (50% of activity). Cast and forged ‘blank’ components from internal group and third-party suppliers are machined, heat treated and assembled at Vigo. The site also has a prototyping department as well as its own machine building/automation department to customise machines and maximise the benefits of the automation programme.

Restructuring

The key elements to the restructuring of the plant have been the significant increase in automation along with a redesign of the material workflows. Manufacturing automation has seen over 140 robots installed to automate individual cells capable of bin picking, machining or assembly, inspection and palletising/packing. This has reduced operator requirements, enabling a single operator to control two cells rather than one, providing direct cost savings. This has also improved quality and reduced material utilisation and scrap. Material flows have been redesigned to reduce the distance material travels in the facility, also assisting efficiencies. Key has been the investment in centrally controlled automated guide vehicles rather than human driven forklift trucks for transportation within the plant. Additional benefits from the investment have included improved quality and health and safety.

Benefits

The restructuring has seen headcount reduce from over 1,000 to c 780 generating €26.6m of savings and adding c 5% to margins as labour costs reduced from 20.5% to 15.0% of sales. Value analysis and value engineering including reduced material wastage have generated a further €6.1m of savings. The company does not provide details on performance at an individual plant level but the cost savings amount to c 6% or double the overall improvement required from the 7.7% overall margin generated in 2019 to reach the target of 10%+.

Additional benefits include improved quality and improved health and safety, both ergonomic from reduced manual labour requirements and reduced accidents, benefiting in particular from the removal of forklift trucks in the facility.

Electrification pathway

The automotive industry transition to EVs is accelerating. Management expects to be powertrain agnostic with upside potential.

Sideshafts

Electric drivetrains are required to handle increased torque range, higher absolute torque levels due to the increased vehicle weight from the battery and to accommodate regenerative braking. This is expected to lead to a 5% increase in the size of the sideshaft. There will also be greater focus on noise, vibration and harshness (NVH) due to the reduced noise of an electric motor, while OEMs are also looking for increased product longevity due to the anticipated increased lifespan of an EV. This will increase the complexity and hence the engineering requirements, which should prove positive for GKN Automotive as the market leader.

Management expects the fitment rate for sideshafts to increase from 2.1 to 2.4 per vehicle by 2030. This will be driven by the increased penetration of four- wheel drive, particularly in battery electric vehicles (BEVs) and an anticipated adoption of rear steering. Note that even ICE powered vehicles are expected to see an increase assisted by changes such as the move from a rigid rear axle to an active system in pick-ups and off-road vehicles.

Exhibit 1: Sideshaft fitment rates

ICE

BEV

Average

2019

2.1

2.3

2.1

2030e

2.2

2.7

2.4

Source: Dowlais Group

Propshafts

Propshafts are expected to become obsolete as the cost of an electric motor and performance permits placement of a motor at both the front and rear axles rather than a single front-mounted power unit with the torque transmitted to the rear through a propshaft.

Torque management systems

AWD systems control the power to the driveshafts, enabling torque vectoring and improved performance, particularly road handling. The move to electric motors, in particular the orientation of the motor and its torque characteristics, will change the requirements of the drive system. For instance, hypoid gears, which translate the power from longitudinal orientation to transverse to the driveshafts, will move to more simple helical gears. On the other hand, greater use of disconnects is likely due to the improved efficiency and hence range achieved through not operating both motors on a four-wheel drive platform in cruise mode.

Management’s expectation is that the value of a system is likely to reduce, but that fitment rates, currently around 20%, will increase to 100% and possibly above given the likelihood of two motors per vehicle, providing overall growth to the market.

eDrive systems

Full systems, known as 3-in-1, are made up of a motor, transmission (geared offtake system) and invertor, all overlayed by control software. GKN Automotive has the capability to manufacture the motors and gears (as in the current contract for a 2-in-1 system on the Fiat 500e) but outsources the invertor manufacture to specialist electronics companies from its own in-house design. It also designs the software, which is integral to the overall package.

Traditional powertrain companies, engine and transmission manufacturers, are focusing on this market as a direct replacement for their ICE related activities. This includes the vehicle OEMs, which have significant legacy capital invested and workforces they are reluctant to restructure. Hence at present high levels of in-sourcing and competitive tendering are being seen, which had dampened management’s enthusiasm for this activity, particularly given its over-riding margin aspirations.

However, the business has won a full 3-in-1 system contract with a new German OEM platform, due to be launched in 2024 (full details have not yet been released) and management sees potential in specialist vehicles where lower volumes reduce the attractiveness to high-volume manufacturers and OEMs, leading to increased outsourcing of the system, including design, where GKN Automotive already has a proven track record.

Overall EV pathway expectations

Exhibit 2 demonstrates management’s expectation of the impact of the EV transition on the GKN Automotive business. Inevitably, the performance will depend on actual contract wins. The strong market share and technology position in sideshafts provides a strong base, with the key to achieving a powertrain agnostic position being the development of eDrive components. This leaves the eDrive systems as optionality for market outperformance.

Exhibit 2: EV pathway expectations

Current % of revenue

Growth rate

Sideshafts

53%

+20–30%

Propshafts

11%

-100%

Torque Management (AWD and eDrive components)

30%

+40–50%

Sub-total

94%

+5%

eDrive systems

6%

Source: Dowlais Group


Exhibit 3: Financial summary

2021

2022

2023e

2024e

2025e

2026e

Year to 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

4,731.0

5,246.0

5,486.6

5,798.9

5,939.4

6,225.0

Cost of Sales

(3,542.0)

(3,937.0)

(4,608.7)

(4,813.1)

(4,870.3)

(5,042.2)

Gross Profit

1,189.0

1,309.0

877.9

985.8

1,069.1

1,182.7

EBITDA

 

515.0

594.0

622.5

712.7

800.1

866.8

Normalised operating profit

 

242.0

333.0

342.5

422.7

510.1

576.8

Amortisation of acquired intangibles

(191.0)

(198.0)

(198.0)

(198.0)

(198.0)

(198.0)

Exceptionals

(144.0)

(48.0)

(90.0)

(100.0)

(70.0)

(60.0)

Associate adjustment

(28.0)

(29.0)

(30.5)

(32.3)

(32.9)

(34.2)

Reported operating profit

(121.0)

58.0

24.1

92.4

209.2

284.6

Net Interest

(133.0)

(121.0)

(83.3)

(86.1)

(83.5)

(77.6)

Joint ventures & associates (post tax)

Finance exceptionals

Profit Before Tax (norm)

 

109.0

212.0

259.3

336.6

426.7

499.2

Profit Before Tax (reported)

 

(254.0)

(63.0)

(59.2)

6.3

125.7

207.0

Reported tax

(44.0)

(14.0)

6.9

(9.3)

(38.1)

(57.9)

Profit After Tax (norm)

74.8

151.8

189.7

248.1

316.4

371.2

Profit After Tax (reported)

(298.0)

(77.0)

(52.3)

(3.0)

87.7

149.1

Minority interests

0.0

0.0

(5.0)

(5.0)

(5.0)

(5.0)

Discontinued operations

0.0

0.0

0.0

0.0

0.0

0.0

Net income (normalised)

74.8

151.8

184.7

243.1

311.4

366.2

Net income (reported)

(298.0)

(77.0)

(57.3)

(8.0)

82.7

144.1

Basic average number of shares (m)

0

0

1,393

1,393

1,393

1,393

EPS - basic normalised (p)

 

N/A

N/A

13.26

17.45

22.35

26.29

EPS - diluted normalised (p)

 

N/A

N/A

13.26

17.45

22.35

26.29

EPS - basic reported (p)

 

N/A

N/A

(4.11)

(0.57)

5.93

10.34

Dividend (p)

0.00

0.00

3.98

5.23

6.71

7.89

Revenue growth (%)

0.0

0.0

4.4

5.4

2.0

4.0

Gross Margin (%)

25.1

25.0

16.0

17.0

18.0

19.0

EBITDA Margin (%)

10.9

11.3

11.3

12.3

13.5

13.9

Normalised Operating Margin (%)

5.1

6.3

6.2

7.3

8.6

9.3

BALANCE SHEET

Fixed Assets

 

8,814.0

5,483.0

5,403.0

5,263.0

5,128.0

4,998.0

Intangible Assets

6,476.0

3,075.0

2,965.0

2,855.0

2,745.0

2,635.0

Tangible Assets

1,742.0

1,813.0

1,843.0

1,813.0

1,788.0

1,768.0

Investments & other

596.0

595.0

595.0

595.0

595.0

595.0

Current Assets

 

1,230.0

1,450.0

1,500.1

1,564.4

1,589.3

1,639.9

Stocks

436.0

498.0

520.0

548.2

559.1

581.3

Debtors

505.0

638.0

666.2

702.3

716.2

744.7

Cash & cash equivalents

275.0

270.0

270.0

270.0

270.0

270.0

Other

14.0

44.0

44.0

44.0

44.0

44.0

Current Liabilities

 

(1,392.0)

(1,472.0)

(1,636.4)

(1,722.1)

(1,764.4)

(1,833.6)

Creditors

(1,008.0)

(1,188.0)

(1,240.4)

(1,307.7)

(1,333.7)

(1,386.6)

Tax and social security

(111.0)

(109.0)

(109.0)

(109.0)

(109.0)

(109.0)

Short term borrowings

0.0

0.0

(100.0)

(100.0)

(100.0)

(100.0)

Other

(273.0)

(175.0)

(186.9)

(205.4)

(221.7)

(238.0)

Long Term Liabilities

 

(1,270.0)

(2,250.0)

(2,101.2)

(1,927.2)

(1,724.8)

(1,511.2)

Long term borrowings

0.0

(1,104.0)

(1,071.5)

(1,023.7)

(917.6)

(790.2)

Other long term liabilities

(1,270.0)

(1,146.0)

(1,029.8)

(903.5)

(807.3)

(721.0)

Net Assets

 

7,382.0

3,211.0

3,165.5

3,178.2

3,228.1

3,293.2

Minority interests

33.0

39.0

37.9

38.2

39.4

41.0

Shareholders' equity

 

7,349.0

3,172.0

3,127.6

3,140.0

3,188.7

3,252.2

CASH FLOW

Op Cash Flow before WC and tax

449.0

516.0

555.5

641.7

727.7

791.5

Working capital

6.0

(32.0)

(10.1)

(13.0)

(5.1)

(10.3)

Exceptional & other

(181.0)

(187.0)

(165.0)

(115.0)

(105.0)

(105.0)

Tax

(37.0)

(72.0)

(76.5)

(97.4)

(121.3)

(140.8)

Net operating cash flow

 

237.0

225.0

303.9

416.3

496.3

535.3

Capex

(159.0)

(199.0)

(325.0)

(280.0)

(287.0)

(294.0)

Acquisitions/disposals

(13.0)

(3.0)

0.0

0.0

0.0

0.0

Net interest

43.0

50.0

(25.4)

(24.8)

(20.9)

(12.6)

Equity financing

0.0

0.0

0.0

0.0

0.0

0.0

Dividends

0.0

0.0

(21.0)

(63.8)

(82.2)

(101.4)

Other

176.0

(1,945.0)

0.0

0.0

0.0

0.0

Net Cash Flow

284.0

(1,872.0)

(67.5)

47.8

106.1

127.4

Opening net debt/(cash)

 

754.0

1,038.0

(834.0)

(901.5)

(853.7)

(747.6)

Closing net debt/(cash)

 

1,038.0

(834.0)

(901.5)

(853.7)

(747.6)

(620.2)

Source: Dowlais Group accounts, Edison Investment Research

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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.

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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 2023 Edison Investment Research Limited (Edison).

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United Kingdom

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United States

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London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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BlackRock Greater Europe Investment Trust — Europe is undervalued and under-owned

BlackRock Greater Europe Investment Trust (BRGE) is managed by Stefan Gries, who seeks to invest in the best wealth-creating businesses on a minimum three- to five-year view. The process has proved successful as the trust’s NAV has outperformed the Europe ex-UK market over the last one, three, five and 10 years. BRGE is one of seven funds in the AIC Europe sector, and its NAV total returns rank first over the last one, five and 10 years. It has also generated very acceptable double-digit absolute total returns over the last decade: NAV and share price are both +10.9% pa.

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