Interactive Investor

Why shares in former GKN business Dowlais are worth buying

7th June 2023 15:34

by Graeme Evans from interactive investor

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The automotive engineer is one to own as margins improve, reckons this City expert. It thinks the shares could be worth 20% more than the current share price.

The GKN Automotive business behind this year’s biggest stock market debut has been added to a City bank’s “buy” list after analysts initiated coverage with a 20%-plus upside for shares.

Jefferies regards Dowlais Group (LSE:DWL), which is worth about £1.7 billion after splitting from “buy, improve, sell” owner Melrose Industries in April, as an ideal way to play the auto recovery.

About 80% of the company’s sales are generated by the Automotive division, with the rest coming from Powder Metallurgy operations. There’s also an early stage hydrogen business, focused on transforming the way energy is stored.

Jefferies said this week that Dowlais benefited from a focus on achieving best-in-class profitability, as well as exposure to the electrification and China growth stories.

The US bank initiated Dowlais with a price target of 155p, which compares with 117p on the day of its demerger and today’s 126.5p.

GKN Automotive generated about £4.2 billion of revenues in 2022, supplying 90% of global manufacturers and contributing technology to about 50% of all vehicles. However, no single customer represents more than 14% of its sales.

It is the world’s leading drive system supplier, with a growing electric vehicle order book accounting for over 40% of new business in 2022. In Powder Metallurgy, the growth opportunities include sintered rare earth magnets for electric motors.

Under the ownership of Melrose, the Dowlais businesses sat in the UK industrials peer group, but Jefferies believes it should now be valued in line with the auto suppliers.

It places the stock at the expensive end of the auto supplier peer group given the margin profile and competitive position.

The bank said work undertaken since the acquisition by Melrose in 2018 had left the businesses in a much stronger position, although much of this has been masked by the impacts of the pandemic on the auto industry.

However, it notes the ambition to improve the Automotive margin from a forecast of around 6.4% this year to the company’s target of 11%, which would make it best-in-class.

Jefferies said: “We see Dowlais as a high-quality auto supplier with attractive margin enhancement potential as the auto recovery comes, although we do not see it as overly dependent on volumes or cost recovery.”

In the company’s maiden trading statement last month, it said it had delivered £1.9 billion of adjusted revenue in the four months to 30 April for 9% growth at constant currency. Adjusted margins were up by over 200 basis points on the same period the previous year.

Chief executive Liam Butterworth called it “a very encouraging start to the year”. He added: “As markets continue to recover, we are increasingly confident of delivering sector leading financial performance, based on our proven financial model and continued execution of our restructuring programs. We remain excited about the future."

Jefferies values the stock at 8.2 times 2024 earnings, which is a modest discount to the total auto supplier peer group but a 10% discount to its US-dominated closest competitors in driveshafts and powertrains. It compares with a current valuation of 7.2 times.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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