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The Dowlais Group (LSE:DWL) is a FTSE 250 an engineering business I hadn't heard much about until this year. But the more I looked, the more I thought there might be incredible value here.
The stock looks cheap, at about 8 times free cash flow and a dividend yield of 7.5%. But the interesting things are just beginning.
What Dowlais did
Dowlais has two stages of operation. This was supposed to be tripled by 2023, but the company has since abandoned its hydrogen storage solution.
The biggest part is the performance of the cars. It accounts for about 80% of its revenue and produces the drive systems that are used in about half of all light vehicles worldwide.
Another part of the company is the powder metal business. It is the market leader in this sector and has more than 3,000 customers.
In its interim report in August, Dowlais announced it was considering selling its Powder Metallurgy division. And that's where I think the potential opportunity is for investors.
By 2023, Powder Metallurgy generated revenue of just over £1bn and £96m in operating profit. Since then, sales have declined slightly, but operating income has remained strong.
The obvious question is what Dowlais can do about selling the project. It's hard to predict exactly, but at today's prices, I think there is a large margin of safety.
I think a conservative forecast would have the Powder Metallurgy business selling for 3 times operating income. That would generate around £288m.
The thing is, Dowlais has a market capitalization of £730m. That means investors could be left with a core car business that made £306m in operating income last year at a price of £442m.
Unbelievable exchange?
As I see it, this may be the kind of opportunity for investors that doesn't come along very often. I'm very interested, but I have a lot to think about.
The first is that the auto business – the segment investors should be leaving behind – has been struggling in 2024. Sales in this part of the company fell by 10% in the first half of the year.
Investors should be aware of this, but it's also good to remember that management says this is due to the decline in car sales. And I expect this will correct itself over time.
That is why the share price has been falling. But I think the stock has reached a point where the value offered to investors more than justifies the risk.
Looking beyond the exterior
Dowlais recorded negative earnings for the first half of 2024, making the stock look expensive and suggested that dividends are at risk of being cut. I don't think any of this is true.
The reason why the profit was negative was due to the deterioration of the Powder Metallurgy business. Despite this, the company made just over 4p per share.
If Dowlais decides to sell this part of the company – and does so successfully – I think the stock could look incredibly cheap. I am looking to start buying it in November.
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