Notes on Dowlais Group plc shifting gears in a bold new era of electric mobility. Will the engine hold?

Dowlais Group plc, a 250-year-old manufacturing titan with roots deep in industrial Britain, has emerged from the shadow of its parent company, reborn for the age of electric vehicles. Once a cornerstone of the combustion engine age, the company now grapples with the seismic shift towards electric vehicles, a transition that threatens to render its core competencies obsolete.

Dowlais? You mean the engineering company?

Yep, that's the one. They're all about advanced engineering—heavy-duty stuff. Think automotive driveline systems, powder metallurgy, and EV components. They specialize in the kind of things that keep modern industry moving: drivetrain systems, e-mobility, and, as mentioned, powder metallurgy.

They’ve been around the block, evolving over time. They used to be part of GKN—a big name in aerospace and automotive. But now, they're leaner, more streamlined. They’ve cut the fat and sharpened their focus since the split, pivoting hard toward electric vehicles and sustainable engineering. They’re betting on the green revolution, and it looks like a smart bet.

Smart bet, if they’ve got the brains and brass to back it up, that is.

Management gets mixed reviews. Some say they’re forward-thinkers, steering the ship in the right direction. Others call them… “pragmatic.” Which, let’s be honest, is often code for cautious, maybe even a little slow to act. But one thing they definitely have is credibility. Customers value consistency, and Dowlais delivers that. It’s not a passionate love affair, but it’s the reliable hand you call when you need a job done right.

Now, some criticisms?

They’ve got a solid foundation, for sure, but they’re not exactly setting off fireworks. Companies like that can go two ways—become rock-solid or just blend into the background. Will they push harder into the next big thing? They’ve got a good start with electric drivetrains, but if they’re not thinking about autonomous vehicles, AI systems, or whatever comes after that, they risk becoming just another replaceable part.

They’ve got potential, no doubt. The real question is: Do they have the guts to seize it?

Dowlais's leadership stands at a crossroads, navigating the automotive industry’s biggest transformation since the Model T. They’re facing skeptical shareholders and industry watchers who, seeing the falling stock price, are demanding immediate results and threatening to break the company up for a quick profit.

Meanwhile, in Dowlais’s R&D labs, engineers are racing against time to perfect revolutionary powertrain systems that could secure the company’s future. Their efforts are sometimes complicated by old-guard executives who see this new direction as a threat to their legacy.

This venerable company, with industrial roots stretching back to 1759, recently emerged from a major corporate restructuring, demerging from Melrose Industries in April 2023. Like a finely crafted piece of work, Dowlais’s true value lies beneath the surface, waiting for the right people to see it.

Dowlais's Heritage and Restructuring:

Dowlais's history is intertwined with GKN and Melrose Industries:

• GKN: Founded in the 18th century, GKN (Guest, Keen & Nettlefolds) became a global engineering giant specializing in aerospace, automotive drivetrains, and powder metallurgy. By the 2010s, facing profitability issues, GKN became vulnerable to a takeover.
• Melrose Industries: A turnaround specialist known for its "buy, improve, and sell" strategy, Melrose acquired GKN in 2018 for ￡8.1 billion. Melrose then divided GKN into three core segments: GKN Aerospace, GKN Automotive, and GKN Powder Metallurgy.
• Dowlais Group: In 2023, Melrose spun off GKN Automotive and GKN Powder Metallurgy into the newly independent Dowlais Group plc, listed on the London Stock Exchange. This allowed Melrose to focus on GKN Aerospace while giving Dowlais autonomy to pursue growth in the EV market and sustainable engineering.

Dowlais's Current Structure and Focus:

Dowlais comprises two main divisions:

• GKN Automotive: A leader in drive systems and EV components, encompassing:

Driveline: Producing sideshafts and propshafts.

ePowertrain: Developing AWD systems, eDrive systems, and related components.

• GKN Powder Metallurgy: A provider of powder metallurgy solutions, offering:

Sintered metal components.

Metal powders.

Additive manufactured components.

Dowlais recently divested its non-core GKN Hydrogen business to focus on its core operations.

Financial Performance and Challenges:

Since its demerger, Dowlais's share price has declined significantly. However, its current valuation (3.5 times EV/EBITDA for fiscal year 2024) presents a potential opportunity for value investors, representing a discount compared to peers. Operating earnings have shown an upward trend, with the potential for increased free cash flow generation if margins improve.

Key financial highlights include:

• Adjusted operating margin of 6.1% for the ten months ending October 31, 2024 (down year-on-year but up from the first half of 2024).
• Automotive division maintained an adjusted operating margin of 6.4%, despite a revenue decline.
• Powder Metallurgy division maintained a consistent 9.0% adjusted operating margin.

Dowlais has also completed a ￡50 million share buyback program.

Challenges include:

• A 20% revenue decline in the ePowertrain segment due to volatility in the EV market.
• Industry forecasts predict a decline in light vehicle sales.
• The transition to a "powertrain agnostic" model presents operational challenges.

Strategic Initiatives:

• Dowlais is implementing several strategic initiatives:
• Portfolio Optimization: Reviewing the GKN Powder Metallurgy business, including potential sale options.
• Margin Expansion: Targeting a 10%+ adjusted operating margin in Automotive over the medium term.
• Cash Generation Focus: Improving free cash flow.
• Portfolio Transition: Securing new business across Driveline and ePowertrain.
• M&A Strategy: Exploring value-accretive acquisitions.
• Sustainability: Pursuing net-zero targets.

Outlook:

Dowlais presents a compelling, if presently challenged, investment thesis for the discerning value investor. Despite revenue and profit gyrations driven by fluctuating EV demand, its relative resilience within the sector has garnered positive market attention. GKN Automotive, the principal revenue generator, boasts a pervasive presence, supplying drivetrain components to a vast swathe of global automakers, thereby mitigating geographic risk.

The long-term narrative remains predicated on the inexorable shift to electric mobility. Dowlais's commanding position within the EV component landscape positions it advantageously to capitalize on this secular trend. However, the order book has seen a deceleration as of late, a consequence of macroeconomic headwinds and dampened consumer confidence. This engenders near-term uncertainty regarding the timing of a market recovery, casting a pall over immediate sentiment.

The potential divestiture of the more resilient Powder Metallurgy division, which constitutes approximately one-fifth of group revenue, necessitates judicious consideration by management to ensure adequate shareholder compensation for the resultant impact on consolidated financials.

Dowlais presents a potential investment opportunity for patient, value-oriented investors. Dowlais occupies a formidable market position, and the long-term trajectory of EV adoption portends well. Nevertheless, this transformative shift is not without its vicissitudes, as reflected in the company's valuation, which languishes at the lower end of its peer group. Ineluctably, given the prevailing volatility within its customer base, further market fluctuations are to be anticipated.

Despite current challenges, the company's strategic initiatives, focus on core strengths, and discounted valuation suggest latent potential. The company's future hinges on its ability to navigate the EV transition, improve operational efficiency, and capitalize on its technological expertise.