FTSE 250 manufacturer Dowlais (LSE:DWL) has just released its trading update for the 10 months to the end of October. And the news has sent the firm’s shares soaring 17%.
The stock was down 55% before Wednesday’s (13 November) announcement. But I think the company is doing the right things and the share price looks like a potential bargain.
The headline news
Dowlais has two operating units. The automotive business makes drive systems and the powdered metal division makes sintered metal components.
Things haven’t been going well during the first six months of 2024. Sales fell 5% and earnings per share declined by 30%.
That continued in the third quarter, with the decline in overall revenues for the year increasing to 6%. Automotive revenues fell 7% as electric vehicle production slowed and powdered metal sales dropped 1.9%.
That isn’t especially encouraging and the risk of this continuing is real. But beyond the performance of the underlying business, there are a couple of positive signs.
Buybacks
The income statement has been ugly in 2024. But I think Dowlais has been very intelligent with the cash it has been generating.
Over the last few weeks and months, the company has been aggressively using its cash for share buybacks. As a result, the number of shares outstanding has been falling.
The firm has £915m in net debt – which is more than its current market cap. And that might make investors question the wisdom of repurchasing shares at this point.
I understand the concern. But with the stock trading at such a low level, I think management is doing the right thing to add long-term value for shareholders.
Valuation
With the stock moving higher, Dowlais has a market cap of £770m. In the context of £4.2bn in (adjusted) revenues during the first 10 months of the year, that doesn’t look like a lot to me.
The company’s profits are still depressed as a result of ongoing restructuring costs. But the powder metallurgy business has made £527m during the first half of the year.
In August, Dowlais announced that it was looking into selling this part of the company off. If this happens, it could be a big catalyst to push the share price higher.
If the firm can use the proceeds to clear its debt, shareholders could be left with a strong automotive business still trading at a very cheap price. I think the potential rewards are well worth considering even with the risks.
Outlook
I expected the Q3 update to cause a big move in the Dowlais share price – in either direction. Sales falling further would make 2024 a very bad year, but any improvement could make the stock look very cheap.
When it comes to my investment thesis though, short-term earnings are beside the point. I think the stock is significantly undervalued and I’m looking for the company to unlock this.
I believe the firm repurchasing shares while they’re cheap and trying to realise the value in its powdered metals business are good moves. I’ve been buying the stock and I expect to continue.
This post was originally published on Motley Fool
