More Watchlist candidates
And some updates on current active ideas
I have raised my price for new and existing subscribers (at renewal). If you are a monthly existing subscriber, the price won’t go up. New price is €325 from €225 previously. You should have received an email about this, if you scroll to the bottom of that email you can cancel (first renewal should be early April when I put up my paywall).
Given the performance and quantity of active ideas I thought I was undercharging a bit at €225.
I will be writing more articles about random stocks that piqued my interest as opposed to only writing about stocks that are high conviction. Splitting up stock picks into watchlist and portfolio candidates.
First one is Dowlais (DWL). They will likely merge with American Axle in a part stock and part cash merger. I laid out some details here:
As you can see (with some serious caveats, more on that below) the stock could be insanely cheap a few years out. A 1.5x 2028 PE ratio. And 2.6x EV/EBITDA multiple.
Current upside in a merger arb for DWL holders if the merger closes is 15%. With 60/40 cash/shares.
I have had DWL on my watch list for a year but couldn’t get comfortable with what was happening with the Chinese auto industry annihilating Western auto market share. It is still a bit unclear to me how exposed auto suppliers are to this. It does appear both companies do have some exposure to the Chinese market though. And there is likely little EV risk as their components are both needed in ICE and EV vehicles. But AXL has nearly 40% exposure to GM (which has been insourcing EV axle’s) Stellantis (16%) and Ford (12%). Dowlais which would be about 50% of Newco has a more diversified customer base. Newco customer base would look like this:
Mix of newco would be 75% Driveline and 25% Metal forming:
I think the big caveats to that <2x PE ratio can be summed up as follows:
Needs $300m of synergies to come through
No more sizable declines of customer market share to Chinese car companies
No more insourcing of car companies, like happened with GM to appease unions (they did win Stellantis contracts after that though)
No large recession (average age of average Western car is quite high at 12-13 years though)
Material restructuring expenses actually need to go close to 0
I count at least 5 things here that need to go right for this to be really cheap.
The last point has also held me back from buying Dowlais (together with the pension liability). I made an attempt to guess Dowlais earnings and it looks something like this:
(It looked way cheaper even 6 months ago, but had to be downwardly adjusted multiple times. So I am very happy with my decision to not buy any shares so far.)
Management guided for restructuring to be complete by 2026 which will cause a material increase in Free cash flow. My guess is that they will have to keep paying into their pension liability until 2030.
So putting it all together, the combined company will be very cheap, but a bunch of different things will have to go right (probably at least 3 out of 5 items on the above list of bullet points). And debt load is sizable, so if margins do get crushed downside will still be material.
Might be an interesting merger arb play though, I do think Dowlais to be the better company long term. There might be a risk this is voted down by DWL holders as AXL shares jumped on the merger. But that risk is probably small. The deal is done on a rather low EV/EBITDA multiple. But as you can see that EBITDA figure needs several sizable asterisks, and on a PE basis the stock is not all that cheap here currently. Especially since other auto part suppliers trade at similar cheap multiples (with much better FCF profiles).
By my calculation you would break even here if the merger closes (by year end) and AXL shares are at $3 by year end (vs $4.5 now). I don’t think the current spread is large enough though, especially Trump and his trade war, but it is for sure one to keep an eye on. I think if the wide spread persists through summer, it will be a buy.
VIC autopart write-ups with more info on DWL (2024) DWL (2023), AXL, AAP .
No position in any of the shares mentioned.