Dowlais Group (LSE:DWL) is a FTSE 250 engineering business that I hadn’t heard much about until this year. But the more I look, the more I think there might be unbelievable value here.

The stock looks cheap, at around 8 times free cash flow and with a 7.5% dividend yield. But the interesting stuff’s just getting started.

What Dowlais does

Dowlais consists of two operating divisions. This used to be three in 2023, but the firm’s since disposed of its hydrogen storage solution. 

By far the biggest division is the automotive operation. This makes up around 80% of revenues and manufactures drive systems used in around half of all light vehicles globally.

The rest of the company’s a powdered metals business. It’s the market leader in this industry and has over 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 could be for investors.

In 2023, Powder Metallurgy generated just over £1bn in revenues and £96m in operating profits. Since then, sales have declined slightly, but operating income’s been steady.

The obvious question is what Dowlais might make by selling the operation. It’s hard to forecast exactly, but at today’s prices, I think there’s a big margin of safety.

I think a conservative forecast might have the Powder Metallurgy business selling at 3 times operating income. That would generate around £288m.

The thing is, Dowlais has a market-cap of £730m. That means investors could be left with the core automotive business that made £306m in operating income last year at a price of £442m.

An unbelievable bargain?

As I see it, this could potentially be the kind of opportunity for investors that doesn’t come around very often. I’m very interested, but there’s more to think about.

The first is that the automotive business – the part that investors are set to be left with – has been struggling in 2024. Sales in this part of the firm were down 10% in the first half of the year.

Investors should take note of this, but it’s also worth keeping in mind that management’s attributing this to car sales slowing. And I expect this to remedy itself with time.

That’s why the share price has been falling. But I think the stock has reached the point where the value on offer for investors more than justifies the risks. 

Looking past the surface

Dowlais recorded negative earnings in the first half of 2024, making the stock look expensive and suggesting the dividend’s in danger of being cut. I don’t think either of these is the case.

The reason profits came in negative was due to a goodwill impairment in the Powder Metallurgy business. Without this, the firm made just over 4p per share.

If Dowlais decides to sell off this part of the company – and does so successfully – I think the stock could look incredibly cheap. I’m looking to start buying it in November.