Few companies are as easy to understand as Castings (CGS). It is an iron casting and machining group based in the Black Country town of Brownhills that operates three foundries. The first of these began operations 190 years ago. The other two sites are (relatively) more recent acquisitions – William Lee, based just south of Sheffield, was bought in 1991 and Scunthorpe-based Castings Ductile was purchased last year.

The group consists of four companies. As well as the three aforementioned foundry operators, there is CNC Speedwell, a machining business acquired in the 1990s that sits next to the original foundry in Brownhills. It allows the company to add more value to the parts cast in the foundries.

Its main customers are the big European truckmakers – the likes of Scania, Volvo (SE:VOLV.B) and DAF, so its fortunes are closely tied to that sector.

More than three-quarters of revenue last year was generated through the supply of parts to these truckmakers. Exports made up 85 per cent of sales, and the bulk (88 per cent) of these were to Europe.

This makes it quite a cyclical business, and the high fixed costs involved in running foundries mean its margins can take a hit if demand for trucks slows. This is evident from its most recent set of results. Castings’ sales fell by 21 per cent in the year to March but operating profit dropped by 76 per cent, with the corresponding margin of 2.7 per cent being the lowest since FactSet’s records began in 1988.

There were a few exceptional reasons for this. Although Castings generally passes energy price increases through to customers via surcharges, it has attempted to smooth these out through hedging contracts. These involve buying a certain amount of power upfront, but as volumes fell so did Castings’ power usage, which led to the imposition of £1.5mn of penalties by its provider.

This covers the lifespan of a contract that runs until September, but the hit was taken in last year’s accounts. Volumes of hedged contracts have been scaled back from October onwards, so no further losses are expected.

Secondly, capital expenditure was much higher than in previous years. A new £17mn production line has been installed at the William Lee site, which will increase group capacity by about 15 per cent as it comes on stream in the latter part of this summer.

Finally, there is the investment made in Castings Ductile. Its assets were bought from the administrators of Aim-traded competitor Chamberlin in June. Although Castings paid only £400,000 for a foundry capable of producing much larger castings (of up to seven tonnes), the business needs to be turned around – it lost £1.3mn last year, including £400,000 in non-recurring costs.

Castings chief executive Adam Vicary told investors on a webinar hosted by Yellowstone Advisory that, although demand for that business can also be lumpy, a new sales force brought in last year has helped to drive orders. He is “pretty hopeful that the business will start to make a meaningful contribution to the group during this financial year”.

And although capital expenditure at the group will remain higher this year than its typical level of between £4mn and £5mn a year as the new line at William Lee completes, the bulk of the spending on this has already been made – £11mn of the £17mn build cost came out of last year’s numbers.

It can easily afford this, as another element of Castings’ simplicity is a tidy balance sheet backed substantially by physical assets.

Although last year’s heavy period of investment resulted in a £17mn cash outflow, Castings has no debt. Even if its £2mn of lease liabilities are factored in, the company still has net cash of more than £13mn and a strong track record of cash generation – last year’s cash outflow was the first since the depths of the global financial crisis in 2009.

And the investments should make Castings a more robust business.

It has been investing heavily in automation for the past decade, adding in 65 robotic lines, which typically pay for themselves within two to three years.

Moreover, the additional foundry line and the Castings Ductile plant offer the opportunity to expand the company’s product range – it can produce larger brackets used in the manufacture of electric trucks, as well as parts used in big agricultural machines made by the likes of John Deere. It also plans to make new parts for the wind energy market.

On top of this, Vicary argued that after a couple of years of declining demand in the heavy trucks market, “things do appear to have stabilised, and we are seeing small improvements in demand”.

The European medium and heavy commercial vehicle market contracted by 6.3 per cent last year, and is expected to shrink by a further 6.4 per cent this year, according to S&P Global Market Intelligence. However, things are expected to take a more positive turn from next year. Stricter rules on truck emissions from 2029 onwards are likely to make future models more expensive, both to buy and to run, so replacements of the existing fleet are expected to be made before then to avoid these additional costs, says Spencer Umbeck, a senior specialist at the research company.

The continued softness in the market this year means that even after a 22 per cent decline in the company’s share price over the past 12 months, it still trades at a price/earnings ratio of 17, which is roughly in line with the average rating attached to a comparable peer group that includes Avingtrans (AVG), IMI (IMI) and Rotork (ROR), according to Andy Hanson, an analyst at house broker Zeus Capital.

This is off depressed earnings, though, which Hanson believes will improve this year even on flat revenue as the power cost penalties are removed and the Castings Ductile business in Scunthorpe becomes profitable. He expects adjusted pre-tax profit to nearly double to £9.9mn this year, and further increase to £13mn by 2027 as the core truck market recovers. FactSet estimates that basic earnings per share will increase by about 80 per cent this year, and by a further 28 per cent in 2027.

On other measures, Castings looks cheap. Its strong balance sheet means that its enterprise value (market capitalisation plus debt, minus cash) is lower than peers’, and in terms of the EV/Ebitda multiple favoured by private equity bidders, Castings trades at 5.4 times, compared with the industry average of about 9.

A forecast dividend yield of 6.5 per cent is also tempting for income investors. This is one of the attractions that has caught the eye of Columbia Threadneedle, which in recent weeks has been a substantial buyer, taking its stake in the company from 5 per cent to more than 17 per cent, according to FactSet. Columbia Threadneedle holds Castings shares in a number of funds, including the CT UK Equity Income Fund (GB00BDZYJV10).

A turnaround in Castings’ fortunes may take time, but the investments that depressed last year’s earnings should make it a more efficient and diversified business capable of delivering much greater profit and cash generation as the market turns and operational gearing kicks in.

Its preference for keeping things simple, and for focusing on practical rather than financial engineering, also protects against downside shocks and should mean it continues to maintain its unbroken run of dividend payments stretching back around 40 years.

It shouldn’t be too surprising that the car industry often finds itself part of the political discourse. It is a huge industry that employs a lot of workers with supply chains crossing many borders.

The global auto market is valued at more than $3tn (£2.2tn) and is arguably the most important segment of the industrial sector. If countries want to boost manufacturing, they need to find a way to drive their domestic automotive industry.

There have been plenty of efforts by governments to do just this, although not all have worked out as well as initially hoped. In the 2010s, governments decided to support the transition to electric vehicles (EVs) using both carrots, in the form of subsidy programmes, and sticks, through goals to eventually ban internal combustion engines. But after some political backlash, particularly in the US, a lot of these plans are being put on hold.

The recent spending bill passed by US lawmakers has removed the tax credits offered to people purchasing EVs. Instead of worrying about carbon emissions, the new US government cares more about reducing imports. The policy is to put tariffs on imported cars, such as BMWs (DE:BMW) and Volkswagens (DE:VOW), to boost the competitiveness of domestic manufacturers such as Ford (US:F) and General Motors (US:GM).

This is an obvious issue for European manufacturers. They need to either build new factories in the US or face the tariffs. And even if they do build factories in the US, input costs will rise.

China threat

European car companies are also being squeezed by Chinese manufacturers, such as BYD (HK:1211), which receive help from their government. This increased competition, coupled with slowing Chinese growth, is a problem for BMW. China is its largest market, comprising 29 per cent of total deliveries last year. This is followed by the US with 16 per cent, Germany with 11 per cent and the UK with 7 per cent. The rest came from other European and Asian countries.

A slowdown in China has been dragging on the whole business. In 2024, BMW’s global deliveries dropped 4 per cent to 2.45mn. In China, they were down 13 per cent to 715,000, while in Germany they fell 3 per cent to 266,000. The only markets that grew were the US and the UK. This, combined with falling prices, meant full-year revenue was down 8.4 per cent to €142bn (£122bn). In the first quarter of this year, revenue slipped by 8 per cent to €33.8bn.

In September last year, management downgraded its full-year guidance as it became clear that things weren’t working out as expected. This was due to macro factors, including “general market weakness in China and subdued demand for electric vehicles”.

However, there was also a BMW-specific problem. It discovered issues with an electronic component of its integrated braking system supplied by Continental. BMW said it would incur “a high-three-digit million amount” in warranty costs, which last year forced it to lower its full-year profit margin outlook from 8-10 per cent to 6-7 per cent.

Share price slump

These problems are being reflected in its share price, which has fallen by 30 per cent since April 2024. This has left the company trading on a cheap forward price/earnings (PE) ratio of just 7, and with a dividend yield of 5 per cent.

This affordable valuation has attracted value investors who look for lowly valued stocks on the brink of a turnaround. Third Avenue Value Strategy portfolio manager Matthew Fine believes BMW is “incredibly well financed, and cheap”, and is attracted by the fact that it distributes most of its free cash flow to shareholders through dividends. As a result, he has made BMW one of his top 10 holdings.

“The headwinds in terms of EV transition, the Chinese threats and the tariff issues make BMW hard to forecast over the next four to six quarters, but over the next three to five years it will be very well financed,” said Fine.

The automotive industry is notoriously cyclical, and at the moment there are a lot of negative stories weighing on BMW. However, the core brand is strong, as are Rolls-Royce and Mini. Importantly, it has a strong balance sheet, which allows it to endure a few difficult years. This is helped by a robust car financing arm, with “receivables from sales financing” increasing by 9 per cent to €55bn last year. 

BMW now finances nearly half of its new car sales and, with interest rates still elevated, these loans now generate more income. In the first quarter, its financial services revenue rose 6 per cent to €10.1bn.

BMW’s balance sheet is undervalued compared with its history, with a price-to-book value of just 0.5.

“If you take the whole market cap of the company and strip out the excess cash and minus the financial services company, it is essentially being valued at zero, and that includes the whole automotive business,” explained Fine.

Even though BMW has a strong balance sheet to fall back on, at some point it will need to start selling more cars. Analysts at Deutsche Bank believe next week could be an important step as it presents its new electric platform, Neue Klasse, to investors.

This includes an upgrade in battery technology to increase the range, as well as bidirectional charging and a new driver interface. Many new cars will be launched on this platform by the end of the decade, with the first due to hit production lines by late 2025.  

This reinforces Deutsche Bank’s conviction that “BMW will maintain its leading position among German original equipment manufacturers in the electrification race”.

However, analyst Tim Rokossa acknowledges that it will continue to be difficult to compete in China due to the “aggressive price competition” fuelled by government support. 

“Neue Klasse’s success in China will require a careful balancing act: adapting to local market demands and implementing a pricing strategy that resonates with Chinese consumers,” says Rokossa.

Model S moment

The question is whether it will be able to produce the cars cheaply enough to compete with Chinese rivals, while maintaining a decent level of profitability.

There is hope that this could prove to be BMW’s ‘Model S moment’. This was when Tesla released its first affordable mass-market electric car that was cheap enough to compete in China, propelling it to the position of most valuable car company in the world.

Even if the Neue Klasse platform is a success, it could take a few years to feed through to BMW’s figures. The company only expects a “slight increase” in automotive deliveries this year, and for pre-tax profit tax to remain flat.

Costs were high last year in preparation for the launch of the Neue Klasse platform, “including the ongoing development of the sixth generation of our battery technology”, the carmaker said. This year, management is forecasting that the operating margin will be flat at around 6 per cent, but it should start to improve as delivery volumes rise.

The automotive industry has always attracted a lot of attention. The pushing and pulling of government policy and increasing geopolitical tensions make it hard to forecast in the short term. However, the bigger picture is that it remains a cyclical industry. At the moment, most car companies are struggling, with Tesla reporting this month that its second-quarter deliveries fell by 13 per cent year on year.

Eventually, the cycle will turn back. At that point, Tesla and BMW will both benefit from wealthier consumers and rising demand. The difference between the two manufacturers is that Tesla is valued at 100 times its forward earnings. BMW’s cheap valuation and strong balance sheet give it a much larger margin of error. Not much needs to go right for a re-rating to occur.