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GKN - CEO designate departs, further write downs

Nicholas Hyett | 16 November 2017 | A A A
GKN - CEO designate departs, further write downs

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On 16 November GKN announced a £80-£130m write-off is expected as a result of a working capital review of its US Aviation business. The review follows a £15m non-cash charge relating to a plant in Alabama announced in October.

The group also announced that CEO Designate Kevin Cummings would be leaving the company with immediate effect, with current CEO Nigel Stein still expected to retire on 31 December. Non-Executive Director Anne Stevens will step in as Interim Chief Executive from 1 January.

The shares fell 7.7% in early trading.

This follows an unscheduled trading update on 13 October when GKN announced it was expecting to take a £40m charge in the fourth quarter relating to two "external claims" - one in Aerospace and one in Driveline. Full year profits before tax at that time were expected to be only slightly above last year.

Our view

As feared, the unexpected write-downs and charges in October have been followed by more nasties.

Significant working capital write-offs are very unwelcome and detail on what actually lies behind the "external claims" remains thin on the ground. £40m is equivalent to 5% of last year's operating profits, and looks set to wipe out any profit growth in 2017.

The board have taken drastic action. But while losing one CEO is unfortunate, effectively losing two at once starts to suggest carelessness. Hopefully whoever takes over from last minute substitute Anne Stevens, gets to kick a ball before they're unceremoniously shoved out the plane door.

Struggling margins in the aerospace business, which generates annual sales of £3.4bn, is adding to shareholder pain. Fortunately the large automotive divisions continue to perform well. Investment in electric drivetrains is weighing on margins at the moment, but is vital to manage a transition to electric vehicles.

In the long term, the pressure will mount for GKN to do the splits, with Aerospace and Automotive going their separate ways. At present though the £1.8bn pension fund deficit binds the group together. With that in mind, GKN should be considered more leveraged than a cursory glance at the net debts of £700m would suggest.

The stock is not highly rated, partly as a result of the pension-induced de facto leverage, partly because of the exposure to the volatile automotive market, and partly (we suspect) because investors are unsure what is going to emerge next. Currently, GKN trades on 9.6 times expected earnings, which well below the rating of many other UK industrials.

GKN is undoubtedly in a mess at the moment, which is a shame, because it's historically been a solid, if unexciting business. Recent share price falls have driven the prospective dividend yield of 3.2% but even if a new CEO can get the business back under control, until the pension situation is sorted out, it's unlikely to be going anywhere fast.

Third Quarter Trading Update

GKN Aerospace saw sales in commercial aerospace slow slightly in the quarter, with military sales ahead of the prior year.

However margins in the division have been "disappointing", as operational challenges, pricing pressure and the end of certain programmes all weighed on performance. These headwinds will continue into the fourth quarter, although will be offset by a one-off retrospective pricing adjustment of £20 million.

By comparison, the performance of GKN Driveline has been good, with sales well ahead of 2% global automotive growth. Even including the impact of the Q4 claim, Driveline's margin is expected to be similar to last year.

Organic sales growth continued at GKN Powder Metallurgy, despite a decline in US automotive production rates, as it continued to benefit from currency translation and acquisitions in China and Turkey. Growth includes passing higher raw material prices on to customers, which also reduces reported margins slightly.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.