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Melrose - Progress in Aerospace and Powder Metallurgy

Nicholas Hyett | 14 November 2018 | A A A
Melrose - Progress in Aerospace and Powder Metallurgy

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Melrose Industries plc Ordinary 48/7p

Sell: 0.00 | Buy: 0.00 | Change -168.45 (-100.00%)
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An unscheduled trading update on the 13 November saw Melrose reveal good revenue growth in the GKN aerospace and powder metallurgy businesses, with margins also improving. Automotive revenues were flat.

The shares rose 6.1% on the day of the announcement.

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Our view

Melrose is a strange beast, and has a more in common with a private equity firm than a normal listed business. It buys struggling industrial groups, improves their performance and sells them on.

Since listing on AIM in 2003 with a market capitalisation of £13m, the group reckons it has created around £5bn in shareholder value. It has delivered an average annual return on investment of some 25% a year.

Of course there's no guarantee it can replicate that performance going forwards, and its most recent deal - acquiring automotive and aerospace engineer GKN in the largest hostile takeover the UK has seen in years - is its biggest to date. Big transactions always come with risk, and investors are placing a lot of trust in management to be able to execute a complex deal well.

GKN joins an existing portfolio that includes ventilation and air conditioning specialist Nortek and generator group Brush, but dwarfs both. It's the success of Melrose's turnaround of GKN's aerospace and automotive businesses that matters.

It's still very early days, but Melrose has plans to improve margins at both businesses through a combination of investment and reducing costs. The first step has seen Melrose strip out the central GKN management team, allowing each of the underlying businesses to function independently. Initial progress is said to be good.

One of the side effects of the deal has been a dramatic increase in debt. The group has also taken on GKN's sizeable pension deficit which has a significant claim on proceeds from asset sales.

The need to settle some of these liabilities probably explains why Melrose is already looking for a buyer for GKN's powder metallurgy business. £270m of the proceeds from any sale need to be paid into the pension, but it was never a major focus for Melrose, so an early get out makes sense.

Going forwards, Melrose's 'turnaround and sale' approach means the dividend shouldn't be the major pull - although the 3% prospective yield is certainly welcome. Instead investors will have to wait for the more unpredictable capital returns that follow a disposal. Given the need to pay down debt, those are likely be some time away. But if Melrose can stick to form, the long term rewards could be substantial.

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Trading Update

Aerospace has seen revenue grow 6% on last year, with "good progress" on margins, including in North America. The Powder Metallurgy operation saw revenues rise 9%, with margins climbing there too. The group's confident it can meet its 14% margin target in the medium term.

Automotive revenues are flat year-on-year, despite industry disruption. Margins also deteriorated, although management is confident it can deliver improvements from 2019.

Sales are flat at Melrose's other businesses, which include Nortek. They have been negatively affected by US/Chinese tariffs, although this isn't expected to be material for the Melrose group.

Net debt and net cash are in line with management expectations and the group is on course to meet market expectations for the full year.

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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.