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Melrose - dividend cut, guidance not possible

Nicholas Hyett, Equity Analyst | 31 March 2020 | A A A
Melrose - dividend cut, guidance not possible

No recommendation

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Melrose Industries plc Ordinary 48/7p

Sell: 114.00 | Buy: 114.25 | Change -10.70 (-8.50%)
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Trading was in line with management expectations up until March, when the group saw a "significant deterioration" in conditions in its end markets. The group is unable to provide a meaningful outlook at this time.

Management is working to cut costs and preserve cash across all its businesses, including taking advantage of government support. Automotive and Powder Metallurgy factories are largely shut outside China and Japan, while Aerospace continues to operate at reduced capacity.

Melrose has current financial headroom of around £1bn, and secured a covenant waiver for June and December of this year. However, the group has still decided to cut the final dividend due to be paid in May in order to preserve cash.

The shares rose 10.1% in early trading.

View the latest Melrose share price and how to deal

Our view

Melrose isn't in peak condition at the moment.

Buying GKN involved taking on considerable debts, not to mention a sizeable pension deficit. While the new management team has made impressive early progress in improving margins, there hasn't been time to sell off the smaller Powder Metallurgy business and shore up the balance sheet.

Against that backdrop the near complete closure of Automotive and Powder Metallurgy and reduction in activity in Aerospace is unwelcome news. Lower sales reduce cash flow to service the debt today and might see total debt climb as the group draws on existing borrowing facilities to meet expenses.

Fortunately Melrose has access substantial liquidity through its banks. Those lenders have also agreed to suspend rules governing how much the group can borrow relative to cash profits for the next year. If the current lockdowns prove short lived that should keep the group ticking over.

However, the decision to cut the dividend, plans to take advantage of government relief schemes and other cash saving measures are a clear indication of the challenges facing the group. If the lockdowns drag on and sales remain on the floor financial headroom will dwindle.

Nor is the recovery likely to be smooth even after the immediate crisis has passed.

It looks increasingly like we're facing a sharp economic downturn this year. That's bad news for car sales, one of Melrose's key end markets, and will also make disposals of the Powder Metallurgy and smaller Nortek businesses more challenging.

Like many companies Melrose has, suddenly and unexpectedly, become a bit of a waiting game. If lockdowns are short and the long term economic impact modest then this will just be a blip on a long term track record of excellent execution. If coronavirus continues to rock the global economy into the summer and beyond the consequences could be severe.

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Full Year Results - 05/03/20

Full year revenues rose 34% to £ 11.6bn. That mainly reflects the acquisition of GKN, but also strong growth in Aerospace. Operating profits rose 35.5% to £ 1.1bn.

The board proposed a final dividend of 3.4p per share taking the full year payment to 5.1p, up 11% year-on-year.

Aerospace reported revenue growth of 7%, reaching £ 3.9bn, with underlying operating margins rising from 9.9% in 2018 to 10.6%. Operating profits came in at £ 409m. The division saw particular improvement in North America - which moved from a £ 43m loss in 2017 to a small profit this year. The group is monitoring its exposure to the troubled Boeing 737 MAX programme.

Automotive revenues fell 6%, in line with the wider market. Underlying operating margins of 7.7% meant the division posted an operating profit of £ 367m year-on-year. The division continues to focus on cost improvements.

The Powder Metallurgy business made some small acquisitions during the year, boosting revenues to £ 1.1bn. Cost control meant operating profits more than doubled to £ 77m.

Nortek revenues rose slightly this year to £ 1.2bn, with operating profits up 27.5% to £ 139m. Melrose has appointed advisers to explore a sale of the business.

Free cash flow during the year rose 73.7% to £ 290m. Net debt fell 5.7% to £ 3.3bn, equivalent to 2.3 times cash profit.

Find out more about Melrose shares including how to invest

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