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Melrose - good progress in GKN turnaround

Nicholas Hyett, Equity Analyst | 5 March 2020 | A A A
Melrose - good progress in GKN turnaround

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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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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.

The shares rose 1.9% in early trading.

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Our view

Melrose buys struggling industrial groups, improves their performance and sells them on. In some respects it's got more in common with a private equity firm than a conventional listed business.

The group's 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.

So far things seem to be going off without a hitch. Step 1 saw Melrose strip out the central GKN management team, allowing each of the underlying businesses to function independently. Spending on R&D and targeting an Asian expansion are early indicators of where the investment will go. Margins look to be improving, through a combination of investment and reducing costs, and while revenue growth isn't top of the agenda there have been promising signs there too.

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. Big transactions always come with risks, and increased debt levels only exacerbate that.

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. Longer serving portfolio member Nortek is also on the block - with proceeds from a sale used to pay down debt, reduce the pension deficit and the remainder returned to shareholders.

Going forward, Melrose's 'turnaround and sale' approach means the dividend shouldn't be the major pull - although the 2.7% prospective yield is certainly welcome. Instead investors will have to wait for the more unpredictable capital returns that follow a disposal. If Melrose can stick to form the long term rewards could be substantial, but there's still plenty of work to do.

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Full Year Results

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.

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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.