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Melrose - sales fall but cash preserved

Nicholas Hyett, Equity Analyst | 7 May 2020 | A A A
Melrose - sales fall but cash preserved

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Melrose Industries plc Ordinary 48/7p

Sell: 169.10 | Buy: 169.20 | Change 4.95 (3.02%)
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Sales over the first four months of the year were down 20% on 2019, as the coronavirus outbreak impacted performance from mid-March.

The group expects to achieve £200m of cash savings in the second quarter from reduction in capital expenditure and working capital. Combined with the dividend suspension, salary cuts and furloughing this meant the group finished April with £1bn of financial headroom - approximately the same as where it started the year.

The group remains unable to provide guidance for full year trading.

The shares rose 2.7% in early trading.

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Our view

Melrose wasn't in peak condition before the coronavirus outbreak struck.

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 to 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.

While exposure to defence markets will provide some shelter for aerospace, the long term outlook for commercial aerospace is pretty bleak. British Airways owner IAG reckons passenger demand won't return to 2019 levels until 2023. Less passengers means less planes, and less planes means less demand for Melrose's products.

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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AGM Statement

Five factories in the Aerospace division are shut, accounting for 5% of sales, while other factories are operating at reduced capacity. Defence factories, accounting for 30% of sales, are expected to be relatively unaffected by the coronavirus outbreak. Overall aerospace sales are down 8% in the first four months of the year.

Automotive and Powder Metallurgy both saw similar trends in the period. Factories accounting for 88% of 2019 sales are closed in whole or in part - although factories in China have reopened and there are signs of a recovery in demand. Across both divisions sales were down 31% year-on-year.

Nortek Air Management and Other Industrial has been less heavily impacted than the other divisions - although sales still fell 12% in the first four months of the year.

Melrose has no debt maturing until September 2022 and leverage covenants have been waived for the period June 2020- December 2020.

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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.