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Melrose - trading ahead of expectations

Sophie Lund-Yates, Equity Analyst | 6 May 2021 | A A A
Melrose -  trading ahead of expectations

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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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Sales rose 8% in the four months to 30 April, which was "modestly ahead of expectations". Excluding Nortek Air Management, which the group has agreed to sell for $3.625bn, sales rose 4%.

Operating margins have improved faster than expected, which meant the group was cash-neutral during the first quarter, typically an outflow period.

Melrose noted that the global semiconductor shortage will likely impact this year's performance.

The shares were up 1.4% in early trading.

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Our view

Melrose is trading ahead of expectations so far this year, a nod to management's deft navigation of the coronavirus crisis. Cost saving programmes have kept the group's head above water, and the fruits of that labour are starting to show with margin improvements across the entire business.

In fact, the Aerospace division managed to turn a profit despite a pandemic-related 27% sales decline. That's an impressive feat that should stand the group in good stead once conditions normalise.

Therein lies the problem, though - no one can be sure how long it will take for air travel to recover, but it's unlikely to rebound fully until at least 2024. Fewer passengers mean fewer planes, and fewer planes mean less demand for Melrose's aircraft parts and engines. The group may find some shelter in its exposure to defence, which makes up 41% of the division's revenue. But ultimately the weakness in commercial air travel will be a drag on overall performance for the next few years.

That brings us to Automotive, the group's largest division. We'd hoped pent-up demand was going to offset some of the weakness in Aerospace, before eventually normalising at the end of the year. Instead, we've seen the global semiconductor shortage weigh on any recovery in Automotive, another issue that could persist at least through the end of this year. With more than half of Melrose's business plagued by factors outside of management's control, it looks like the group will have another tough slog to 2022.

The sale of Nortek Air Management for $3.6bn will also see one of Melrose's better assets and profit drivers leave the business. This could make progress slower than it otherwise would have been. We understand the rationale for the deal though- the group wasn't in peak condition before the pandemic, and buying GKN involved taking on considerable debts, not to mention a sizeable pension deficit.

The Nortek sale will help rejuvenate the balance sheet, and management plans to use the proceeds to pay off debt, which is currently equivalent to 7.4 times cash profits - which is much higher than we're comfortable with. Some will also be returned to shareholders.

It's hard to overstate the hurdles. However, the good news is managing industrial businesses through difficult market conditions is what the Melrose management team do best, and a lighter debt load will make the group nimbler to manoeuvre through the difficult year ahead. We've been provided some reassurance about the longer term, but looking shorter-term, we expect some ups and downs.

Melrose key facts

  • Price/Earnings ratio: 23
  • 10 year average Price/Earnings ratio: 12.1
  • Prospective dividend yield (next 12 months): 1.4%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Trading Update

Aerospace sales were down 27% in the first quarter, compared to the same period last year, and 33% compared to pre-pandemic levels. That reflects the effect of travel restrictions, which continued to weigh on demand. Cost saving projects meant the group made a modest profit.

An uptick in demand meant Automotive sales were up 28% from 2020 levels, but still 13% below 2019, as the semiconductor shortage weighed. Cost saving efforts meant margins in this division increased from the second half of last year.

Powder Metallurgy delivered market share gains, which helped sales rise 35% from 2020 levels and 1% from 2019 levels. Margins were also improved "significantly."

Nortek Air Management sales were up 28% and 27% against 2020 and 2019 respectively. The sale of this division is on track.

Sales were up 12% against 2020 levels but down 12% on 2019 in the Other Industrial division, and margins were flat.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.