Melrose has completed the £2.6bn sale of Nortek Air Management. The group intends to return £730m to shareholders, equivalent to 15p per share, by way of a B2 share issue and subsequent redemption. A share consolidation following the return will mean the Melrose share price remains broadly unchanged.
A brief trading statement alongside the announcement confirmed the group continues to trade in line with expectations, with recovery in Automotive and some signs of progress in Aerospace.
The group has also completed the disposal of Brush for £100m.
Melrose shares rose 2.3% in early trading.
The sales of Nortek and Brush encapsulate what Melrose is all about. Buy ailing industrial conglomerates, improve results and sell them on - returning the proceeds to investors. The initial reward this time round is a 15p per share capital return. In practice this means a single cash payment in September (albeit achieved through a convoluted B share system - the details of which investors don't need to concern themselves with overly).
However, the capital return is smaller than some might have expected, amounting to just 27.9% of the total disposal value. The leftover cash is instead being spent on debt reduction and reducing the pension deficit - with net debt expected to fall to under 2 times cash profits (EBITDA).
The smaller payout reflects understandable caution about future trading in the key aerospace and automotive industries. But Melrose has been trading ahead of expectations so far this year. We think that's testament 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 in 2020 despite a pandemic-related 27% sales decline. 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 components. 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.
It's hard to overstate the hurdles. But managing industrial businesses through difficult market conditions is what the Melrose management team do best, and following the Nortek sale a lighter debt load will make the group nimbler. That provides some reassurance about the longer term, but there will nonetheless be turbulence ahead.
Melrose key facts
- Price/Earnings ratio: 20.4
- 10 year average Price/Earnings ratio: 12.4
- Prospective dividend yield (next 12 months): 1.6%
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.
Half Year Trading Update and Nortek sale
Alongside the proposed capital return Melrose will contribute around £100m of the Nortek sale proceeds to GKN's UK pension scheme, reducing the schemes deficit to less than £200m, as well as reduce net debt so that leverage will be below 2 times cash profits.
Automotive and Powder Metallurgy have benefited from a recovery in the global automotive market, tempered by a global semiconductor shortage. While it is "too early to state with certainty" there are also "some encouraging signs for the Aerospace Division that the start of a recovery for that sector is in sight".
Since acquisition the GKN business have generated £500m of free cash flow. While the board is currently taking a cautious approach to shareholder returns, it expects to make a further significant return of capital next year if current recoveries continue.
The disposal of Brush is the final business to be sold from the FKI acquisition in 2008, which resulted in an overall Internal Rate of Return (IRR) of 29% over the lifetime of the group's ownership.
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.
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