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Melrose - automotive spin-off announced

First half underlying revenue was £3.9bn, up 4.3%, helped an 11% increase in Aerospace revenue as the industry continued to recover...

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First half underlying revenue was £3.9bn, up 4.3%, helped an 11% increase in Aerospace revenue as the industry continued to recover. Underlying operating profit fell from £196m to £171m, primarily reflecting declines in Automotive and Powder Metallurgy due to inflationary headwinds and supply chain issues.

Melrose announced plans to spin off its Automotive and Powder Metallurgy businesses under a new publicly traded holding company. Melrose will keep hold of its Aerospace business and shareholders will get shares in both companies.

The group's on track to fully offset the impact of inflation and meet full year expectations.

The group completed its £500m buyback on 1 August and has announced a 0.825p interim dividend, a 10% year-on-year increase.

The shares fell 1.9% following the announcement.

View the latest Melrose share price and how to deal

Our View

Melrose supplies components to the aerospace and automotive industries. Both industries were upended by the pandemic, so the story over the past year's been one of redemption. Now the group's on more stable footing, management is ready for a long-overdue move to separate its automotive businesses from Aerospace.

The group specialises in buying, improving, and selling on ailing manufacturing businesses. Back in 2018 the group bought GKN via a hostile takeover, so it should come as no surprise that it's ready to shed two of the GKN businesses it acquired, Powder Metallurgy and Automotive. The two are still struggling against supply chain and inflationary headwinds, but management is confident these won't derail plans to drive margins up to 14% and 10% respectively.

Should the spin-off take place, the two businesses would be housed in a separate, publicly listed company that specialises in automotive manufacturing. Melrose will retain ownership of its Aerospace business, and shareholders will end up with shares in both companies.

On paper this sounds like a solid plan. Management's said the new automotive business will maintain a similar shareholder return programme to that of the existing business. That means they'll move forward with targeted acquisitions, improve them, and sell them on for a profit--which is shared out among investors. Conservative balance sheet management means debt's under 2x cash profits (EBITDA), so although the division of liability isn't quite clear yet, both should have some room to manoeuvre.

But it won't be quite so simple. Economic doom and gloom is hanging heavy over the entire market. Neither automotive nor aerospace is a great place to hide when the economy's in a down cycle. Plus neither has recovered fully from the pandemic, and free cash flow is in the red--so it could be some time before the group can make meaningful purchases without overloading on debt.

There's also a chance Melrose is gearing up to sell Aerospace to a foreign buyer. The group promised to keep the defence-heavy business on British soil for 5 years when it was purchased--but the clock runs out in 2023. If That's where this story is heading, Melrose could find itself at the centre of a regulatory battle to keep the business from changing hands.

Melrose is trading at 16.2 times expected earnings and above the long-term average, reflecting investor confidence in management's ability to pull this off. Given the marked recovery in aerospace and opportunities in automotive, this may well be the case. But considering the execution risk ahead, investors should be prepared for volatility.

Melrose key facts

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.

First Half Results (underlying)

Revenue in Aerospace rose from £1.2bn to £1.4bn, reflecting a recovery in the industry post-covid. This fed into a 63.4% increase in operating profit to £67m, helped by improving margins.

Revenue was broadly flat at £2.0bn in the Automotive sector despite a 3% volume decline. But inflationary headwinds and the lag between their impact and recovery through renegotiated customer contracts meant operating profits fell from £121m to £78m.

Volumes were 9% lower in Powder Metallurgy, reflecting the group's decision to exit lower-margin businesses as well as the impact of supply chain issues and Covid lockdowns. This meant revenue fell from £535m to £515m. Despite profitability improvements, the revenue decline fed into a 15.6% operating profit decline to £54m.

Corporate and Other Industrial lost a total of £28m.

The Ergotron disposal completed in the current period on 6 July, for a proceeds of £519m.

Including the cost of restructuring, the group had a free cash outflow of £104m, down from an inflow of £131m last year. This together with the buyback program meant net debt increased from £1.0bn to £1.3bn ignoring the impact of exchange rates.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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 disclosure for more information.

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Written by
Laura Hoy
Laura Hoy
ESG Analyst

Laura is part of HL's ESG analysis team, working to offer research and analysis to help with sustainable decision making. She also works with other parts of the business to help integrate ESG.

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Article history
Published: 8th September 2022