Melrose Industries plc (MRO) Ordinary Shares 48/7p
HL comment (19 November 2019)
Melrose has continued to trade in line with management expectations, according to a brief third quarter trading update, despite disruption from the General Motors strikes in the US.
The shares were broadly flat in early trading.
Melrose is a strange beast, and has a more in common with a private equity firm than most other listed businesses. Put simply it buys struggling industrial groups, improves their performance and sells them on.
Since listing on AIM in 2003 with a market capitalisation of £13m, the group reckons it has created around £4.8bn in shareholder value. It has delivered an average annual return on investment of some 25% a year. Of course there's no guarantee it can replicate that performance going forwards, and the 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.
It's still early days, but so far the deal seems to have gone off without a hitch. The first step has seen 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.
Going forward, Melrose's 'turnaround and sale' approach means the dividend shouldn't be the major pull - although the 2.5% 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.
Third Quarter Results
Aerospace sales rose 5% in the quarter, accompanied by good margin improvement, as the division outperformed management's longer term growth expectations.
Automotive saw sales fall 5%, following the General Motors strike, although margin improvements meant profits advanced year-on-year. Powder Metallurgy also suffered disruption from the industrial action - with sales down 13%.
The Nortek Air & Security business saw sales trends improve compared to the first half of the year, delivering modest sales growth with margins similar to last year.
Net debt was in line with management expectations. That reflects significant investment and restructuring costs, partially offset by efforts to reduce working capital in GKN.
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 disclosure for more information.
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