ii view: GKN owner Melrose plunges

A second-quarter loss and no dividend. Can this turnaround specialist turn it around? 

First-half trading update to 30 June

• Revenue down 27%
• Aerospace sales down around 18%
• Automotive & Powder Metallurgy sales down 36%
• No half-year dividend payment

Guidance:

• Likely to make a small adjusted operating profit
• Aerospace full-year sales expected to be down approximately 25-30% on last year

Chief executive Simon Peckham said:

"This has been an extraordinary period which has needed our management teams and employees to carry out difficult actions with speed and determination.  As a result we have generated £200 million of free cash flow and started to adapt our world leading businesses to take advantage of the market and acquisition opportunities the future will bring.  For this year the focus is on cost control and cash generation, but we have protected investment in innovation for the future.  Whilst timetables will have been affected, we remain confident that our businesses will adapt and produce good returns for our shareholders."

ii round-up:

Turnaround specialist Melrose (LSE:MRO), and previous buyer of aerospace and automotive business GKN, today announced a 27% fall in first-half sales, mauled by the coronavirus. 

The sales plunge exceeded City estimates of closer to 16%, with payment of a pending half-year dividend considered inappropriate. It previously cancelled its final 2019 dividend payment. 

Melrose shares fell by more than 20% in UK midday trading and have more than halved year-to-date. Shares for aircraft engine maker Rolls-Royce (LSE:RR.) are down by a similar amount, while automotive catalytic converter maker Johnson Matthey (LSE:JMAT) shares have fallen by around a quarter. 

Aerospace component sales are down by nearly a fifth as grounded airlines have cancelled orders for new planes. Sales for the full-year are expected to fall between 25% and 30% compared to last year. 

Automotive & powder metallurgy sales, given closed car dealerships and production plants at the height of the Covid lockdown, are down by over a third in the first half.  Aerospace, automotive and metallurgy sales last year generated over 80% of group revenues. 

Falling into an unstated second-quarter loss, Melrose expects to make a small adjusted operating profit in the half-year, aided by recent recovery in China. Broker Morgan Stanley now expects full-year profit expectations to be slashed by around 30%.

Cost saving actions are expected to generate a net beneficial contribution of £100 million in 2021. Moves are likely to include job cuts. The group has cash in hand of over £300 million and committed bank headroom of over £1.1 billion. 

First-half results are scheduled for early September.

ii view:

Melrose is a company which potentially polarises opinion and creates debate. Is it a "short-termist asset-stripper," as considered by some UK politicians as it previously battled to acquire GKN? Or a necessary force of capitalism as it restructures companies attempting to improve productivity and enhance shareholder value?

Last year’s adjusted operating profit jumped by 35% to £1.1 billion. Loss-making GKN contracts of over £600 million were being addressed, with record group wide investment being made in areas such as technology and new product development. Now, Covid-19 has hit it between the eyes. Aerospace and automotive are two highly impacted sectors under required population lockdowns.  

For investors, the company’s track record of successful acquisitions and value enhancing sales, including McKechnie/Dynacast and FKI, offer long-term reassurance. As of 31 December 2018, it had returned £4.5 billion of cash to shareholders. But the world from when GKN was acquired is now very different. With the dividend suspended and additional restructuring now required on top of the original turnaround plan, investors will likely require added long-term patience.  

Positives: 

• A track record of previous acquisitions and value enhancing sales
• Cost savings to give a contribution of £100 million in 2021

Negatives:

• Both aerospace and automotive hit by Covid-19
• Its strategy can create conflict with governments and trade unions

The average rating of stock market analysts:

Buy