ii view: Melrose buys, improves and sells another big business

Its Nortek Air Management business is being sold for £2.62 billion. We assess prospects. 

Proposed sale of Nortek Air Management

ii round-up:

Turnaround specialist Melrose Industries (LSE:MRO), owner of the GKN aerospace and automotive business, today announced the proposed sale of its Nortek Air Management business.

The supplier of critical air management and heating and ventilation systems to datacentres and other businesses is being sold to US company Madison Industries for $3.625 billion (£2.62 billion).

Melrose shares rose by more than 1.5% in UK trading, with the share price having almost doubled over the last year. Shares for automotive catalytic converter maker Johnson Matthey (LSE:JMAT) are up more than 60% over that time while shares for aircraft engine maker Rolls-Royce (LSE:RR.) are down by around 8% over the last year.  

The Air Management sale accounts for most of the Nortek Group it acquired in 2016. It is expected to complete in the second or third quarter of 2021 and comes following Melrose’s previous flagging of its intention to sell. 

Proceeds of the disposal will be shared between reducing group debt, topping up the GKN staff pension scheme by around £100 million, and returning some cash to shareholders. Details of the return to shareholders will be announced shortly after the sale completes. 

Melrose bought what it considered to be the underperforming Nortek Group for $2.8 billion or £2.2 billion in 2016. It has generated around $1 billion of cash inflows since being acquired. Ergotron and Nortek Control businesses, which also form part of the Nortek Group, will stay with Melrose and be sold at an appropriate later time. 

Since bringing Nortek Air Management under its wing, Melrose has almost doubled its adjusted operating margin from approximately 8.6% to 15.3% through the implementation of operational best practices. Profit has risen to £188 million from £91 million. 

In the year to the end of December, Melrose overall reported a loss of £523 million versus a profit of £55 million made in 2019, given the significant disruption caused by the pandemic to both its former GKN aerospace and automotive businesses. 

Its AGM is scheduled for 6 May.  

ii view:

Melrose’s strategy to buy, improve and sell was reiterated within this latest announcement. It looks to buy good manufacturing businesses, improve their performance, typically over a three to five-year investment horizon. It then sells a more profitable and better cash generating asset to a new owner and return cash to shareholders and other key stakeholders. The chairman noted that this latest disposal “demonstrates the strength of the Melrose strategy.”

For investors, a 27% annual sales drop over 2020 for its former GKN aerospace business was not in the thinking or projections when it originally acquired GKN. Neither was what has proved to be a temporary suspension of the dividend payment. Management is now having to work even harder to make additional restructuring on top of the original turnaround plan. 

But this latest sale sees Melrose sell a ventilation business after the possible peak in demand for systems to aid with Covid-19 has been reached. Sales and margins recovered sharply in the second half of 2020 for its automotive and powder metallurgy business, while this latest sale further improves the health of the GKN staff pension scheme. Its deficit will be down to around £200 million from a previous £1 billion under Melrose ownership. Dividend payments began earlier in 2021, and any proceeds from this latest sale add to the £4.5 billion-plus of funds already returned to shareholders since Melrose was established in late 2003. In all, despite ongoing risks, the group’s strategy looks to have again proven its long-term worth.  

Positives: 

• A track record of previous acquisitions and value enhancing sales
• Restarted dividend payment

Negatives:

• Cautious outlook previously given for its aerospace business
• Its strategy can create conflict with governments and trade unions

The average rating of stock market analysts:

Buy