ii view: Melrose plans automotive demerger

Shares in this FTSE 100 engineering and industrial company have risen by more than 80% over 10 years. We assess prospects. 

First-half results to 30 June

• Revenue up 4.8% to £3.59 billion
• Pre-tax loss of £358 million, up from a loss of £275 million
• Interim dividend up 10% to 0.825p per share
• Net debt up 36% to £1.29 billion 

Chief executive Simon Peckham said:

"Since acquiring GKN in 2018 we have reinvigorated each business to achieve its potential. The proposed demerger now gives each an exciting opportunity to individually grow shareholder value through organic growth and acquisition in both platforms.”

ii round-up:

Turnaround specialist Melrose Industries (LSE:MRO) today announced the planned demerger of its GKN Automotive and GKN Powder Metallurgy businesses into a separately listed stock market company in the first half of 2023. 

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The demerger will leave Melrose still owning the GKN Aerospace components company it purchased under its original £8 billion purchase of GKN back in 2018.  

Melrose shares fell by around 6% in UK trading Thursday having come into this latest announcement down by close to 15% year-to-date. Shares for aircraft engine maker Rolls-Royce (LSE:RR.) are down by over a third during 2022, while auto catalytic converter maker Johnson Matthey (LSE:JMAT) has retreated by around 5%. The UK focused FTSE 250 index is down by a fifth year-to-date. 

The newly separated out company containing the former GKN Automotive business will have the dual strategy of profitable organic growth as well as targeting mergers and acquisitions across the automotive sector where management sees opportunities as a consolidator. 

The continuing Melrose business and holding the former GKN Aerospace business will retain a strategy to buy, improve and sell, with future acquisitions post the demerger targeting either the aerospace sector or the wider industrial arena. 

Revenues for Melrose during the six months to the end of June rose by just under 5% to £3.59 billion, pushed along by an 11% improvement for its Aerospace business. Automotive revenues remained broadly flat. 

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Adjusted pre-tax profit rose 12% during the period to £128 million, helped by an improvement for its aerospace margins. The interim dividend rose 10%. 

On an overall group statutory basis, a loss of £358 million compares to a £275 million loss in the first half of 2021. Accompanying management outlook comments point to trading remaining in line with expectations. 

ii view:

Melrose looks to buy high-quality manufacturing businesses, improve their performance typically over a three to five-year investment horizon, and then sell a more profitable and better cash generating asset to a new owner and return cash to shareholders and other key stakeholders. 

It recently completed the sale of Ergotron, acquired as part of its £2.2 billion Nortek air conditioning purchase. Adjusted operating profit margins across the Nortek businesses were almost doubled under Melrose’s ownership. Together with the £0.8 billion of cash generated by the Nortek businesses while owned, its constituent sales over the past 18 months had produced over £3.1 billion in cash proceeds.

For investors, high economic outlook uncertainty and rising interest rates over a tough backdrop. Worries about a global economic slowdown persist, not helped by ongoing pandemic shutdowns in China. Automotive revenue at Melrose stayed flat while overall group net debt rose. 

On the upside, Melrose now has an impressive track record of business turnarounds. It has returned over £5 billion of cash to shareholders since it was established in late 2003. A planned demerger of the aerospace and automotive businesses should allow for more focused valuations for each, particularly aerospace where some recovery has been seen.

On balance, and while the ongoing journey will likely experience bumps and turbulence, management’s strategy looks to remain worthy of long-term backing.

Positives: 

• A track record of previous acquisitions and value enhancing sales
• Two small businesses could prove vulnerable to takeovers themselves

Negatives:

• Its strategy can create conflict with governments and trade unions
• Uncertain economic outlook

The average rating of stock market analysts:

Buy