ii view: Melrose trading ahead of expectations

Reinstating the interim dividend with signs of aerospace recovery continuing. Buy, sell or hold? 

First-half results to 30 June 2021

• Revenue up 5% to £3.54 billion
• Pre-tax loss of £151 million, down from a loss of £585 million
• Net debt down 70% to £1.03 billion
• Interim dividend of 0.75p per share (2020: nil)

Chairman Justin Dowley said:

"We are continuing to see recovery in all our businesses with trading ahead of expectations. As with all its promises, Melrose has delivered its acquisition funding commitment to GKN pensioners early.  We have scope on our balance sheet to return more money to shareholders next year and we are excited by the upcoming possibilities."

ii round-up:

Turnaround specialist Melrose (LSE:MRO) and owner of the GKN aerospace and automotive businesses today reported trading ahead of expectations with automotive sales up 34% and signs of recovery in aerospace continuing to emerge. 

The pre-tax loss for half to the end of June narrowed to £151 million from last year’s loss of £585 million with all businesses achieving an improvement in the adjusted operating profit margin compared to the full year 2020. 

Melrose shares rose by more than 4% in UK trading, adding to a gain of around 54% from a year ago. Shares for automotive catalytic converter maker Johnson Matthey (LSE:JMAT) are up close to 20% over that time. Shares for aircraft engine maker Rolls-Royce (LSE:RR.) have gained by a similar 50% plus. 

The pension funding deficit for the 2018 acquired GKN business has been reduced to around £150 million from a previous £1 billion. Melrose, which earlier in the year announced the return of £729 million or 15p per share to shareholders following the sale completion of its Nortek Air Management business, also reinstated the interim dividend with a payment of 0.75p per share. 

Aerospace sales fell by a third versus 2019 and 18% compared to 2020, which had included a first quarter largely unaffected by Covid. The civil aerospace business is now weighted more towards the faster narrowbody plane recovery, while defence demand remains strong and broader divisional restructuring ongoing.

For its automotive driveshafts division, although the semi-conductor shortage had remained a broader industry drag, sales across Europe and Asia Pacific had outpaced those of the Americas. China sales grew by a fifth. In the transition to electric vehicles, the business had also won business for both global automotive makers and pure-play electric vehicle manufacturers. Investment in next generation eDrive capabilities is also being made. 

Group net debt fell to £300 million at the end of June from £3.4 billion a year earlier, although when including the soon to be paid £729 million return of capital to shareholders, now sits at just over a one billion.

ii view:

Melrose looks to buy good 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. Melrose, and including the previously announced £729 million return, has now returned over £5 billion of cash to shareholders since it was established in late 2003. 

For investors, a one third drop in sales for its former GKN aerospace business compared to the first half of 2019 was not in the thinking or projections when it originally acquired GKN. Neither was what proved to be a previous temporary suspension of the dividend payment. Management is having to work even harder to make additional restructurings on top of its original GKN turnaround plan. 

But a recovery in its automotive markets has been seen while early recovery signs for aerospace continue to emerge. Its earlier 2021 business sale saw it selling a ventilation business after the possible peak in demand for systems to aid with Covid-19 had been reached. The dividend payment is back being paid and an estimated share price to net asset value per share of 1.1 times sits below a three-year average of 1.5 times, suggests the shares are not expensive. In all, Melrose’s strategy continues to prove its long-term worth. 

Positives: 

• A track record of previous acquisitions and value enhancing sales
• Reduced net debt

Negatives:

• Ongoing trading challenges for both automotive and aerospace businesses
• Its strategy can create conflict with governments and trade unions

The average rating of stock market analysts:

‘Strong buy’