ii view: why Melrose shares just rocketed higher

Signs of recovery away from its aerospace business offer encouragement at this turnaround specialist. 

First-half results to 30 June

• Adjusted revenue down 26% to £4.36 billion
• Adjusted operating profit down 90% to £56 million
• No interim dividend payment
• Net debt up 4% to £3.39 billion since 31 Dec 2019 

Chairman Justin Dowley said:

"These are extraordinary times which we have addressed with rigorous cash management and decisive restructuring actions; recently, and encouragingly, we have started to see trading improving in some key end markets. Crucially, we own good businesses with significant improvement opportunities and have an experienced management team with an excellent track record. We have delivered good returns in tough times before and as we continue to make the strategic changes needed to position our businesses within their changed market environments, we are confident of doing so again."

ii round-up:

Turnaround specialist Melrose (LSE:MRO), and previous buyer of aerospace and automotive business GKN, today reported tentative signs of recovery following a hit from the coronavirus. 

Trading for its automotive, powder metallurgy and key Nortek Air businesses has been at the upper end of management expectations since the end of the first half of its financial year in June. 

Melrose shares rallied by 17% in UK trading, having more than halved year-to-date. Shares for automotive catalytic converter maker Johnson Matthey (LSE:JMAT) are down just over 15% while shares for aircraft engine maker Rolls-Royce (LSE:RR.) are down more than 60% in 2020. 

Although revenue for the former GKN automotive business fell by 37% in the first half, early signs from sales in the second half indicate that the recovery may be faster than management previously predicted. Automotive accounted for nearly two-fifths of overall sales in 2019. 

Trading for the Nortek Air business, generating just over a tenth of 2019 sales, is proving robust given its exposure to ventilation and air quality in commercial and residential buildings – ventilation which helps remove potential Covid-19. 

Nortek sales in July and August were up 13% on last year. Nortek also has exposure to the growing data centre industry. Management will review the strategic future of Nortek in early 2021.

Less favourably, full-year sales projections for its aerospace business, accounting for just over a third of 2019 sales, continue to point towards a decline of between 25% and 30%. Hit by grounded airlines under the pandemic, first-half revenues fell by just under a fifth. Profit margin expectations for the division were lowered from 12% to 10%. 

More broadly, improved banking terms have been negotiated with committed bank facilities standing at nearly £1.2 billion as of the end of June. No interim dividend was declared given the emphasis on conserving cash. 

ii view:

Melrose’s strategy to buy, improve and sell was reiterated within these results. It looks to buy high quality underperforming manufacturing businesses and invest in making them stronger, better businesses for the benefit of all stakeholders, whilst delivering good returns for shareholders. Having delivered in the last global crisis, management believes its model will once again deliver in the challenging circumstances of the corona crisis. 

For investors, the company’s track record of successful acquisitions and value enhancing sales, including McKechnie/Dynacast and FKI, does offer some reassurance. FKI, for example, was bought for £1 billion and sold for £1.4 billion. Melrose notes that is has returned £4.7 billion of cash to shareholders since being established in late 2003. Troubles for other manufacturers could also bring further buying opportunities.

But the world as it was when GKN was acquired has changed due to Covid-19. With the dividend suspended and additional restructuring now required on top of the original turnaround plan, investors will likely require patience while a recovery is established.  

Positives: 

• A track record of previous acquisitions and value enhancing sales
• Improved trading for some of its businesses

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