Metalrax turns the corner

The history of Metalrax is a tale of industrial decline and corporate complacency. While shares in many UK engineering groups have hit new highs in the current economic recovery, Metalrax is still worth only a tenth of its stock-market value of 15 years ago, and less than its book value last July. A value trap or a special situation? On balance, we think the latter.

That's because the company has some decent businesses, which should make money when they are efficiently run in benign markets. Those two conditions are now close to being met. An energetic new chief executive, Andrew Richardson, arrived in late 2007 from Halma - one of the UK's best-managed engineers - to drive through a much-needed renewal plan. That is now starting to bear fruit. And, judging by what Metalrax said in January, the economy started to recover.

That means 2011 could be a year of earnings upgrades and share price recovery for Metalrax. James Henderson, a fund manager who bought the shares for Lowland Investment Company, says it's relatively simple for an engineer with decent products but poor profit margins to drive a radical increase in profits simply by making basic operational improvements. And even if we're wrong and Metalrax fails to recover, the share price should be cushioned by the value of the firm's assets.

After one early acquisition (from Halma) and many more disposals over the past three years, Metalrax now runs eight companies. Six are grouped into a 'specialist engineering' division that accounts for about two thirds of group sales; the other two – one specialising in bake-ware for professional caterers, the other in high-end kitchen equipment for consumers – form a 'consumer durables' unit.

Both posted slight revenue declines in the first half of 2010, reflecting falling volumes in Metalrax's later-cycle engineering businesses and Mr Richardson's plan to ditch unprofitable product lines. Yet that plan, combined with accelerated cost-cutting during the recession, pushed up gross profit margins from 22 to 26 per cent, so the group actually swung into profit at the operating level.

When the company posts its full-year results on next week, the two businesses that serve the automotive and off-highway markets, Toolspec and Weston Body Hardware, will probably show the strongest bounce compared to 2009. Yet the consumer division also saw a marked improvement in the final six months of 2010, says Ben Thefaut at broker Arden Partners.

Of course, Metalrax still has problems, above all debt. Management had to waste vital reconstruction time during the financial crisis dealing with panicky bank managers, and for much of 2009 the equity was priced to go bust. Even now, net borrowings of £12.7m are huge relative to projected profits, and a deal that management negotiated with banks in late 2009 led to noticably higher interest payments last year. That rules out dividends for the foreseeable future.