Melrose develops split personality

If you’re in the business of turning companies around, what do you do when that work is done but the market in which it operates is in such a hole that it makes no sense to sell them?

Melrose Industries (MRO) is facing this problem, having largely completed a restructuring of the automotive and powder metallurgy arms of the GKN engineering business it acquired for £8.3bn in 2018.

Its overhaul of GKN’s aerospace arm is expected to take another year, but given the fact that markets are still recovering from pandemic-related disruption, it doesn’t expect benefits from the already restructured units to be fully felt for a few years.

Car production numbers across Europe fell below 10mn last year and were about 30 per cent below pre-pandemic levels, according to trade body ACEA. Global air passenger traffic in July remained at about three-quarters of 2019, according to the International Air Transport Association.

Melrose’s solution is to create a demerged holding company that will house both its automotive and powder metallurgy arms, which currently account for about 62 per cent of group revenue. This will be listed separately on the London Stock Exchange, some time after its 2022 results are published next year. The aerospace arm will remain within the existing group. Read more on the break up plans here. 

The demerger “is a way of giving new life to both businesses”, chief operating officer Peter Dilnot said.

“Now would not be an appropriate time for us to sell those businesses for cash,” he added.

They are performing relatively well, given the economic backdrop. Group first-half revenue of £3.59bn was 6 per cent above consensus forecasts and adjusted earnings before interest and tax was 4 per cent higher.

Melrose managed to pass through inflation in both aerospace and powder metallurgy but had around £30mn of additional costs in automotive. It expects to recover these in the second half and left full-year earnings guidance unchanged.

It also reiterated its belief that the restructuring will allow it to achieve longer-term operating margin targets of 10 per cent in automotive and at least 14 per cent in both powder metallurgy and aerospace.

A demerger will help “release trapped value”, particularly in the aerospace division, which is well positioned to benefit from a recovery in the industry, analysts from Stifel argued.

Investec put the value of the automotive arm at £4.9bn and aerospace at £5.1bn. Combined, their current market cap is just £5.6bn. We had already made our case for why we thought it was undervalued in July (‘Melrose grinds through the gears at GKN’, IC, 8 July 2022). This move adds to it. Buy.

Last IC View: Buy, 153p,07 Jul 2022