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Melrose picks up pre-split pace

Adjusted margins improve in both aerospace and automotive
March 2, 2023
  • Restructuring and intangibles charges lead to pre-tax loss
  • Double-digit revenue growth forecast for aerospace arm

Turnaround specialist Melrose’s (MRO) restructuring of GKN has been its longest and most painful to date.

Although the company’s board is hoping the forthcoming split between its aerospace and automotive arm will lead to the market reassessing the value of each business, it still has some way to go to make back the £8bn it paid for GKN in 2018, let alone achieve the type of return on its investment that previous deals have made.

There have been definite signs of progress, though, with the company’s revenue, adjusted profit and cash flow figures for 2022 all beating analysts’ expectations – although it still declared a £307mn statutory pre-tax loss (from a £660mn loss in 2021), as it amortised £458mn of goodwill and incurred a further £144mn of restructuring costs.

Melrose’s board had previously argued that the benefits of the restructured aerospace business would become apparent through operational leverage as activity in the sector picked up. A 51 per cent gain in adjusted operating profit on an 11 per cent increase in revenue suggests this is indeed the case. More of the same should follow, with the company forecasting double-digit revenue growth for this year on the back of stronger civil aerospace and defence markets.

There have also been improvements in the automotive arm, which will be spun out alongside the powder metallurgy and hydrogen arms as a separate listed entity next month, known as Dowlais (details will be published in a circular on 3 March). The automotive business grew revenue by 7 per cent, with adjusted operating profit up 24 per cent as its adjusted operating margin widened to 6.3 per cent, from 5.4 per cent.

Melrose argued the Dowlais business had been “transformed” under its ownership. It has extricated itself from more than £300mn of “low margin or lossmaking” contracts, replacing this with more profitable work, with better long-term prospects – 42 per cent of the £5bn of automotive orders won last year related to electric vehicles.

The valuation case is made somewhat murky by the demerger. Focusing on the restructured aerospace arm, which will be a £3bn-turnover company post-split, our buy recommendation is predicated around the influx of cash flows (the company is forecasting around £18.5bn-worth by 2060) expected on revenue-sharing deals based on future jet engine flying hours, for which the company says most of the heavy lifting in capital expenditure terms has already been done.

We’ll await the circular before making any judgement on Dowlais, though.

Last IC View: Buy, 131p, 08 Sep 2022

MELROSE (MRO)   
ORD PRICE:157pMARKET VALUE:£6.35bn
TOUCH:156.75-157p12-MONTH HIGH:169pLOW: 95p
DIVIDEND YIELD:1.5%PE RATIO:na
NET ASSET VALUE:176p*NET DEBT:21%
Year to 31 DecTurnover (£bn)Pre-tax profit (£mn)Earnings per share (p)Dividend per share (p)
20188.15-542-11.84.6
201911.01060.905.1
20207.13-679-11.70.75
2021 (rebased)6.65-660-10.31.75
20227.54-307-5.402.325
% change+13--+33
Ex-div:09 Mar   
Payment:18 Apr   
*Includes intangible assets of £6.8bn, or 169p  share. NB: 2022 dividend represents second interim payout of 1.5p.