Melrose suffers heavy losses amid pandemic disruption

The engineering conglomerate doesn’t foresee aerospace demand recovering in the second half and is guiding to a 25-30 per cent drop in sales for the full year. It says the business should “broadly” break even.  

Unfortunately for Melrose, it operates in multiple markets that have been squeezed by Covid-19. The automotive business – which was already battling headwinds from the US-China trade war prior to this crisis – saw sales plunge by almost 40 per cent to £1.5bn on the back of global factory shutdowns. It registered a £64m adjusted operating loss. The group says there have been signs of improvement in the second half, with recent trading in China being ahead of last year.

Putting everything together, Melrose’s adjusted operating profit plummeted to just £56m in the first half of the year, versus £541m a year earlier. On a statutory basis, the group swung to a £581m operating loss, weighed down by the amortisation of acquired intangibles, £179m of asset writedowns and £99m in restructuring costs. Much of this restructuring relates to the aerospace business as Melrose looks to “substantially reduce” its cost base and move the adjusted operating margin from 3.4 per cent to 10 per cent.

The group says it made a conscious decision to “favour cash generation over profit”. Thanks to a reduction in net working capital and cutting capital expenditure by a quarter, free cash flow improved by 39 per cent on last year to £118m. But with this inflow being offset by acquisitions spending and currency movements, net debt at average exchange rates ticked up 2 per cent from the December year-end position to £3.3bn, equivalent to 3.4 times cash profits (Ebitda).

One of Melrose’s lending covenants is that net debt not exceed 3.5 times Ebitda, but this has been waived for the June and December 2020 test dates as well as for June 2021. Melrose’s lenders have also agreed to increase this multiple to 5.25 for the December test date next year. Net debt would come down significantly should an anticipated sale of Nortek Air Management materialise – the group has been coy on this front, saying it will “review strategic options” for the business next year.

Numis is predicting adjusted operating profit of £238m for the full year – well down from the £1.1bn seen in 2019 – increasing to £516m in 2021.