Melrose Industries — Short-term trading versus long-term value creation

Melrose Industries (LSE: MRO)

Last close As at 17/05/2024

GBP6.70

74.80 (12.57%)

Market capitalisation

GBP8,167m

More on this equity

Research: Industrials

Melrose Industries — Short-term trading versus long-term value creation

Recent weakness in the share price (down 25% in Q122) reflects investors’ macro concerns. Melrose Industries’ value realisation occurs through disposing assets to vendors aware of the longer-term value. We expect disposals in 2022 (Ergotron and possibly GKN assets) to prove Melrose’s ‘buy, improve, sell’ model once more and support our valuation.

David Larkam

Written by

David Larkam

Analyst, Industrials

Industrials

Melrose Industries

Short-term trading versus long-term value creation

Forecast update

Industrials

12 April 2022

Price

117p

Market cap

£5,175m

Net debt (£m) at 31 December 2021

950

Shares in issue

4,372m

Free float

98.7%

Code

MRO

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(2.7)

(31.6)

(32.4)

Rel (local)

(8.3)

(31.4)

(36.9)

52-week high/low

191p

109p

Business description

Melrose Industries acquires underperforming industrial companies. It undertakes operational improvements through restructuring and investment before disposing of the assets. Deals are individually financed through new equity (and debt) with proceeds returned in cash post value realisation.

Next events

AGM

5 May 2022

Capital markets day

8 June 2022

Analyst

David Larkam

+44 (0)20 3077 5700

Melrose IndustriesMelrose is a research client of Edison Investment Research Limited

Recent weakness in the share price (down 25% in Q122) reflects investors’ macro concerns. Melrose Industries’ value realisation occurs through disposing assets to vendors aware of the longer-term value. We expect disposals in 2022 (Ergotron and possibly GKN assets) to prove Melrose’s ‘buy, improve, sell’ model once more and support our valuation.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/20

7,723

(41)

(0.6)

0.75

N/A

0.6

12/21

7,496

252

4.1

1.75

28.5

1.5

12/22e

7,699

360

6.4

2.25

18.3

1.9

12/23e

8,348

545

9.6

3.00

12.2

2.6

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Forecast update

Automotive markets had been expected to recover in 2022 as supply constraints receded. However, the Ukraine situation is putting additional pressure on supply chains, reducing forecasts to a flatter year in 2022. Hence, we have reduced our sales expectation for Melrose’s Automotive division by c £150m, which, with a 30% drop through, leads to a reduction of £45m in EBIT. We have made a similar adjustment to Powder Metallurgy automotive sales, affecting profits by c £10m. We have trimmed the Other Industrial division to reflect higher investment in the hydrogen storage business. Overall changes to FY22 forecasts are normalised PBT down to £360m from £405m (-11.1%), normalised EPS of 6.4p from 7.2p (-11.1%). Our changes to FY23 forecasts are PBT of £545m from £628m (-13.2%) and EPS 9.6p from 11.0p (-12.7%). While it is disappointing the automotive market remains depressed, it is worth noting that there is still significant pent-up auto demand given the market is still 15% below pre-pandemic peak levels and Melrose’s recovery momentum continues and margins are expected to expand by 130bp in 2022.

Valuation: Disposals to realise value

Key to Melrose’s ‘buy, improve, sell’ model is the final asset disposal when value is realised. Nortek Air Management & Control and Brush were sold in 2021 for a combined sum of c £2.5bn. The remaining Nortek asset, Ergotron, is soliciting offers that, given its US bias, are unlikely to be hindered by the current issues in Europe. Powder Metallurgy could also enter the disposal stage in 2022. While the market background is clearly less favourable than hoped for in automotive, we note recent auto deals Apollo/Tenneco for $7.1bn and Cummins/Meritor for $3.7bn. Our valuation remains 226p (see our initiation note published on 29 October 2021).

Exhibit 1: Financial summary

£m

2019

2020

2021

2022e

2023e

Year to December

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue (ex Associates)

 

11,592

7,723

7,496

7,699

8,348

Cost of Sales

(8,732)

(6,858)

(6,394)

(6,467)

(6,929)

Gross Profit

2,860

865

1,102

1,232

1,419

EBITDA

 

1,534

521

734

894

1,081

Operating profit (before amort. and excepts.)

 

1,102

141

375

484

681

Amortisation of acquired intangibles

(534)

(472)

(452)

(452)

(452)

Exceptionals

(250)

(156)

(374)

(250)

(200)

Share-based payments

Reported operating profit

318

(487)

(451)

(218)

29

Net Interest

(213)

(182)

(123)

(124)

(136)

Joint ventures & associates (post tax)

0

0

0

0

0

Exceptionals

Profit Before Tax (norm)

 

889

(41)

252

360

545

Profit Before Tax (reported)

 

105

(669)

(574)

(342)

(107)

Reported tax

(51)

114

172

0

0

Profit After Tax (norm)

699

(27)

197

281

420

Profit After Tax (reported)

54

(555)

(402)

(342)

(107)

Minority interests

(9)

(3)

(4)

(2)

(2)

Discontinued operations

(106)

32

1,283

0

0

Net income (normalised)

690

(30)

193

279

418

Net income (reported)

(61)

(526)

877

(344)

(109)

Average Number of Shares Outstanding (m)

4,858

4,858

4,695

4,372

4,372

EPS - normalised (p)

 

14.3

(0.6)

4.1

6.4

9.6

EPS - normalised fully diluted (p)

 

14.3

(0.6)

4.1

6.4

9.6

EPS - basic reported (p)

 

(1.2)

(11.0)

18.7

(7.9)

(2.5)

Dividend (p)

1.70

0.75

1.75

2.25

3.00

Revenue growth (%)

(-1.2)

(-20.0)

2.0

2.4

8.4

Gross Margin (%)

24.7

11.2

14.7

16.0

17.0

EBITDA Margin (%)

13.2

6.7

9.8

11.6

13.0

Normalised Operating Margin

9.5

1.8

5.0

6.3

8.2

BALANCE SHEET

Fixed Assets

 

14,322

13,515

11,438

11,126

10,824

Intangible Assets

9,822

9,299

7,437

6,985

6,533

Tangible Assets

3,432

3,133

2,528

2,668

2,818

Investments & other

1,068

1,083

1,473

1,473

1,473

Current Assets

 

3,918

3,165

2,584

2,609

2,697

Stocks

1,332

1,126

893

904

942

Debtors

1,970

1,658

1,184

1,198

1,249

Cash & cash equivalents

512

311

473

473

473

Other

104

70

34

34

34

Current Liabilities

 

3,486

3,363

3,124

3,053

3,120

Creditors

2,461

2,456

2,051

2,076

2,163

Tax and social security

106

188

142

142

142

Short term borrowings

284

165

462

462

462

Other

635

554

469

373

353

Long Term Liabilities

 

7,203

6,207

3,358

3,570

3,507

Long term borrowings

3,464

2,926

903

1,145

1,185

Other long term liabilities

3,739

3,281

2,455

2,425

2,322

Net Assets

 

7,551

7,110

7,540

7,112

6,894

Minority interests

26

29

33

33

33

Shareholders' equity

 

7,525

7,081

7,507

7,079

6,861

CASH FLOW

Operating Cash Flow

1,534

521

734

894

1,081

Working capital

58

371

62

(20)

(65)

Exceptional & other

(519)

(9)

(321)

(335)

(250)

Tax

(117)

(14)

(65)

(79)

(125)

Net operating cash flow

 

956

869

410

460

641

Capex

(495)

(265)

(225)

(500)

(500)

Acquisitions/disposals

119

(11)

2,693

0

0

Net interest

(120)

(127)

(137)

(60)

(72)

Equity financing

0

0

(730)

0

0

Dividends

(237)

0

(69)

(84)

(109)

Other

Net Cash Flow

223

466

1,942

(184)

(40)

Opening net debt/(cash)

 

3,482

3,283

2,847

950

1,134

FX

90

7

40

0

0

Other non-cash movements

(114)

(37)

(85)

0

0

Closing net debt/(cash)

 

3,283

2,847

950

1,134

1,174

Source: Company accounts, Edison Investment Research

General disclaimer and copyright

This report has been commissioned by Melrose Industries and prepared and issued by Edison, in consideration of a fee payable by Melrose Industries. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Melrose Industries and prepared and issued by Edison, in consideration of a fee payable by Melrose Industries. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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