The Aerospace division traded in line with expectations in 2022 and is experiencing strong momentum into 2023.
Melrose also released combined results for its Automotive, Powder Metallurgy and Hydrogen divisions (DemergerCo), which grew revenues by 6% to £5,200m, ignoring the effect of exchange rates. This was 7% better than the consensus forecasts for DemergerCo set out in Melrose's half year results presentation. Operating profit rose by 21% as these divisions managed to offset inflationary headwinds.
The planned demerger of the Automotive, Powder Metallurgy and Hydrogen divisions is "progressing well" with the intention to seek shareholder approval at the end of March 2023.
The shares were unmoved in early trading.
View the latest Melrose share price and how to deal
Our View
Melrose supplies components to the aerospace and automotive industries. Both industries were upended by the pandemic, so the story over the past year's been one of redemption. Now the group's on more stable footing, management is ready for a long-overdue move to separate its Automotive businesses from Aerospace.
The group specialises in buying, improving, and selling on ailing manufacturing businesses. Back in 2018 the group bought GKN via a hostile takeover, so it should come as no surprise that it's ready to shed two of the GKN businesses it acquired, Automotive and Powder Metallurgy.
In the latest trading update, Melrose provided estimated 2022 results for the so-called DemergerCo, which we thought looked promising. In March 2023, Melrose shareholders will vote on whether the proposed spin-off of DemergerCo will go ahead, and if approved, Melrose will look to complete the demerger shortly after.
Should the spin-off take place, the two businesses would be housed in a separate, publicly listed company that specialises in automotive manufacturing. Melrose will retain ownership of its Aerospace business, and shareholders will end up with shares in both companies.
On paper this sounds like a solid plan. Management's said the new automotive business will maintain a similar shareholder return programme to that of the existing business. That means they'll move forward with targeted acquisitions, improve them, with the aim of selling them on for a profit--which is shared out among investors. Last we heard, conservative balance sheet management means debt's under 2x cash profits (EBITDA), so although the division of liability isn't quite clear yet, both should have some room to manoeuvre.
But it won't be quite so simple. Economic doom and gloom is hanging heavy over the entire market. Neither automotive nor aerospace is a great place to hide when the economy's in a down cycle. Plus neither has recovered fully from the pandemic, and free cash flow is in the red--so it could be some time before the group can make meaningful purchases without overloading on debt.
There's also a chance Melrose is gearing up to sell Aerospace to a foreign buyer. The group promised to keep the defence-heavy business on British soil for 5 years when it was purchased--but the clock runs out in 2023. If that's where this story is heading, Melrose could find itself at the centre of a regulatory battle to keep the business from changing hands.
Melrose is trading at 15.6 times expected earnings and above the long-term average, reflecting investor confidence in management's ability to pull this off. Given the marked recovery in aerospace and opportunities in automotive, this may well be the case. But considering the execution risk ahead, investors should be prepared for volatility.
Melrose key facts
All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.