ii view: Melrose details cash return to shareholders

Another cash return and some signs for the start of a recovery noted at its aerospace business.

Cash return and trading update

Chief executive Simon Peckham said: 

"The Board is delighted to have completed the sale of Air Management to Madison Industries, who are committed to continuing the development of this business.  

“We have taken a conservative view for the level of the current return of capital, but if markets continue to recover, we expect to announce a further significant return next year.” 

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ii round-up:

Melrose (LSE:MRO), the turnaround specialist and owner of the GKN aerospace and automotive businesses, today announced the return of approximately £730 million to shareholders following the sale completion of its Air Management business.

The return equates to 15p per existing ordinary share and will be accompanied by a proposed share consolidation. Trading across the company had remained in line with its early May AGM update, with recovery for the automotive industry helping its own automotive and powder metallurgy divisions, although tempered by global semi-conductor shortages. Some encouraging signs for the start of a recovery were also outlined for its aerospace division.

Melrose shares rose by more than 2% in UK trading, leaving them up by more than 80% since pandemic induced market lows in March 2020. Shares for automotive catalytic converter maker Johnson Matthey (LSE:JMAT) are up more 65% over that time, while shares for jet engine maker Rolls-Royce (LSE:RR.) are down by around 3%.

The Air Management sale accounts for most of the Nortek Group that Melrose acquired in 2016. It supplies critical air management and heating and ventilation systems to datacentres and other businesses, and was sold for a previously confirmed $3.625 billion (£2.62 billion). Since bringing Nortek Air Management under its wing, Melrose has almost doubled its adjusted operating margin from approximately 8.6% to 15.3% through the implementation of operational best practices.

The proposed return of capital will reflect previous disposals and value returns to shareholders, and will include a proposed share consolidation of 9 new ordinary shares for every 10 held. This is done in order to minimise the impact on the market price of Melrose shares while ensuring shareholders retain the same pro rata interest in the company following the capital return.

ii view:

Melrose always looks to buy good manufacturing businesses, improve their performance typically over a three to five-year investment horizon, and then sell a more profitable and better cash generating asset to a new owner. it then returns the cash to shareholders and other key stakeholders. Melrose, and including this latest return, has now returned over £5 billion of cash to shareholders since it was established in late 2003. 

For investors, a 27% annual sales drop over 2020 for its former GKN aerospace business was not in the thinking or projections when it originally bought GKN. Neither was what proved to be a temporary suspension of the dividend payment. Management is having to work even harder to make additional restructurings on top of its original GKN turnaround plan. 

But this latest sale sees it selling a ventilation business after the possible peak in demand for systems to aid with Covid-19 has been reached. A recovery in its automotive markets has been seen while early recovery signs for aerospace appear to be emerging. The dividend payment recommenced earlier in 2021, and an estimated share price-to-net asset value per share of 1.1 times sits below a three-year average of 1.5 times, suggesting the shares are not expensive. In all, and despite a still challenging trading backdrop, Melrose’s strategy continues to prove its long-term worth.

Positives: 

• A track record of previous acquisitions and value enhancing sales
• Restarted dividend payment

Negatives:

• Ongoing trading challenges for both automotive and aerospace businesses
• Its strategy can create conflict with governments and trade unions

The average rating of stock market analysts:

Buy