Share Prices & Company Research


03 September 2020

Melrose Industries

Ben Staniforth, Research Analyst, Redmayne Bentley

Melrose Industries Plc is a UK-based active investment and acquisition company, specialising in purchasing underperforming companies, primarily industrial products manufacturers. It aims to create significant cost reductions and then sell the company, often within a five-year time frame. Their half-year report for 2020 was released today (3rd September).

The report included some promising figures and has received praise from many investment brokers, with ‘outperform’ and ‘buy’ ratings placed on the company. Although the results were not great from an absolute standpoint, they are positive due to the report showing some solid performers across several markets. Profits at Melrose fell by 90% in the first half of 2020 but its Nortek, Auto and Powder Met divisions have shown great strength in recovering from the lows of the market in March.

In particular, the Aerospace division has been struggling the most, especially its investment into GKN Aerospace. GKN manufactures components for the auto and aerospace industries. The aerospace sector has taken a significant hit with people being less willing to fly, along with travel restrictions due to the Coronavirus pandemic. This has impacted on income expectations for the next few years. The worst-case scenario for Melrose is that if it cannot reduce costs at GKN, and demand for air travel does not return for a reasonable level for the next few years, GKN will continue to be a large loss-maker for Melrose.

Melrose has managed to implement some quite substantial cost savings so far in GKN, amounting to c£100m. Much of the savings will come from redundancies and factory closures, with the factory in King’s Norton earmarked for closure in 2021, causing 200 redundancies, with GKN stating that “it did not have a sustainable future”. Although redundancies and factory closures are good short-term fixes for bad performance, they may not aid the long-term growth of the company when or if demand for aerospace components recovers. Melrose has previously said that the decision to close the factory was that of GKN and not Melrose.

The best-case scenario for Melrose is one where its better performing divisions continue to recover, and for the aerospace division to make a U-turn. If GKN experiences a rise in demand from the aerospace industry for its components and, therefore, revenue recovers, the management at Melrose could focus more on the growth and cost saving at GKN rather than survival and restructuring of the company, allowing Melrose to move cost saving closer to their average of c7% of the total cost base. It must be noted that even with as little as a 3% increase in cost savings at GKN, Melrose’s profitability will continue to recover based on forecasted estimates.

There still seems to be a solid underlying value in Melrose shares, especially with the increased flexibility in financial covenants allowing management room to concentrate on operational performance. Based on the recovery of multiple divisions and cost-saving strategies being implemented in the aerospace division, a good level of upside could be created in the long term. In most scenarios, the best case for Melrose is more likely than an increased level of downside as travel restrictions are lifted, other divisions offset the bad performance of GKN and cost-cutting measures are implemented.

Please note that investments and income arising from them can fall as well as rise in value. Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
Melrose Industries
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