Melrose says changes at GKN having positive effect

7th Mar 2019 07:14

(Sharecast News) - Melrose Industries said its results for 2018 are ahead of the board's and analysts' expectations, eight months after acquiring engineer GKN.On a reported basis, the turnaround specialist swung to a loss before tax of £550m and lost 12p per share after the laborious tussle for GKN was completed last April, resulting in significant acquisition-related items from the GKN deal.The £1.2bn of adjustment items included amortisation of intangible assets, restructuring costs and acquisition and disposal costs.On an adjusted, like-for-like basis, the FTSE 100 group generated revenue of £9.1bn for 2018, which fed through to a profit before tax of £703m, up 172%. Adjusted diluted earnings per share rose 36% to 13.3p, though this was short of the 14.1p expected by analysts.On an annualised adjusted basis, as if GKN has been there for a full year, adjusted operating profit rose to £1.1bn from revenues of £12.25bn. This was higher than the consensus analyst forecast of £980m. Annualised adjusted diluted EPS were 13.8 pence, up 41%.On the balance sheet, a £629m provision was made for poorly performing GKN contracts, but management said the contracts "offer a large potential for performance improvement in the future". Group net debt stood at £3.48bn at the year end, resulting in a net debt to EBITDA leverage ratio of 2.3 times, ahead of the previous guidance of 2.5.Having quickly removed duplicated central functions and decentralising GKN's various businesses, Melrose management said the changes were already having a "positive effect".Chief executive Simon Peckham said for the GKN businesses an important change has been a "refocus on profitable sales rather than solely on growth", while investment had also been made in performance and delivery, particularly in critical supply chains.Melrose's strategic mantra is 'buy, improve, sell', but some of its previous acquisitions were not improving.While Nortek Air & Security made continued progress, generator maker Brush, a legacy from the 2008 acquisition of struggling manufacturing conglomerate FKI, continues face difficult markets, leading the board to again reduce the holding value of the business in the accounts.On the outlook, Pekham saw the potential to deliver "some of the significant upside we see in 2019 despite continuing market volatility, particularly for Automotive", further details of which will be divulged at an investor event on 3 April.In Automotive, he said present indications are consistent with a slowdown, but stressed that this is "not currently expected to cause a major impact on 2019 profitability"."Our businesses are not without their challenges, particularly geopolitical, with Brexit and automotive sector uncertainty continuing. However, our businesses are proactive and will adjust their operations where appropriate."For 2019 analysts forecast adjusted operating profit of £1.1bn and EPS of 14.2p.Melrose shares had risen 3% to 185.55pp by 1022 GMT on Thursday.The results are better than expected, said broker Liberum, with the profit beat driven by Aerospace and Automotive, Powder Metallurgy and Nortek "all very much as expected" and debt slightly better than expected."These results are very much the scene setter ahead of 3 April when the potential and timetable for GKN will be unveiled [...] Yesterday's small disposal will be slightly dilutive, circa 0.7p, but the key point from the numbers is that the strength of Aerospace substantially de-risks the 2019 outlook particularly around investor nervousness around Auto."JPMorgan Cazenove said adjusted revenue and EBITA were 1% and 5% ahead of its forecasts on a like-for-like basis and so upgraded its 2019 EPS by 4% despite the dilutive divestment of Off-Highway Powertrain.With are a lot of moving parts to the results, Cazenove analysts said "there should be no ambiguity" as underlying revenue and profits are ahead of consensus forecasts on a comparable, like-for-like basis, "despite the market's concern on the end market development, notably in Automotive, and speaks to the impact management actions are already having at GKN".They added that the results confirm the "key tenant of the investment case" following the GKN acquisition and "the market continues to undervalue management's opportunity to drive significant margin and earnings improvement. We believe this is true even in a mixed end market environment given Melrose plans rarely rely on strong revenue growth".Investec also picked up on free cash flow being substantially better than expected, offsetting the currency headwind and helping reduce net debt leverage below guidance."Our estimates are barely changed in spite of challenging end markets and the disposals. The shares currently trade close to old GKN ratings, which seems unjust in view of the business improvement under way and next month's CMD."Investec also noted that the £629m provision on the balance sheet as part of its fair value exercise, linked to around 10% of revenue in loss-making contracts. "Full provision has been made upfront, to be utilised so that the contracts run off at breakeven. Obviously, this has raised operating profits, by £63m in the period of ownership (and £93m for 2018 annualised), but the results were better than we anticipated even before this adjustment. The remaining 90% of revenue is making more acceptable margins and should respond, along with the loss-makers, to Melrose's detailed initiatives to improve the business."