Melrose happy to find 'no black holes' in GKN business

The FTSE 100 group reported a statutory loss before tax of £303m for the half year after booking significant acquisition related charges but only including 73 days of trading from GKN. Adjusted for these charges PBT was £240m and proforma PBT as if GKN had owned for the full six months to 30 June was £401m.

Proforma revenue would have been £6.2bn but statutory revenues were £2.9bn versus £1.08bn in the pre-GKN half year of 2017. Net debt stood at £3.4bn at the period end, which equates to leverage of 2.4x in line with expectations, and the board declared an interim dividend of 1.55p per share, up 11% on last year.

Melrose, which operates according to the mantra of “buy, improve, sell”, said it "moved quickly" upon taking control of GKN on 19 April to decentralise the new business and "empower" each management team in accordance with its usual model, freeing them from "head office bureaucracy".

"This is the first step in the important cultural change that, alongside our operational investments, we consider is key to securing the improvements we believe are achievable for the world class GKN businesses," said chairman Christopher Miller.

He said plans have been agreed with each of GKN's divisions to realise the full potential of GKN's "currently underdeveloped", businesses. "Our work with them to date has reinforced our belief in the scope for improvement in the GKN businesses as well as the timeline necessary for achieving it," said Miller, who from January will be taking up the role of executive vice chairman alongside David Roper, with current senior independent director Justin Dowley becoming non-executive chairman.

GKN Aerospace has been reorganised globally around three core capabilities, Aerostructures, Engine Systems and Special Technologies, while there was an immediate effort on "fixing" key underperforming and historically underinvested Aerostructures sites in the loss-making business in North America, where customer relationships had become poor.

The Automotive arm's Driveline business delivered a half year performance in line with expectations amid a successful programme ramp up in the Americas and Europe, while in the ePowertrain business a plan has been put in place to address "a number" of operational challenges uncovered for the business in North America, while investment is being made to handle an exciting pipeline of over £2.5bn for the pioneering electric powertrain or 'eDrive'.

Melrose also confirmed that advisers had been appointed to explore a sale of the GKN Powder Metallurgy business, as indicated at the time of the takeover, the long-term focus is on the Aerospace and Automotive divisions.

Melrose's other businesses, ventilation specialist Nortek that was bought for £2.2bn two years ago, and generator maker Brush, bought as part of the £1bn purchase of FKI in 2008, were mixed.

Nortek's HVAC made a "bright start", the Air Quality unit saw "modest" sales growth but has new product developments on track, and the Security & Smart Technology unit was hit by the expiry of a significant volume contract and is facing continued market challenges but felt to be "well positioned to meet them".

In Brush, the Hawker Siddeley Switchgear business "performed well", but the rest of the business continued to be adversely impacted by significant challenges and uncertainties within the power generation market, with restructuring "progressing well" and all parts of the business remain under review.

On the group outlook, Miller concluded by saying that tariffs and raw material inflation may create some headwinds, but overall trading was in line with the board's expectations for the full year.

Melrose shares rose almost 3% to 229.1p in early trading on Thursday.

Broker Peel Hunt said it was a "very busy" set of numbers, with the focus on the GKN commentary "which has clearly started in a positive form" and so "reads better than we thought it might". The minor Nortek niggles "are not new news".

"There is considerable value generation to come," said analyst Harry Philips.

JPMorgan Cazenove said the update for GKN "ticks all the boxes", with the H1 run-rate ahead of its forecasts and significant early progress at GKN, with management has reconfirmed all acquisition commitments and targets.

Analysts said they continue to see significant upside to earnings and for shareholders and "do not see the upside captured in the current share price which, after a period where top-down news flow has weighed on the stock", reiterating an 'overweight' rating with a new price target of 285p.

Investec felt the results "will reassure" and said that, despite current macro-economic concerns, "the risk to consensus forecasts would appear to be to the upside driven by margin improvements – the main driver of value creation for Melrose".

The bank noted that Melrose has not provided margin targets for Aerospace or Automotive at this stage, but does believe it can deliver "in excess of 300bp" of margin improvement by 2022 for GKN, whereas Investec currently estimates 310bps.