Melrose stock soared on Thursday, despite the engineering business owner suffering heavy losses and scrapping its dividend as it indicated signs of a recovery.
The turnaround specialist, which owns British aerospace and automotive giant GKN following a hostile takeover in 2018, had a tough first half of 2020, posting an operating loss of £581 million as revenue tumbled 26% to £4.36 billion. It was forced to write down £179 million of assets due to Covid-19, including £133 million in aerospace. Adjusted operating profit plunged 90% to £56 million.
However, encouraging signs of a recovery in its Nortek Air Management business and in GKN’s automotive and powder metallurgy units sent the stock 13% higher to 114p.
There were no indications of such a recovery in aerospace as Melrose set out plans to cut jobs in GKN’s aerospace division, which sells aircraft parts to
among others. The unit, unsurprisingly, suffered due to travel restrictions imposed to contain the spread of coronavirus. Sales fell 18% in the first half and are expected to be 25% to 30% over the full year. The company said a “significant reduction” in its worldwide workforce was inevitable.
Read:Melrose Industries Stock Has the Touch of a Turnaround Specialist
GKN’s automotive unit also had a bad start to 2020, with sales falling 37% compared with the previous year. However, Melrose said early signs in the second half indicated a quicker than expected recovery in automotive sales. “China is currently ahead of last year and in the U.S. sales are only marginally below prior year levels. Europe is proving a bit slower but there are nonetheless some encouraging signs,” the company said.
The London-listed company specializes in buying high quality underperforming manufacturing businesses and investing in them to make them stronger. Melrose said its ‘Buy, Improve, Sell’ strategy worked during the last global financial crisis in 2008 and was confident it would deliver again amid the Covid-19 crisis.
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Under this strategy, Melrose acquired Nortek, which provides cooling and heating technology to homes across the U.S., in 2016. Nortek’s air business has been less impacted by the pandemic, and sales in July and August were 13% up on the previous year—at the higher end of management’s expectations. Melrose said it would review strategic options for Nortek Air in early 2021.
Looking ahead. With a heavy reliance on aviation and the car industry —two of the sectors worst affected by the coronavirus pandemic—it’s no surprise Melrose struggled in the first half of the year. Travel restrictions grounded the majority of the world’s aircraft and factory closures and plunging car sales hit the automotive sector. The recovery signs were less expected and are being well received by investors.
RBC Capital Markets analyst Mark Fielding said the update provided a number of positives, including the trading recovery, restructuring actions and the potential for disposal in 2021. He maintained an ‘outperform’ rating on the stock with a target price of 160p.
Steering struggling businesses through tough times is what Melrose does best. The company has its work cut out this time but you’d be brave to bet against it.