The Melrose share price is rising: should I buy now?

The Melrose share price is rising. Royston Roche discusses the company’s recent sale of Nortek Air Management and also its fundamentals.

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The Melrose (LSE: MRO) share price rose about 35% in the past year. Recently, there has been a lot of interest in the company. It announced last week that it would return £730m to its shareholders. Melrose buys companies, improves and sells them, and then returns the proceeds to its shareholders. 

Here, I will review the company fundamentals of this FTSE 100 stock.

Melrose’s recent sale

Melrose completed the sale of Nortek Air Management for £2.62bn to Chicago-based Madison Industries. The company will use the proceeds to pay down debt and contribute approximately £100m to the GKN UK defined benefit pension schemes. GKN is the engineering giant bought by Melrose in 2018. In addition, it will return £730m to shareholders, equivalent to 15p per share, through a share consolidation.

In the words of chief executive Simon Peckham, “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.”

Melrose had purchased Nortek for £2.2bn in 2016. It also generated more than £700m while it was in the company’s ownership. Melrose will retain two divisions Nortek, Ergotron and Norton Control. The recently sold division makes approximately 73% of Nortek’s revenues. In my opinion, this was a successful deal for the company.

Fundamentals

The company’s revenue grew at a rapid pace from 2017 to 2019. However, the Covid-19 pandemic had an impact in 2020. It fell 24% to £8.77bn. According to the recent trading update, Melrose’s Automotive and Powder Metallurgy divisions saw recovery in the automotive sector. It also notes some encouraging signs in the Aerospace division. 

The company reported a loss of £533m in 2020 compared to £51m in the previous year. The adjusted earnings per share for 2020 were 2.4p compared to 14.3p in the previous year. The cash flows were good. Operational cash flows for 2020 were £764m. The balance sheet is stable. The recent Nortek Air Management division sale reduced the company’s net debt to two times EBITDA (earnings before interest, taxes, depreciation, and amortisation) as of 30 June 2021.

Melrose has achieved an average annual return on investment of 21% since its first acquisition in 2005. The returns are extraordinary and it shows a successful turnaround strategy once it acquires businesses. Some of the leading shareholder returns on original equity include 3.0 times for Dynacast, 2.6 times for FKI, and 2.3 times for Elster. 

The Melrose share price – risks to consider

The global economy has started to pick up but it might take a few years to recover. The aerospace industry, in particular, is one of the most affected by the pandemic. The company has significant revenue from this sector. This could hurt the Melrose share price.

The company acquires businesses and sells them later. Not all business ventures will be successful. So, if any future acquisitions do not meet the financial purpose, then future profits could drop. 

Final view

Taking all things into consideration, I like the company’s business model. However, due to the uncertainty in the business environment, mainly in the aerospace sector, I would continue to keep the stock on my watchlist. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Royston Roche has no position in any of the shares mentioned. The Motley Fool UK has recommended Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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