At 227p, Melrose Industries (LSE: MRO) is certainly priced for growth as this valuation amounts to around 20x consensus forward earnings estimates of 11.19p per share. But while this is certainly an elevated valuation, I don’t believe it’s a ridiculous one for the highly successful industrial turnaround specialist.
Last year showed how the group is still proving adept at buying up underperforming businesses, improving sales by investing in growth areas, simplifying operations to juice margins, and then sell them on for a potentially large profit. In 2017 its largest business, Nortek, posted a decent 2% bump in revenue to £1,873.2m, while a focus on cost controls led to underlying operating profits rising 52% to £284.3m.
Although its smaller Brush business continued to struggle due to weak demand for gas turbines, the progress of Nortek bodes well for Melrose’s latest acquisition, aerospace supplier GKN. Given GKN’s giant size, if Melrose’s management team is able to increase operating margins from their current 7% to above its 10%+ target, the rewards for shareholders could be substantial.
A turnaround bearing fruit
Another richly-valued option investors like is grocer WM Morrison (LSE MRW), whose current share price of 266.4p represents a forward P/E ratio of around 20. Morrison has rebounded from recent sector-wide problems more quickly than peers, as shown by a stellar 3.6% uptick in like-for-like sales, excluding fuel, in the quarter to May.
This is down to management going back to basics at its grocery stores and also broadening its wholesale distribution arrangements through deals with the likes of McColl’s and Amazon. Its large food manufacturing capabilities also mean higher margins on many of its products than peers, which is part of the reason underlying pre-tax profits rose 11% last year to £374m, while revenue only increased 5.8%.
With profits rising and net debt falling below £1bn last year, Morrison is increasingly well-placed to build on its already impressive dividend prospects as well. Last year’s payout of 10.9p represents a full year yield of 3.8% that, alongside steady growth opportunities, makes it an interesting option.
And one for the risk-takers
A riskier but potentially higher reward sub-£3 stock is home improvement chain Kingfisher (LSE: KGF), which owns brands such as B&Q and Screwfix. The company is in the midst of a large turnaround programme that is seeking to increase margins by raising purchasing power at a group-wide level across its operations in the UK and Europe and investing in growth areas such as online sales.
So far, this turnaround is having mixed results. H1 like-for-like sales dropped 1.1% as a great Q2 performance from its UK brands was overshadowed by continued poor trading in France. Gross margins also went the wrong way during the period, but management reiterated its guidance for an overall annual improvement as they rebounded strongly in Q2.
However, if management can replicate the success it’s found with Screwfix, whose sales rose 11.8% in Q2, at its foreign outposts and simultaneously boost margins by having its wide range of brands order and sell more of the same goods, there’s great potential here. This is still a big if. But if you’re bullish, then Kingfisher’s 3.88% dividend yield and valuation of just 11 times forward earnings could prove tempting right now.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Ian Pierce owns shares of Amazon. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK owns shares of Melrose. The Motley Fool UK has recommended McColl's Retail. 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.