Melrose Industries finals

Melrose Industries, an engineering company that seeks to acquire businesses it understands, improve them by a mixture of investment and changed management focus, realise the value created and then return it to shareholders. I have a holding in my income portfolio (epic code: MRO).

Melrose Industries announced their final results today, the results are after a number of major disposals and receipt of the cash, but before the return of capital that has only recently taken place.  See here for the details.

Revenue was reported as £1,732.8m up 64.9% on a continuing businesses basis, but down 3.3% on like-for-like basis (assuming a full year's ownership of Easter in 2012).

Normalised EPS on a continuing basis (also excluding exceptional and amortisation costs) was 12.8p up 45.5% on last year, due mainly to the Elster acquisition and statutory diluted EPS was 9.3p compared to a loss last year of (0.9p).  There is a final maintained dividend of 5.0p, producing a full year dividend of 7.75p, an increase of 2% on last year.

During the year free cash flow of £113.1m was generated, compared to a free cash outflow of -£9.1m last year.  Five disposals during the year realised gross proceeds of £950.4m, of which £600m was returned to shareholders in 2014 by way of a return of capital and a 11 for 13 share consolidation.  Net debt was therefore reduced substantially by £856.9m to just £140.8m.  Adjusting net debt for this year's return of capital, gearing would be 33.9%, net debt would be 2.3x EBITDA and their operating cash flow 21.3% of net debt.

Management state in their outlook that much of their recent growth has been from margin improvement rather than revenue growth.  They say that sales growth remains challenging and they face a likely negative impact from the strength of Sterling (over 87% of sales were to outside the Sterling area in continuing businesses last year).  They do believe though that there is more margin improvement to come.

Undoubtedly the  amount of profit being squeezed from the Elster acquisition is exceptional, with sales declining by -3% on a like-for-like basis, EBIT was improved by +37%.  Although as they mention there is further to come from margin improvement, management need an uplift in their markets to enhance a realisation from this acquisition.

In the short-term some investors will be concerned whether margin improvements at Elster will be sufficient to off-set the headwinds from a strong pound and continuing weak market demand for all of their businesses.  This should not concern longer-term investors who are likely to experience, as in the past, market beating total shareholder returns; although the private equity type model is not to everyone's liking and the 2.5% yield not compelling.