Melrose Industries PLC (LON:MRO) has published the following trading update for the half year period ended 30 June 2020 prior to the publication of its interim results. All numbers are calculated at constant currency.
Overview
The Period covered by the trading update has been extraordinary. For part of this Period the Automotive and Powder Metallurgy businesses had factories that were largely closed in Europe and the Americas, and the Aerospace and Nortek businesses had factories which were largely open but with hugely reduced requirements. As a consequence, your Board cancelled the final dividend due in May 2020, negotiated waivers for its EBITDA to net debt covenant for June and December 2020, and focused the Group on cash generation. Your Board is grateful for the swift and unanimous support of its lending banks in renegotiating these banking arrangements which has been a significant benefit to Melrose stakeholders.
As a result of this cash focus, the Group has generated c.£200 million of free cash flow, before restructuring costs and the acquisition of Forecast 3D in January 2020, resulting in net debt, at constant currency, reducing by c.£90 million in the Period. Consequently, the committed bank headroom has increased to over £1.1 billion as at 30 June 2020. Additional to this headroom the Group has cash in hand of over £300 million. The Group therefore beat its target of being cash neutral in what was a hugely difficult trading environment and your Board is pleased with this achievement.
It is natural that, as the businesses recover from the consequences of closed factories, some working capital requirements will need to increase as factories re-open. Importantly, there is still the opportunity to reduce inventories in the Group by over £150 million to significantly mitigate this, which is in addition to the c.£200 million of reduction in inventory and capital expenditure achieved since March 2020.
It is also necessary to adapt the businesses for the new economic environment, which means that there has to be an even stronger focus on cost reduction throughout the Group with some inevitable impact on employee numbers. Your Board estimates that such cost reduction measures taken this year will have a net beneficial contribution to the Group of c.£100 million in 2021 after assuming the scheduled withdrawal of worldwide government support schemes and furlough.
Trading update
In the Period Group revenue declined by 27% which was reflective of trading in line with expectations until mid-March 2020 followed by a steep decline in the second quarter. The focus on cash and reducing working capital has some detrimental effect on profitability for the year. The Group was loss-making in the second quarter of this year, but rebounded to be breakeven at the adjusted operating profit level in the month of June as recovery started to take place. This means Melrose is likely to make a small adjusted operating profit in the Period. Bearing in mind the focus on cash generation, your Board regards this as a significant achievement.
In line with the industry, sales in Aerospace for the Period reduced by approximately 18% and are not expected to recover in the second half of the year. Overall it is anticipated that sales for the year are likely to reduce by approximately 25-30% year-on-year and for the business to broadly breakeven. Therefore, a substantial reduction of the Aerospace cost structure is underway. This will significantly improve this business’s performance in 2021 without relying on sales growth from the level anticipated this year. This is a world leading business and as such is well positioned in its market to adjust to the demands of the new aerospace environment.
The Automotive and Powder Metallurgy businesses saw very similar trends to each other in the Period with a sharp decline in the second quarter due to many of their factories being shut and sales in the Period subsequently being down 36%. However, these businesses are also now seeing recovery. With COVID-19 cases currently rising in parts of the world and an unknown effect of customer restocking it cannot be certain these trends will continue at their current strength, but at present trading in China is ahead of last year (and has been for a couple of months), trading in the US is forecast over the summer to be within 10% of last year and there are some signs of improving European demand. All of this currently gives hope for a faster recovery than was sometimes feared would be the case though it is too early to be certain of this.
Existing travel restrictions mean that the Automotive Investor Day in New York, intended to be held in October 2020, will be rescheduled.
Nortek Air Management is performing well, and as a result, sales in the Period were only down 7%. The exciting StatePoint technology, aimed at improving the energy and water usage in data centres around the world, is gaining significant traction, with forecast sales this year of over $100 million. The business is receiving significant interest in its products from a number of data centre providers. Melrose announced on 5 March 2020 that it had appointed advisers to explore the strategic options for Nortek Air Management: this review was suspended later in March this year. Whilst there remains uncertainty on timing, it is the intention to revisit these options early in 2021. In the meantime, there is confidence that the improvements in these businesses this year (StatePoint and elsewhere) have further enhanced the quality of this division.
The Other Industrial businesses are in various end markets impacted by COVID-19 to variable extents. Brush is benefiting from the significant restructuring projects which it completed in 2019 and Ergotron has seen strong demand for its health sector products.
While the COVID-19 crisis has been challenging for all our businesses, the Group has sought to protect investment in R&D and continue to develop world leading technologies. Aerospace is investing in ground-breaking technologies for both electric and hydrogen powered aircraft. Automotive pressed ahead with its investment in e-Drive auto systems and recently produced its millionth e-Drive unit. Powder Metallurgy has continued to develop its 3D printing capability including the acquisition of Forecast 3D. Nortek Air Management, as stated above, is also continuing to develop its revolutionary StatePoint technology. Further development of these and other exciting projects are key to the successful development of the Group.
While we are encouraged by the strong cash performance in the Period, your Board does not consider it appropriate to pay an interim dividend to shareholders in 2020. The Company will publish its full interim results on 3 September 2020.
Simon Peckham, CEO of Melrose Industries PLC, said:
“This has been an extraordinary period which has needed our management teams and employees to carry out difficult actions with speed and determination. As a result we have generated £200 million of free cash flow and started to adapt our world leading businesses to take advantage of the market and acquisition opportunities the future will bring. For this year the focus is on cost control and cash generation, but we have protected investment in innovation for the future. Whilst timetables will have been affected, we remain confident that our businesses will adapt and produce good returns for our shareholders.”
