2021 was challenging for Melrose Industries (LSE:MRO) as the FTSE 100 stock dropped by 18.3%. As a quick reminder, this firm is essentially a holding company. It uses its resources to acquire struggling engineering businesses. New management is then installed to turn these companies around, eventually adding value to Melrose’s books and enabling the group to resell them later for a higher price.
Let’s explore what happened throughout last year.
Spring: results and disposal of Nortek
Delivered early in the year, the 2020 full-year results for this FTSE 100 stock were as bad as expected. Excluding its Nortek Air Management division, aerospace, automotive, powder metallurgy, and other industrial segments all saw revenues tumble courtesy of the pandemic. Overall, the group’s revenue fell from £10.9bn in 2019 to £8.8bn. And because of operational disruptions as well as changes in strategy, margins also suffered. The result was after-tax income dropping from a gain of £55m in 2019 to a loss of £523m the following year.
However, management’s focus in 2020 shifted from profit generation to cash generation. The change in strategy was to reduce the risk of becoming over-reliant on debt financing, and this plan appears to have worked. Free cash flow for the year increased by 6% to £628m while net debt fell to £2.8bn from £3.3bn.
In April, the leadership informed investors that it had signed a deal with US firm Madison Industries to sell its Nortek Air Management business for £2.62bn. Melrose acquired the company back in 2016 for £2.2bn and has received around £700m of cash inflow since then. That places the total return from its 2016 acquisition at 78%. On an annualised basis, that’s a return of 21.2% each year – something seemingly not reflected in the FTSE 100 stock’s share price.
The deal was closed in June, with most of the proceeds used to pay off debt. However, £100m was used to reduce the pension deficit of GKN – an aerospace business acquired in 2018. And £730m was returned to shareholders through a special dividend.
Overall, the mixed performance didn’t satisfy every investor, and the stock ended up falling around 20% by mid-July.
September: FTSE 100 stock starts to look healthier
As the disruptions of the pandemic started winding down, operations once again ramped up. Total revenue for the first six months came in 5% higher at £3.8bn. However, £832m of this originated from its recently disposed Nortek Air Management. Obviously, that income will no longer be generated moving forward.
The bottom line stayed in the red, albeit by only £151m versus £585m the previous year. But thanks to the surge in cash provided by the recent sale, net debt fell drastically from £2.8bn at the start of the year to £300m. This jump in financial health seemed to give investors confidence in the recovery process since the share price jumped over 10% within a few days.
What’s next for Melrose?
In October, management reported further improvements within its aerospace segment with a 16% revenue growth. But its automotive and power metallurgy divisions continue to suffer from supply chain disruptions. Combining this uncertainty with the spread of the Omicron variant pushed the share price even further down, bringing the full-year loss to 18%.
A clearer picture will form when the full-year 2021 report is released in March. If the impact is less severe than expectations, the FTSE 100 stock could start recovering quickly. But the reverse is also possible.
