Market news and updates from Melrose and Halma.
Market News
US equity markets were little changed last night – S&P 500 (+0.2%); Nasdaq (+0.1%) – as Biden hails ‘progress’ with Xi to fix frayed US-China Ties. Xi said China wants to be friends with the US, adding that his nation won’t fight a war with anyone. “China does not seek spheres of influence,” Xi said, after striking deals with Joe Biden on restoring military communications and combating fentanyl.
This morning in Asia, markets were mainly down following a three-day rally as traders assess the impact of the Xi-Biden meeting and ongoing China property sector weakness: Nikkei 225 (-0.3%); Hang Seng (-1.5%); Shanghai Composite (-0.7%). The FTSE 100 is currently trading 0.1% lower at 7,484. Companies trading ex-dividend today include Unilever (0.95%), Bunzl (0.62%), M&S (0.39%), GSK (1.01%) and Shell (1.01%).
The dollar and Treasuries rose – the 10-year currently yields 4.50% – while gold trades at $1,967 an ounce. Sterling drifted and currently trades at $1.2382 and €1.1408. Oil slipped to $80.50 a barrel.
Cisco fell by 11% post-market after a disappointing forecast added to concern that companies are holding back tech spending. Walmart reports later and is expected to disclose a strong back-to-school quarter.
EV makers are under pressure, held back by consumer doubts about price, range and charging infrastructure, David Fickling writes. But like the solar industry in the late 2000s, the raw materials glut should transform the sector once it works its way into consumer prices.
Source: Bloomberg
Company News
Melrose has this morning released a very upbeat trading statement for the four months from 1 July to 31 October, upgraded its guidance for the full year, and provided a first guide for 2024. The shares had rallied somewhat over the last two weeks and in response today’s update they are up a further 2% in early trading.
Melrose is a tier one aerospace technology supplier with established positions on all the world’s high-volume aircraft. Its products are on-board c.90% of civil aircraft on the market today (wide and narrow body) and the company generates 95% of its revenue from industry-leading positions. Revenue is split 70% civil, 30% defence, and is generated from two divisions: Engines and Structures.
R&D excellence and long-standing relationships create high barriers to entry and mean the company is well positioned for the next generation of technology, particularly that enabling zero emission flight – additive manufacturing, composite structures, and electric and hydrogen propulsion.
The civil industry is enjoying a strong market recovery from the Covid-19 lows and is expected to enjoy long-term structural growth as airlines upgrade their ageing fleets after years of underinvestment. Defence is also growing given the escalation of geopolitical tension as NATO countries work to meet commitments to spend 2% of GDP.
A strong management team has an excellent long-term track record of delivery. For 2025, the company is targetting revenue of £4.0bn (CAGR of 11% between 2023 and 2025) and an operating margin of 17%-18% (i.e., operating profit CAGR of 41% between 2023 and 2025). Growth will be driven by structural market growth, aftermarket contribution from engines, and further business improvements.
80% of profit is expected to come from Engines and over 80% of this from the aftermarket. The business has OEM-level capability and responsibility for selected engines which gives more technical and commercial advantages than normal for a Tier 1 supplier. Engines is a leading independent Tier 1 partner to all major engine OEMs with its lucrative and diverse Revenue and Risk Sharing Partnerships (RRSP) portfolio providing balance and resulting opportunities.
During the four months to 31 October, trading was better than expected, with revenue up 18%, driven by higher underlying demand. The margin performance was substantially better than expectations, driven by higher aftermarket demand and pricing, and the successful delivery of operational improvements.
In Engines, revenue grew by 18%, while margins were comfortably more than 25%. This strong performance was driven by good aftermarket trading, up 24%, from higher volumes, increased scope, and positive pricing. Engine OE volumes continue to increase, albeit they are constrained by industry OEM supply chain issues which are ongoing. Given the higher profitability of aftermarket, the resulting business mix is generating stronger margins and this shows no signs of slowing down.
In Structures, revenue grew by 17%, with the margin rising above 4%, ahead of the previous guidance. This is primarily due to business improvement projects progressing faster than expected. In particular, restructuring benefits from global plant consolidation are coming through and the repricing of contracts is ahead of plan. As a result, the division has positive momentum and is improving the quality of its earnings.
In response to the positive trading, the group has raised its full-year profit guidance, although revenue guidance of £3.3bn and £3.4bn (+18%) is a touch below previous guidance of £3.35bn-£3.45bn. However, due to the stronger underlying margins, full-year profit expectations have been upgraded by 7% to £400m-£410m, more than doubling profits compared to last year. This reflects ongoing confidence in the performance of the business, with Engines full-year margins now expected to be 25% (vs. previous guidance of 24%) and Structures margins 4% or more. The group margin is expected to be over 12%.
Earlier in the month, the group announced that GKN Aerospace and GE Aerospace have significantly widened their long-term partnership with a new agreement that expands RRSP participation on the GEnx programme, the fastest-selling high-thrust engine. In addition to the current OE focus, the new agreement also covers new technology insertion, aftermarket repair of high-volume engines structures, and production of fan cases for a range of GE engines. GKN Aerospace will receive a greater share of life of program aftermarket revenue. Although there is no material change to short-term guidance, the benefits will flow through significantly in the medium term, with total incremental sales estimated to be around $5bn over the full 30 year+ life of the GEnx engine.
Melrose has a 4% programme share on the GTF PW1100G variant impacted by a rare condition in powder metal used to manufacture certain of their engine parts. The full potential cash impact to Melrose spread over the period to 2026 could be in the range of c.£200m if it was assumed that this is all a programme cost. However, Melrose has also highlighted that two ongoing industry consequences of the issue are likely, namely generally higher aftermarket pricing in a supply constrained industry and legacy engines potentially flying for longer – both will be beneficial to the company.
Melrose has a strong balance sheet with free cash flow ramping up sharply. This is expected to drive attractive shareholder returns through a progressive dividend and 5%-10% buybacks p.a. as the spending on restructuring comes to an end. Because of higher confidence and strong progress, the company commenced a £500m share buyback programme (7% the market cap.) at the beginning of October to run for the next 12 months. In today’s statement, the group discloses that free cashflow and net debt, including the buyback, are in line with expectations, with year-end leverage expected to be c.1.3x net debt to EBITDA.
The group has also provided its first guidance for 2024. Revenue is expected to be between £3.5bn and £3.7bn (up 7.5% at the midpoint). Adjusted operating profit is expected to be £520m-£540m, with a margin of 15%. This is 4% better than current market forecasts even whilst prudently assuming demand will continue to be constrained by supply. Growth will become higher when these constraints ease. In addition, significant operational improvements are on track in both Engines and Structures to enhance margins further.
Including the cash impact arising from the recent announcements about the GTF Engine (see above), ongoing restructuring spend, and the share buyback, Melrose expects leverage in 2024 to be comfortably below 2x, better than the previous medium-term leverage guidance.
Overall, the group says its 2025 targets ‘are substantially more underpinned than before’. As a reminder, the Engines margin is expected to be 28% in 2025 and above 30% post 2025, driven by strong aftermarket demand. Structures is targetting a margin of 9%.
Remember also the company has previously announced several senior management changes, with its CEO and Finance Director standing down in March 2024. Both will be replaced by internal appointments, providing essential operating continuity.
Source: Bloomberg
Halma has today released results for the six months to 30 September 2023 which were in line with market expectations. Guidance for the full year has been reiterated and in response the shares are up 4% in early trading.
Halma is a global group of life-saving technology companies, with a focus on safety, health, and the environment. The group’s technology is used to save lives, prevent injuries, and protect people and assets across a broad range of sectors including commercial and public buildings, utilities, healthcare/medical, science/environment, process industries, and energy/resources. The main growth drivers include increasing health and safety regulation, demand for healthcare from an ageing population, and demand for life-critical resources. Strong market positions deliver upgrade and replacement sales opportunities as customers seek to maintain regulatory compliance and conform with best practice. As a result, customer spending is often non-discretionary and drives sustained demand throughout the economic cycle.
During the half-year, revenue grew by 8.6% to £950.5m, helped by a 5.3% contribution from M&A, offset by a 2.1% currency headwind. The organic increase at constant currency was 5.4%, with price increases averaging around 2%. These increases were supported by continued product investment to ensure they continue to address customers’ needs and resulted in a stable gross margin at the group level. Group order intake is ahead of the comparable period last year and close to revenue in the year to date.
By geography, the strongest performances (on an organic constant currency basis) were in the US (+9.6%) and Mainland Europe (+9.2%), while the UK grew modestly (+3.1%). Organic revenue fell by 6.6% in Asia Pacific, reflecting declines in China, partially offset by a strong performance in Australasia. By division, strong growth was generated in Environmental & Analysis (up 8.8% organically) and Safety (+6.5%). As expected, Healthcare was flat (+0.3%).
The group’s operating margin fell by 30 basis points to 20.0%, in the middle of the group’s target range of 18%-22%. Adjusted profit before tax grew by 3% to £177.5m and was flat in organic constant currency terms.
Cash conversion improved to 96% and was above the 90% target. Over the last six months, net debt has moved from rose from £597m to £619m, with financial gearing of only 1.4x net debt to EBITDA, well within the target of ‘up to 2x’. This enables continued investment, both organically and by acquisition, to support continued growth. R&D expenditure was up 5%, representing 5.5% of revenue, and the group has made five acquisitions in the year to date for an aggregate consideration of £126m. The group has a promising acquisition pipeline.
Halma has a fantastic dividend track record, having grown the payout by 5% or more every year for the last 44 years. Today, the group has declared a half-year payout of 8.41p, 7% higher than last year.
The statement highlights that the current operating environment presents both challenges and opportunities. However, the group remains on track to make further progress in the second half of the financial year and to deliver ‘good’ organic constant currency revenue growth in the full year to March 2024. The current expectation is for full year adjusted PBT to be in line with analyst consensus expectations, currently £389m, with a range of £377.4m to £396.2m.
Source: Bloomberg