Melrose Industries Plc

Melrose Industries Plc (LON: MRO) is an FTSE 100 listed investment Group that specialises in buying manufacturing businesses with strong fundamentals, which can be further improved in terms of performance.

The Company will publish interim results on 3 September 2020.

Investment Highlights – Melrose Industries Plc –  Buy at GBX 101.80

• The Company has significant financing available from banking syndicate, which will help them to focus on cash generation and adapt quickly to market conditions.
• The Company generated a strong free cash flow of around £200 million and managed to reduce net debt by approximately £90 million on a constant exchange rate.
• As per valuation metrics, EV/Sales, EV/EBITDA and Price/Book Value multiples of the Melrose Plc are currently lower as compared to the corresponding multiples of the General Industrials It reflects, shares are undervalued as compared to the industry.

Financing Update (Released on 4 August 2020)

The Company agreed with banking syndicate for amended arrangements including improved financial covenants to 31 December 2022. MRO is committed to RCF (revolving credit facility) of around £3.2 billion repayable in January 2023 and term loan of approximately £0.9 billion with extension till April 2024. The Company is also committed to two bonds of £450 million with maturity in September 2022 and £300 million with maturity in May 2032.

Update on Trading Performance (released on 22 July 2020)

• The Company showed a revenue decline of 27% and was trading in line with expectations until Q1 and then experienced a steep decline in Q2.
• The Company shifted focus in reducing working capital and generating cash after making a loss in Q2 and recovered well in June 2020.
• MRO has witnessed a recovery in Automotive and Powder Metallurgy businesses, while Aerospace sales are expected to recover in H2 FY2020.
• The Company’s Nortek Air Management is performing well for the period.
• MRO’s subsidiaries such as Brush and Ergotron are performing well in the uncertain period.

One Year Share Price Chart

Daily Chart as of August 28, 2020, before the market close (Source: Refinitiv, Thomson Reuters).

Key Risks

The ongoing Covid-19 mayhem has already impacted the sales in H1 FY20, and it continues to impact the business growth trajectory in the near term. The Group could not meet the target of being cash neutral due to the difficult trading environment.

Technical Performance

From the technical standpoint, shares were trading well above the short-term support level of 20-day simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further.

Valuation Methodology

Conclusion

During the first half of the financial year 2020, the Company shifted focus to cash generation and generated free cash flow of £200 million. The environment in which the Company is operating has shown some signs of recovery. Despite the Covid-19 crisis, the Company has sought to maintain investment in R&D to develop world-leading technologies.

Moreover, the amended arrangement with lending banks shall provide flexibility and headroom to continue to focus on cash generation and adapt the Group as needed. In the first half of 2020, the Group’s Nortek Air Management unit performed well. MRO adapted quickly to the new economic environment with a strong focus on cost reductions. The stock made a 52-week low and high of GBX 72.00 and GBX 309.40, respectively.

Over the course of 4 years (FY15 - FY19), the company's revenue surged from GBP 261.10 million in FY15 to GBP 10,967 million in FY19. Compounded annual growth rate (CAGR) stood at 154.58 per cent.

Based on the decent growth prospects and support from the valuation as done using the above method, we have given a “BUY” recommendation at the current price of GBX 101.80 (as on 28 August 2020, before the market close at 4:32 PM GMT+1), with lower double-digit upside potential based on 12.20x Price/NTM Cash Flow (approx.) on FY20E cash flow per share (approx.).

DS Smith Plc

DS Smith Plc (LON: SMDS) is a corrugated packaging provider in Europe. It also provides plastic packaging services across the world.

The Company will release interim results for FY2021 on 10 December 2020.

Investment Highlights: DS Smith Plc – BUY at GBX 258.90

• The Company has shown decent financial performance in the financial year 2020 with improved profitability margins and cash flows.
• SMDS business was benefited from the strong performance of the Packaging business along with benefits from the acquisition of Europac and strong focus on value-added packaging.
• As per valuation metrics, EV/Sales, EV/EBITDA, Price/Cash Flow and Price/Book Value multiples of the DS Smith Plc are currently lower as compared to the corresponding multiples of the General Industrials It reflects, shares are undervalued as compared to the industry.

 Financial Highlights – Financial Year 2020 (30 April 2020)

(Source: Annual Report, Company Website)

• For the financial year ending 30th April 2020, driven by a lower performance from Northern European, Eastern European and North American operations for the period, the revenue declined by 2% to £6,043 million (FY2019: £6,171 million). Revenue was also impacted by lower selling prices realised on packaging sales and foreign currency translation effects.
• On Profitability Front, driven by strong control over operating costs, the Company has shown decent improvement on the profitability matrix.
• The cash position has increased to £595 million as on 30 April 2020 (30 April 2019: £382 million), indicating significant liquidity available to meet working capital needs and to mitigate the impact of Covid-crisis.
• The Company has a decent balance sheet with total assets of £8,625 million as on 30 April 2020 (30 April 2019: £8,511 million) and decent free cash flow of £354 million.

One Year Share Price Chart

Daily Chart as of August 28, 2020, before the market close (Source: Refinitiv, Thomson Reuters)

Key Risks

Volatile commodity pricing for recovered paper and paper grades can create significant short-term challenges to capture appropriate margins by aligning raw material cost to packaging sales revenues. Multiple political/economic factors from Brexit to foreign exchange/interest rates significantly impact the level of consumer spending and customer demand for packaging products. 

Technical Performance

From the technical standpoint, 14-day RSI is currently in an oversold zone, which means there is a good potential for a short term rebound in the stock price.

Valuation Methodology

Conclusion

The Company has shown improvement in financial performance for the financial year 2020. Despite the declined in revenue, the bottom-line performance improved, with improved profitability. SMDS till date has not witnessed any material impact to the business from COVID-19. Overall, the Group seems to be well-positioned to respond to the evolving global landscape. Also, the management stays confident in the future prospects of the business. SMDS has a resilient business model with consistent FMCG and e-commerce customer base. The Company has an investment-grade rating of BBB from S&P, which indicate a stable outlook. The stock made a 52-week low and high of GBX 244.80 and GBX 397.80, respectively.

Over the course of 5 years (FY15 – FY20), the company's revenue surged from GBP 3,820 million in FY15 to GBP 6,043 million in FY20. Compounded annual growth rate (CAGR) stood at 9.61 per cent.

Based on the decent growth prospects and support from the valuation as done using the above method, we have given a “BUY” recommendation at the current price of GBX 258.90 (as on 28 August 2020, before the market close at 4:25 PM GMT+1), with lower double digit upside potential based on 12.00x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.).

*All forecasted figures and Industry Information have been taken from Refinitiv, Thomson Reuters.

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