Questor share tip: Buy Melrose as unit sale 'validates' its business model

The City cheered Melrose yesterday after it sold Dynacast at a good price. Although the shares edged lower, many analysts said the sale was another "validation" of the company's business model.

Melrose
335.7p -3.2
Questor says BUY

Melrose is a specialist investment group that buys industrial companies, turns them around, and then sells them on at a profit for shareholders. It focuses on engineering and manufacturing businesses and aims to generate a significant return over three to five years.

Yesterday, Melrose said it had struck a deal with a company managed by private equity firm Kenner & Co for the sale of Dynacast, which makes die-cast metal parts, for about £370m. The sale includes the pension liabilities.

The price is good and appears to be ahead of City expectations.

Melrose bought Dynacast, along with McKechnie Aerospace, in 2005 for £429m from private equity group Cinven.

Christopher Miller, chairman of Melrose, noted yesterday that "almost £1bn of cash will have been generated from McKechnie & Dynacast which were acquired for £429m in 2005."

The money, worth about 70p a share, will be returned to shareholders through a buyback. All the cash will be paid to Melrose on completion of the deal – so there is no deferred payment to wait around for.

Another nice part of the transaction for shareholders is that Melrose will retain all the cash generated by Dynacast up to completion of the deal, expected in August. This could be as much as $30m (£18.3m)

The buyback will ultimately see about 20pc of Melrose's equity being repurchased, with analysts calculating that the sale and reduction of shares could be dilutive to earnings by a few percentage points.

The shares are trading on a December 2011 earnings multiple of 11.4, falling to 10.3 in 2012. This looks cheap when compared with engineering companies that are separate listed entities – and there is the dividend attraction as well. The current prospective yield is 3.7pc, rising to 4pc in the year to December 2012.

Melrose's remaining businesses have strong exposure to the power generation and oil and gas spaces, which is positive because of the global structural shortage of energy.

Businesses currently owned by Melrose include Acco, which makes cranes and hoists, and Bridon, which makes wire ropes. It also owns Brush Turbogenerators, the world's largest independent manufacturer of turbogenerators, as well as Harris Waste Management, which processes scrap metal.

In its recent trading update, Melrose revealed a good start to 2011 – especially in energy.

Brush reported that orders were 15pc higher on a year-on-year basis and Melrose's Hawker Siddeley Switchgear unit noted that orders were up 50pc ahead of last year.

The shares were first recommended at 154p on September 4, 2009, and they are now 118pc ahead compared with a FTSE 100 up 21pc.

The rating on the shares remains buy.

The company is Melrose plc, listed under the symbol MRO, not Melrose Resources, which is listed as MRS.