The firm is currently trading at a level that looks incredibly cheap to me. But is it a value trap?

Getting rich with engineering

Melrose is a goliath within the engineering industry. Similar to a private equity firm, it identifies promising businesses within the engineering sector and acquires them.

However, instead of fully integrating these businesses, it performs a full evaluation of operations. Through this process, it can quickly identify where improvements can be made, or whether any products or services need to be discontinued. Typically Melrose holds onto an acquired business for several years, making improvements throughout. Eventually, it sells it at a higher price, returning the profit to shareholders.

This “Buy, Improve, Sell” strategy has been in place since the company was founded in 2003. And while acquisitions can be a risky approach to growth, the management team seem to be making smart decisions that have rewarded shareholders immensely.

How this FTSE 100 stock adapted to Covid-19

At the start of the pandemic, Melrose’s share price fell off a cliff, falling by almost 70% within a month. The catalyst for the decline appears to originate from fears surrounding the disruptions of the automotive and aerospace industries, both of which, Melrose is heavily invested in.

However, the share price has begun a steady recovery although it remains below its pre-pandemic levels. Today the company has a market cap of £7.9bn, which is only 1.8 times its revenue for the first six months of 2020. This would indicate the stock is relatively cheap, but a closer look is needed.

As expected, 2020 half-year revenues were significantly lower compared to a year ago. Melrose also made a loss of £560m over the same period. While this is concerning, it may not be a serious long-term problem.

At the start of the pandemic, the management team deliberately switched tactics to focus on cash generation instead of profits. They cut dividends as part of the tactical shift. Naturally, this only further exacerbated the declining share price, but it did increase cash available to the firm.

Overall, this new approach has brought the total cash balance to £1.5bn.

Stock market recovery: can Melrose rise again?

The pandemic continues to be a significant disruptive force within the market. But after taking a step back, I feel it’s only a short-term problem. Melrose’s decision to focus on generating cash over profits was a brilliant move in my eyes.

It now has an enormous cash war chest at its disposal to see it through the final few months of the pandemic. Therefore,  it can easily pay its obligations on leases and debt without needing to raise additional capital.

The business is certainly not out of the woods, and there are many more challenges left to face. As a shareholder, I believe Melrose is fully equipped to deal with whatever comes its way, and expect the share price to recover and potentially reach new highs by the end of 2021.

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Zaven Boyrazian owns shares in Melrose. The Motley Fool UK has recommended Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

That’s not a problem with these two stock picks, both of which have posted barnstorming share price growth over the last five years. Especially my first pick.

Melrose Industries

Melrose Industries (LSE: MRO) is one of those unglamorous blue-chips that private investors can easily overlook, to their cost. It has grown into a company worth £10.83bn by purchasing underperforming manufacturing businesses, then working hard to turn things round. It’s probably best know for its recent takeover of GKN.

Melrose aims to revive its acquisitions and sell them at a profit, then return the proceeds to shareholders. It only floated on AIM in 2003, but since then has posted an average shareholder return of 25% a year, and created £4.8bn of shareholder value.

The share price is up an astonishing 352% over the last five years, against a rise of around 14% across the FTSE 100 as a whole. Despite this, it trades at a relatively modest 16.7 times forward earnings, roughly similar to the valuation for the index as a whole.

This is a growth stock rather than an income play, although it does yield 2.2% a year, covered 2.7 times. You also have to brace yourself for lumpy profits, which can bounce around depending on the timing of acquisition and sales.

That makes it very difficult to look at one set of company results and gauge the underlying trend. However, Melrose now has 16 years of storming success under its belt, which is an impressive track record for any company.

Informa

Exhibitions, events and business publishing group Informa (LSE: INF) can’t match that level of share price growth, but it’s nonetheless up 77% over five years, way ahead of the index. It has nudged higher today after reporting continued growth in revenue, adjusted profit, earnings and cashflow, with full-year group revenue on track to hit 3.5%.

Underlying revenues grew 2.8% in the 10 months to 31 October, and that’s ahead of its key November-December trading period, which is seasonally stronger. Informa has been enlarged by its recent tie-up with UBM, and is now a £10bn company with a global reach in the knowledge and information economy, including professional, commercial and academic.

Recent growth came despite two “impacts”, in Dubai and also Hong Kong, where civil protests have slightly dented revenues. Informa also issued a new €500m bond to strengthen its balance sheet and lower the overall cost of debt and extending average maturity to 5.5 years. Its debt recently doubled to £2.68bn, roughly a quarter of its market-cap, but is not a major concern.

Informa currently trades at 15.9 times forecast earnings, which means it’s fractionally cheaper than the FTSE 100 as a whole, despite its dramatically superior share price performance. The forecast yield is 2.9%, covered 2.2 times, so this one is also primarily a growth play.

Things look solid if not spectacular on that front, with earnings expected to climb 3% this year and 5% next. A solid company for challenging times.

The post £1,000 to invest? I’d buy this FTSE 100 thrashing growth hero inside an ISA appeared first on The Twelfth Magpie.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Many buy-to-let investors have done well over the last 20-30 years, during which time UK house prices have risen massively. But I think this opportunity may have passed, at least for now.

According to mortgage lender Nationwide, house prices in London and the South East are now falling from record highs. Buy-to-let landlords are also facing a cocktail of rising costs, including changes to mortgage tax relief and new energy efficiency requirements. I think there are better opportunities elsewhere.

The ultimate turnaround?

If you’re attracted by the wealth-building potential of property investment, I think FTSE 100 engineering group Melrose Industries (LSE: MRO) is worth considering.

Melrose buys troubled industrial groups, turns them around, and sells them on. Its management has an impressive track record. According to the firm, £1 invested in 2005 would have been worth £18 by March 2018.

Last year, the group made headlines with a hostile takeover of aerospace and automotive group GKN. It’s too soon to say whether Melrose management will be able to repeat previous successes. But progress so far seems positive. The group’s 2018 results were said to be ahead of expectations and showed a reduction in leverage along with promising signs of cash generation.

Profits could soar

Melrose is targeting a medium-term operating profit margin of 11% for the GKN business. The equivalent figure in 2017, prior to the group’s takeover, was just 6.4%.

Melrose says that GKN suffered from problems including poor integration of acquisitions, a complicated management structure and a lack of clear strategy and discipline on spending. By fixing such issues and resolving loss-making contracts, the firm believes it can hit these profit targets with only minimal sales growth.

Melrose stock looks fairly priced to me, on 14 times 2019 forecast profits, and with a 2.5% dividend yield. I think the downside risk is limited at this level. I’d rate the shares as a buy at under 200p.

A better way to play property?

Another way to play the UK property and construction market is by investing in firms which provide the tools and equipment needed for building. One of my top picks in this sector is equipment hire firm VP (LSE: VP).

In a trading update today, the company said that its main UK business was performing well, with “stable demand” from infrastructure, construction and housebuilding customers. This seems to suggest the UK economy is in reasonable health, despite Brexit concerns.

The firm also owns an international business, which operates in the oil and gas industry, and owns a test and measurement business based in Australia. Although smaller, I suppose these operations could help to offset the cyclical risk of a UK downturn.

Happily, there’s no sign of a slowdown yet. Analysts’ forecasts indicate that the group’s earnings are expected to rise by 14% to 93.5p per share this year. This puts VP on a 2019 forecast price/earnings ratio of 10.5, with a dividend yield of 3.0%.

This valuation may seem modest, but I’m concerned we may be at a late stage in the economic cycle. On that basis, I’d rate the shares as a hold at current levels.

The post Why I’d dump buy-to-let and buy this FTSE 100 dividend stock today appeared first on The Twelfth Magpie.

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• Prediction: 2 FTSE shares that could outperform the S&P 500 between now and 2030
• Below £5 now, here’s where this deeply undervalued FTSE 100 defence star ‘should’ be trading today

Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Each company takes a different approach, but in both cases their shares prices have stumbled recently and have fallen by at least 20% since the start of the year.

“No black holes found”

Buying a company is a bit like buying a house. There’s always a risk you’ll find something nasty after you pick up the keys. Luckily, FTSE 100 turnaround specialist Melrose Industries (LSE: MRO) has plenty of experience looking for skeletons in closets.

In its first set of results since completing the purchase of aerospace and automotive engineering group GKN, Melrose management confirmed its view that “GKN offers an outstanding opportunity”. Performance so far has been in line with expectations and “no black holes” have been found.

The right time to buy?

GKN was already a good engineering business, but its financial performance was often disappointing. Melrose believes it can correct this, improving operating profit margins and selling selected parts of the business.

As outside investors, we don’t have the insight into GKN’s business to understand how easy this will be, or even whether it’s possible.

However, Melrose founders Christopher Miller, Simon Peckham and David Roper have an impressive track record. Between 2005 and early 2018, these turnaround specialists claim to have delivered a total shareholder return of more than 3,000%.

Analysts’ forecasts put Melrose stock on a forecast P/E of 14.9 with a dividend yield of 2.5% for the current year. Earnings are expected to rise by 22% next year, as improvements to GKN’s operations start to deliver results.

In my view, this could be a good long-term buying opportunity.

A tricky situation?

Another executive who’s built a loyal following by delivering stunning shareholder returns is Geoff Wilding, executive chairman of flooring group Victoria (LSE: VCP).

Mr Wilding’s ‘buy and build’ strategy of repeated acquisitions has seen the Victoria share price rise by more than 1,000% over the last six years. Sales of flooring and carpets have risen from £71m in 2014 to £425m last year.

This strong momentum is expected to continue. Sales for the year ending 31 March 2019 are expected to rise by 40% to £599m, while adjusted earnings are expected to climb 34% to 42.1p per share.

All of this sounds great. So why have the firm’s shares fallen by 40% since the start of September?

Things to worry about

At the end of October, Victoria said that profit margins would be 1%-1.5% lower than market forecasts. City analysts appear to have interpreted this as a profit warning. Consensus earnings forecasts for the current year have now been cut by 12%.

Another concern is that the group’s debt levels have now reached what I see as quite high. Using figures from the firm’s latest accounts, my sums suggest net borrowings of about £340m.

That represents almost 3.4 times the firm’s pro forma earnings before interest, tax, depreciation and amortisation (EBITDA) of £104m. That’s well above my preferred limit of 2x EBITDA.

I don’t see an immediate risk here, as the firm remains profitable and cash generative. But I think debt reduction needs to be a priority. In the meantime, my view is that Victoria’s forecast P/E of 11.6 is probably high enough. This isn’t for me at the moment.

The post Have £2,000 to invest? Why I think this FTSE 100 growth stock could be a bargain after 30% drop appeared first on The Twelfth Magpie.

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• Prediction: 2 FTSE shares that could outperform the S&P 500 between now and 2030
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Regardless of this, I firmly believe that for long-term share investors — i.e. those looking to buy and hold shares for a minimum of five years — this recent weakness provides a great opportunity to grab a bargain.

Take Melrose International (LSE: MRO), for example. It’s lost more than 20% of its value in the month to date, adding to late September’s painful losses and it last closed at its cheapest since September 2016. Meanwhile Schroders (LSE: SDR) has been one of the Footsie’s worst October performers too. It’s dropped around 16% since the turn of the month and is now changing hands at its lowest level since August 2016.

I reckon both businesses are hot buys as of right now.

Terrific trading updates

This severe share price trouble comes in spite of both companies issuing positive trading releases in recent weeks.

I’ve tipped Schroders to be a big profits generator in coming years thanks to its Asian expansion programme, though the investment community remains spooked by the fund outflows that struck earlier in the year.

It’s righted the ship since then, however, and third-quarter numbers showed total assets under administration finally rising from levels seen at the turn of 2018, up to £439.1bn as of September from £435.7bn at the start of January. Still, share pickers greeted this consensus-beating result with little more than a shrug.

Things haven’t been much better at Melrose either as its value started collapsing almost straight after the release of half-year results in September. This is even though the turnaround specialist advised that its major acquisition of GKN had revealed no nasty surprises upon closer inspection, and that the engineering business’s Aerospace division had incurred no additional, painful charges.

Trading may be a bit tough for some of its divisions right now, but the company’s long-term outlook remains robust, aided by the vast investment and restructuring steps it is making with regards to GKN.

Dancing dividends

This bright profits picture at Melrose — rises of 21% and 20% are predicted for this year and next — means dividends are expected to keep rising as well. Last year’s 4.2p per share should rise to 4.4p this year and again to 5.2p next year, analysts say.

Dividend yields clock in at an inflation-beating 2.8% and 3.2% therefore, and with that aforementioned share price weakness also leaving the Footsie firm on a forward P/E ratio of 12.9 times, I consider it to be a terrific bargain to buy today.

Schroders is even cheaper, the business sporting a P/E multiple of 11.9 times, while yields also blast past those of its FTSE 100 compatriot. Last year’s 113p per share reward is predicted to move to 113.7p this year, resulting in a 4.5% yield. And for 2019, the yield moves to 4.6% thanks to a projected 117.7p dividend. Like Melrose, I reckon the asset manager is a great dip buy today.

The post These FTSE 100 dividend stocks are dealing at two-year lows. Why I think they are brilliant buys appeared first on The Twelfth Magpie.

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• Prediction: 2 FTSE shares that could outperform the S&P 500 between now and 2030
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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK owns shares of Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

GKN was a FTSE 100-listed firm before Melrose took it over this year, and those that previously owned GKN shares now own around 57% of the shares of the enlarged business, which gives you an idea of how big a mouthful GKN is for Melrose. But Melrose is no stranger to handling acquisitions. The firm specialises in buying what it describes as “good” manufacturing businesses with strong fundamentals “whose performance can be improved.”

Buy, improve, sell

The company aims to finance its deals with as little debt as it can and then improves operations by investment and by changing the management focus of businesses acquired. When things are ticking over smoothly with decent growth and profit figures, Melrose sells the business and returns the proceeds to its shareholders. So, investors holding shares in the firm can look forward to periodic capital returns, and when the time comes to let GKN go, the payment could be substantial if things go well.

And so far, things are going well. Melrose took control of GKN on 19 April and delisted it from the stock exchange on 21 May. Christopher Miller, Chairman of Melrose Industries, said in today’s report that the directors “moved quickly to decentralise GKN and empower the operational management teams.” That sounds like the approach that well-known investors Warren Buffett and Charlie Munger take when they acquire businesses for Berkshire Hathaway.As well as pushing operational responsibility downline, I reckon it frees the management teams from bureaucracy, allowing them to flourish at their entrepreneurial best. Mr miller said that Melrose has already reduced central functions and agreed strategic plans with operational management, “who are now focused on implementation.”

I think such moves are both necessary and potentially effective. Melrose’s board of directors mainly come from the world of finance so it is necessary to rely on the operational management of acquired companies to run day-to-day operations. But the cost savings and benefits flowing from freeing up and re-energising management teams can lead to spectacular financial returns as we can see in the track records of both Melrose Industries and Berkshire Hathaway. The directors at are pleased with their acquisition of GKN and expressed their confidence in the outlook by pushing up the interim dividend 11%.

Another business improver

The company reminds me of its FTSE 100 peer 3I Group (LSE: III). The firm operates the two divisions of Private Equity and Infrastructure with more than two-thirds of its assets under management in the Private Equity division. The business model is similar to Melrose’s in that 3I buys businesses with the aim of improving them and then selling them for a profit.

However, 3I goes for companies in a wider range of sectors and targets firms with an enterprise value between €100m and €500m in Northern Europe and North America. There is a portfolio of 35 unquoted assets and one quoted stake on the books at the moment and the firms span the sectors of consumer goods, industrials, business & technology services and others.

I think both Melrose Industries and 3I Group have great potential and are worth your research time now.

The post Why I’m expecting good investor returns from these 2 slick FTSE 100 firms appeared first on The Twelfth Magpie.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK owns shares of Melrose. The Motley Fool UK has recommended Berkshire Hathaway (B shares). Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Its biggest test yet 

The first is industrial holding company Melrose (LSE: MRO). The company has been in the news of late because of its successful acquisition of automotive and aerospace giant GKN in a cash and stock deal worth some £8.1bn.

The deal, which is by far Melrose’s largest, isn’t without risks, but given the company’s long history of successfully buying, improving and selling on industrial firms for substantial returns, I’m willing to give management the benefit of the doubt. On top of this, GKN is a great target for a cost-cutter such as Melrose.

GKN has leading positions in several key markets but has for years struggled to achieve simple internal targets such as operating margins in excess of 10%. This is where Melrose shines, which is clear in its latest annual results that saw it achieve a 52% rise in operating profits at its recently acquired Nortek business, with operating margins rising significantly to 15.2%.  

Given the sensitive nature of GKN’s relationships with aerospace customers, management will need to tread carefully in its usual cost-cutting exercises. However, Melrose is far from an 1980s-style asset stripper and invests substantial amounts in parts of its acquired businesses that have the potential for long-term returns.

This bodes well for the company’s ability to deliver long-term returns from the GKN aerospace business while selling off the automotive and metallurgy businesses that it sees less of a future for. With substantial scope to increase returns at that leading aerospace business, I reckon Melrose’s long, long history of delivering market-walloping returns for shareholders can continue for a long time coming.

Even more financial progress on tap?

Another great business that I think could deliver outsized returns in the coming years is luxury fashion house Burberry (LSE: BRBY). The company has been very successful in recent years in turning around its image and cementing its brand as truly upmarket, which has driven strong sales growth in luxury-loving China and helped boost margins.

With a new management team in place that appears more responsive to investors’ desire for improved financial performance, I reckon this strong competitive position could be turned into even more impressive sales and margin improvements in the years ahead. This would continue recent trends as operating margins have risen considerably in recent years and were up from 12.5% to 14.6% year-on-year in the half to September.

And as the Chinese anti-corruption drive appears to be winding down, there’s good reason to expect previously-wary wealthy Chinese to return to Burberry in droves. This is already starting to play out as in the quarter to December the group recorded a 2% uptick in same-store sales, driven by mid-single-digit growth in the Asia Pacific region.

With a cash-heavy balance sheet, a strong new CEO and creative chief refocusing on the brand’s strengths, and great competitive position, I reckon Burberry could be a fantastic long-term holding for new and experienced investors alike.

The post Two FTSE 100 start stocks I’d buy with £2,000 today appeared first on The Twelfth Magpie.

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK owns shares of Melrose. The Motley Fool UK has recommended Burberry. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Today’s bid follows the news on Friday that GKN has agreed a $6.1bn deal to sell its Driveline automotive business to US peer Dana Inc.

As a GKN shareholder, I now have the chance to decide whether to accept the Melrose offer. In this article I’ll explain what I’m planning to do, and why.

What’s this offer worth?

Melrose wants to buy GKN with a cash and stock offer which it says values the group at £8.1bn, or 467p per share.

However, this is not a cash deal. GKN shareholders would receive 1.69 new Melrose shares and 81p in cash for each of their shares. At the time of writing, this equates to an offer price of 449p per GKN share.

The value of the Melrose bid will rise and fall in line with the turnaround specialist’s share price. GKN management says it believe the business is worth more than 500p. It has published a defence document today which values the group’s business at 503p, on a sum-of-the-parts basis.

I think it’s probably fair to assume that Melrose management has a similar view, based on today’s offer.

An uncertain outcome

Melrose has made clear that today’s price is final and “will not be increased under any circumstances”. GKN shareholders have until 29 March to decide whether to accept.

The question for shareholders is which management team they trust to deliver the next 50p of value above the Melrose offer.

I’m impressed by Melrose’s track record of success, which has seen it generate a 3,000% return for shareholders since 2003. However, I’m also aware that GKN’s new chief executive, Anne Stevens, has a very strong track record.

From what I’ve heard, there isn’t a clear consensus view among big institutional shareholders about which outcome they prefer.

One downside is that if Driveline is sold to Dana, GKN shareholders will end up holding US-listed Dana shares. Some fund managers won’t be permitted to hold foreign shares, so there could be heavy selling pressure in the market.

I’d imagine that a facility might be available to allow small private investors like us to sell their Dana shares without having to take delivery of them. But as small shareholders, our votes are also likely to be irrelevant. Big fund managers will be making this decision for us.

What I’m going to do

My plan is to do nothing for now. If the Melrose offer is accepted, I can decide then whether I want to own Melrose shares, or sell my GKN stock into the market.

If the Melrose offer fails, then I’ll hold onto my GKN stock and wait for the group to publish its interim results in the summer. These should provide me with more information on the group’s turnaround before I have to decide whether I want to vote in favour of the Dana deal, which isn’t expected to be approved until Q4.

Right now, I think the best decision is to do nothing.

The post Why I believe GKN plc could be worth more than 467p appeared first on The Twelfth Magpie.

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Roland Head owns shares of GKN. The Motley Fool UK owns shares of GKN and Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

It’s been a few years since the LSE has seen a good ol’ fashioned hostile takeover the size of Melrose Industries’ (LSE: MRO) proposed acquisition of GKN (LSE: GKN). And although it’s far from clear as to whether GKN’s thus-far-recalcitrant management team will eventually accept any improved offer, I think shareholders of both groups could benefit significantly from the deal.

For GKN, there are a few upsides. On one side, if it goes through its shareholders would own 57% of the enlarged Melrose, which has proposed paying a large chunk of the purchase price in its own equity. Considering private equity-like Melrose’s repeated success in buying, improving and selling on a series of industrial firms, becoming shareholders would be a great thing if past performances can be repeated.

On the flip side, even if the takeover offer falls through, GKN’s board and new CEO will be extra motivated to repair the group’s recently dented reputation, move forward with much-needed plans to improve margins and recover from the series of recent profit warnings from mis-accounted inventories.

And GKN is in a good position to achieve these goals as the company is a market leader in critical-but-niche areas of automotive and aerospace design where barriers to entry for competitors are high. This gives the new management team a solid base from which to begin cranking up margins in the coming years if it remains a standalone firm.

A history of success

For Melrose’s current shareholders, the main reward from the deal going through would be the possibility of supercharged returns due to the sheer size of it, which at £7.4bn is by far the largest attempted by the company.

In its presentation supporting the takeover, Melrose’s management team has laid out a plan for improving operating margins above GKN’s internal 8%-10% target that it has repeatedly failed to achieve, with consensus analyst forecasts for 2017 margins coming in well below that at 7.7%.

This would be achieved through head office simplification, exiting lower margin and non-core business lines and investments in higher return areas. Judging by the firm’s success with its current and past purchases, where margins have improved between 500 and 900 basis points at each company, this plan comes across as very realistic, even if Melrose has never attempted to turn around such a large company before.

Just as important as making internal improvements at the companies it purchases, Melrose has been largely successful with the timing and price for disposals it’s made. Between improving margins, reaping the benefits of increased cash flow and striking attractive sale prices for its firms, it has delivered over a 3,000% return to its shareholders since first listing in 2003.

If I were a GKN shareholder, I’d be looking at this index-walloping return with a fair bit of envy and hoping both companies’ boards can find a suitably attractive price at which to make a deal.

The post Why GKN plc and Melrose Industries plc shareholders should be over the moon appeared first on The Twelfth Magpie.

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• Prediction: 2 FTSE shares that could outperform the S&P 500 between now and 2030
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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK owns shares of GKN and Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

That news would have been enough to perk up the share price, but GKN has gone one better. After “an intensive analysis” it has decided to separate its Aerospace and Automotive businesses into two separate companies.

Many investors have been calling for the firm to split itself up in this way for some time.

Their view — which I share — is that it should release considerable value from both businesses. Although a takeover bid would be welcome, I’m inclined to agree with the GKN board’s view that Melrose’s offer was “entirely opportunistic” and undervalued the company.

Why the bid is good news

Under UK takeover rules, Melrose has until 9 February to make a firm offer for GKN or to withdraw from the process. If I was a shareholder, I wouldn’t be too concerned either way.

In my view, what’s most valuable about this bid proposal is that it provides the market with a credible independent valuation of GKN’s business. Melrose is an industrial turnaround specialist with an excellent track record. If it’s willing to pay 405p per share (about £7bn) for GKN, then I feel confident that over perhaps a five-year period, GKN could be worth significantly more than this.

Interestingly, Melrose shares have risen by about 6% today. That suggests to me that the firm’s investors also think GKN could be a profitable buy at this level.

How the split will work

GKN hasn’t yet confirmed the process for separating its aerospace and automotive divisions. But it has confirmed that they will become separate companies.

I suspect that one will retain the GKN branding and stock market listing, while the second will be spun out to become a new listed company. Existing shareholders may receive shares in the new firm, while future shareholders will be able to choose which they wish to invest in.

History suggests that separating these businesses will improve the focus and accountability of management at each firm. This should result in stronger growth and a higher valuation than the combined business would have achieved.

What’s next? Project Boost

GKN’s management admits that “while sales have been growing, both profit margins and cash generation have been below expectations” in recent years. They aren’t wrong.

According to the data service I use, sales have increased by an average of 9% per year since 2011, but after-tax profit has fallen by an average of 2.8% per year over the same period.

To address these issues, the company is now entering into a comprehensive two-year turnaround programme dubbed Project Boost under its new chief executive Anne Stevens. This will run in parallel to the work needed to finalise the split.

Should I buy?

I don’t know what GKN’s share price will do next week. But based on today’s news from the company and the view taken by Melrose, I’m fairly confident this stock should be worth substantially more than 405p over the next few years.

On that basis, I’d continue to give GKN a ‘buy’ rating.

The post Should I pile into GKN plc, up 25% today? appeared first on The Twelfth Magpie.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of GKN and Melrose. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.