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.

According to its analysts, the FTSE 250 — the second tier of companies listed on the London Stock Exchange — was one of the leading global indexes over the last decade. Not only was its 12% annualised return comparable with that of US equities (the S&P 500 returned the most with 13.6%), it also significantly outperformed the more internationally-focused FTSE 100 (7.4%).

As good as these numbers are, however, they pale in comparison to what investors could have achieved had they had the skill or good fortune to buy and hold the best performing UK-listed companies.

Let’s take a closer look at the three biggest winners since 2010.

On the podium

In third place is online property portal Rightmove (LSE: RMV). Thanks to its virtual monopoly in the UK, the company achieved a compound annual growth rate of 30.52% over the period. When it’s considered that the housing market hasn’t exactly boomed since 2010 (quite the opposite in some parts of the country), that’s some result.

Right now, shares trade on a forecast 30 times earnings. That might look expensive but it does begin to make sense when the company’s long history of generating huge returns on the capital it invests is considered. Operating margins are consistently above 70%, there’s stacks of cash on the balance sheet and very little debt.

A valuation approaching £6bn suggests management might struggle to replicate this incredible growth going forward, but I suspect the firm’s dominance of its industry means it will continue rewarding investors. Indeed, the recent uplift in sentiment in the housing market following the election can only be good news for Rightmove.

Boasting a compound annual growth rate of 32.34%, the company providing the second-highest returns was Melrose Industries (LSE: MRO). For those unfamiliar with the name, the £12bn FTSE 100 business specialises in buying manufacturing firms with strong fundamentals and then setting out to improve their performance.

Based on its price movement over the last decade, you could say Melrose is pretty good at what it does. Back in January 2010, the stock could be yours for around 18p. Today, it’s available for 233p.

With shares currently trading on 16 times forecast earnings (and coming with a seemingly-secure 2.1% yield, covered well over twice by profits), I think there’s still money to be made. Indeed, management reported in November that recent trading had been in line with expectations.

And the winner is…

Occupying top spot on the list of best performing shares is equipment rental company Ashtead (LSE: AHT).

According to Refinitiv, £1,000 invested in the firm at the beginning of 2010 — when the shares were trading around 85p a pop — would be worth around £35,611 at the end of 2019, assuming all dividends had been reinvested (something we heartily recommend at the Fool UK). All told, the company achieved a staggering compound annual growth rate of almost 43% over the period. 

Can Ashtead’s outperformance continue? Its latest results were certainly encouraging, with the company posting a 14% rise in revenue (to £2.68bn) and 6% rise in pre-tax profit (to £690m) over H1. What’s more, the stock trades on just 12 times earnings. Considering the high profit margins the company is able to achieve, that still looks great value to me.

The post ALERT! Here are the best performing UK stocks over the last decade appeared first on The Twelfth Magpie.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK owns shares of Melrose. The Motley Fool UK has recommended Rightmove. 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.

Here are a couple that I have to confess I haven’t paid much attention to myself. So have I missed out on a brace of hidden gems?

DCC

International sales, marketing and support services group DCC (LSE: DCC) has seen its stock more than double in the past five years, turning it into a £7bn business. However, the share price trajectory has flattened out lately, with the share price now trading at roughly similar levels to three years ago.

The group has been a strong and steady grower, with earnings per share rising by double digits for each of the last five years although, again, there are signs of a slowdown. EPS growth is expected to slow to 4% both this year and next.

This looks like a growth stock rather than play, as the yield is just 2.1%, although nicely covered 2.5 times by earnings. The group’s four divisions – LPG, Retail & Oil, Technology and Healthcare – look set to continue growing quite nicely, according to management, which said in July’s Q1 statement that profits are significantly weighted towards the second half of its financial year, which is expected to be “another year of profit growth and development.” Markets will know more when it reports its interims on Monday (30 September).

This acquisition-hungry business now operates across 18 countries, which gives it continued growth opportunities, and Rupert Hargreaves reckons it could double your money over the next three-to-five years. DCC has an excellent track record for delivering shareholder returns, although that’s reflected in its valuation, which is currently 18.8 times forward earnings. Sometimes you have to pay for quality.

Melrose Industries

This company’s motto is “Buy, Improve, Sell”, a nice, pithy description. Melrose Industries (LSE: MRO) aims to buy good manufacturing businesses with strong fundamentals, whose performance it reckons can be improved.

That’s worked out astonishingly well for investors. They’ve seen the share price graph 350% over five years, driving its market-cap to almost £10bn, making it one of the fastest growing stocks on the entire FTSE 100.

Earlier this month, Melrose’s interims showed a 75% increase in adjusted pre-tax profit to £428m, from £244m in the first half of last year, while revenue doubled to £6bn. It still hosted a pre-tax loss, although this narrowed from £372m to £128m on a statutory basis. If that looks odd, it’s due to the nature of the business, as acquisitions and sales can lead to massive lurches in both profits and losses. Happily, the overall trajectory has been positive.

As Alan Oscroft has pointed out, you need to be patient and have long-term horizons and like your profits lumpy. Melrose also aims to reduce risk by financing its acquisitions with a low level of leverage.

The stock trades at 15.2 times forecast earnings, with a forecast yield of 2.7%. Again, this is a growth rather than an income play. Melrose looks a strong buy and hold to me.

The post Why I’d buy these 2 overlooked FTSE 100 stocks 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
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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK owns shares of Melrose. The Motley Fool UK has recommended Lloyds Banking Group. 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.

Over the past 12 months, shares in the engineering conglomerate have slumped by 30%, underperforming the FTSE 100 by 22.5% excluding dividends. The sell-off has only accelerated over the past few months. Indeed, since mid-May, the stock has been off 40%.

But why are investors rushing for the exits, especially when Melrose has such an impressive record of producing returns for them?

Buy, improve, sell

Melrose is an expert at buying, improving and then selling underperforming engineering companies, like GKN, which the group finally acquired after a protracted takeover battle earlier in the year for £8bn.

Since its first acquisition in 2005, Melrose has delivered £4.8bn of value to investors using this strategy, and investors who bought in at the IPO have seen their investment grow at an average rate of 25% per annum over the past 13 years.

These are fantastic results, and I see no reason why Melrose’s experienced team cannot continue to churn out similar returns for investors going forward.

That being said, headwinds are growing for the group’s engineering businesses. Brexit and Trump’s trade war are both significant threats to Melrose’s enterprises. It would appear that these concerns are behind the recent sell-off.

However, this is not the first time management has had to contend with unfavorable operating conditions, and with this being the case, I believe now could be the time for savvy value investors to build a position in the stock. 

City analysts seem to agree. Over the past few months, 2018 earnings per share (EPS) estimates for 2018 have jumped 20%. As EPS estimates have gone up, and the share price has gone down, Melrose’s valuation has only gotten cheaper. Right now, the stock is changing hands for just 12.8 times forward earnings. 

In my mind, this valuation severely undervalues Melrose’s prospects, and that’s why I rate the stock a ‘buy’ today.

Troubled times 

Another growth stock that I believe is currently a ‘buy’ is RPS (LSE: RPS). 

Shares in this consultancy business have lost around a third of their value over the past six months. These declines have taken the stock down to a valuation of just 11.8 times forward earnings. There is also a 4.8% dividend yield or offer.

It seems that the market has soured on the RPS business because earnings are falling. The City was expecting the group to announce a 230% rebound in EPS for 2018, but today management has come out to confirm that fee income “will be marginally below market expectations,” while profit before tax and amortisation for the year will be “slightly below” 2017’s figure. 

Unfortunately, management also expects more of the same in 2019.

Time to buy? 

The firm’s downbeat outlook is disappointing, but I think it presents an exciting opportunity for patient investors.

RPS is struggling to grow because the group is investing heavily in its offering around the world. Over time these efforts should pay off, although they will hit earnings in the near term. However, I reckon that long-term holders won’t be disappointed when the growth comes through. 

As there’s also a 4.8% dividend yield on offer, investors are being paid to wait for a recovery.

The post Why I’d buy this FTSE 100 dividend stock right now after falling 30% appeared first on The Twelfth Magpie.

More reading

• 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

Rupert Hargreaves does not own any share 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.

And to begin with, the stock performed exceptionally well, nearly doubling in value over the next 12 months. However, after jumping to a high in June 2015, the stock slumped back below its IPO price at the beginning of 2016. But the stock then charged higher to an all-time high of 490p at the beginning of June this year. 

Over the past 40 days, the positive performance of the past few years has been almost entirely erased. At the end of last week, the stock was changing hands for just 300p, 39% below the all-time high. Once again, the stock has clawed back a chunk of these declines today, rising 23% in early deals.

One trick pony? 

Indivior’s shares are highly volatile because the business essentially only has one product. The company’s opioid addiction Suboxone Film generates 80% of revenue. While the market for this product is tremendous, Indivior’s fat profit margins have other companies itching to get in on the action. 

The latest challenger is India’s Dr.Reddy’s Laboratories. Dr. Reddy’s has received approval from the Food and Drug Administration to launch a generic version of Suboxone Film cutting into Invidior’s revenues. Last week the company warned that its revenue and profit guidance for 2018 was “no longer valid” following Dr. Reddy’s assault on the market, a warning which sent Indivior’s shares plunging. 

Today the stock is rising off the back of the news that Dr. Reddy has been blocked from selling its rival product with a court injunction. This is positive news for the company in the near term, but what worries me is that it competitors are clearly massing for an assault on Indivior’s lucrative business. 

With the US suffering from an opioid addiction crisis, lawmakers are unlikely to protect the group’s monopoly forever. So, it is no surprise City analysts expect Indivior’s earnings per share to fall by more than 60% over the next two years. 

Despite this dour forecast, the shares trade a forward P/E of 17.9. With the long term outlook uncertain, I’m avoiding the company.

Creating investor wealth

In my opinion, Melrose (LSE: MRO), on the other hand, has a much brighter outlook. The company essentially operates as a private equity business. It buys, improves and then sells engineering businesses, rewarding shareholders with large payouts when deals complete. 

The company’s record at creating value is flawless. Between 2012 and 2017, Melrose estimates it has created £3.6bn in value for shareholders, an average annual return of 22%, roughly two and a half times the average FTSE 250 annual return over the same period. 

The company’s latest target is GKN, which it acquired earlier this year with the goal of transforming the business. City analysts are expecting big things. Earnings growth of 53% is pencilled in for 2018 and growth of 36% is projected for 2019. 

Based on these estimates, the stock is trading at a slightly pricey forward earnings multiple of 15.7, but in my opinion, this is a price worth paying for a business growing at 30%+ per annum with a record of creating billions of pounds in profit for investors. In fact, based on its record, I would rate Melrose as one of the cheapest growth stocks in the FTSE 250.

The post Are these the cheapest growth stocks in the FTSE 250? appeared first on The Twelfth Magpie.

More reading

• 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

Rupert Hargreaves owns no share 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.

However, within the industrial sector there continue to be some strong growth opportunities which still trade on low valuations. Here are two prime examples which could be worth investing in today.

Improving performance

Reporting on Tuesday was Melrose Industries (LSE: MRO). The company’s 2017 financial year was relatively successful, with the performance of Nortek being strong. It was able to deliver revenue growth of 2%, with increased momentum in the second half of the year. Operating profit was up 52% on the prior year, and is up 67% on the last full year prior to its acquisition.

Of course, significant restructuring costs were incurred in the first full year of Nortek ownership by Melrose. However, the company’s long term future appears to be positive. So too does that of another of Melrose’s businesses, Brush. Consultations with employees have commenced, with the view to putting in place a restructuring plan.

Looking ahead, Melrose is forecast to post a rise in its bottom line of 4% this year, followed by further growth of 14% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 1.4, which suggests that it could offer a high rate of return. With the company having a proven business model, its performance could improve in future years as it continues to execute its growth strategy.

Turnaround potential

Also operating in the industrials sector is automotive specialist GKN (LSE: GKN). The company has been the target of an unsolicited approach by Melrose, which it has sought to fight off. GKN believes it is well-placed to deliver a successful turnaround, and that it is putting in place the right strategy to do so.

Looking ahead, the market consensus suggests that this is the case. It is due to report a rise in earnings of 13% this year, followed by further growth of 11% next year. This puts the company’s shares on a PEG ratio of 1.1, which indicates that they are undervalued at the present time. Certainly, there is a risk that the company will be unable to effect a successful turnaround, but this seems to have been factored into its valuation.

While there is the potential for a combination between Melrose and GKN, it seems unlikely to happen at the present time. Of course, this may change in future and it could mean that investors in both companies end up with one slice of the merged group. However, with the companies being fairly well-diversified, they are likely to offer favourable risk/reward ratios in the long run.

The post 2 bargain stocks in which I’d invest £1,000 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

Peter Stephens owns shares in 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.

The company, which operates a private equity-style business model buying struggling engineering businesses and working to turn them around before a sale, reported today that its two subsidiaries are facing significant headwinds. 

The group said its Nortek subsidiary faces currency headwinds in 2018 and that the market for the Brush unit has been “very difficult“. 

Brush, which manufactures electricity generating equipment for the power generation, industrial, oil & gas and offshore sectors, has been impacted by wider industry trends and has been a thorn in the group’s side for some time now. 

Meanwhile, Nortek, which makes air management, security and home automation devices is suffering from exchange rate movements on products imported from China. 

Still, revenues in the period from 1 July to 29 October were up 3% year-on-year, and a  full review of Brush is currently under way to improve performance. 

Temporary setback

On the back of today’s news, shares in Melrose slumped by 9.7% in early deals before paring losses to trade down only 6% at the time of writing. However, I believe that these declines present an excellent opportunity for investors to buy into the Melrose story. 

It has a history of producing outsized returns for investors. Since inception in 2003, the company has acquired a handful of struggling businesses at knockdown prices before instigating a turnaround and selling the companies. 

Management is extremely good at this process having generated £5.2bn in shareholder value since 2003. The average annual return on investment during the period is 26%. 

Considering this historical performance, I’m confident that the current headwinds are only temporary. Even though Brush has been a problem area for some time, at the end of August, the firm reported that progress at Nortek is going to plan with £47m spent to cut staffing levels by 5% and boost profit margins by a third. Further margin expansion is expected in the years ahead. 

Placing a value on growth 

Even though I’m positive on the outlook for Melrose, it’s difficult to value the company’s shares. On a P/E basis, the shares trade at a forward multiple of 22.1, which looks expensive. However, the whole business model is based not on earnings growth, but book value growth through the transformation and sale of businesses. 

The average City estimate puts the current value of its business portfolio at 260p, with a bull case scenario of 290p, nearly 35% above the current price. It will take time for management to unlock this value, so investors shouldn’t expect a sudden share price rally overnight, but these figures show that the value is there.  

The bottom line 

Overall, today’s update is disappointing, but I believe it does not detract from the company’s long-term growth story. 

Melrose has a long history of producing impressive returns for investors, and progress at Nortek shows that the group hasn’t lost its edge. Over the next few years, investors should be able to reap the benefits, as they have in the past. 

The post Is today’s 10% decline a buying opportunity for this falling knife? appeared first on The Twelfth Magpie.

More reading

• 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

Rupert Hargreaves owns no share 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.

After conducting a rights issue to fund the acquisition of a new business in August last year, investors have flocked to Melrose seeking to benefit from the firm’s business of turning around underperforming industrial businesses. During the past six months, shares in Melrose have added 34%.

Meanwhile, after recovering from its near-death experience at the beginning of 2016, shares in Glencore have charged higher over the past 12 months, outperforming almost every other stock trading in London. Indeed, since January 2016 shares in Glencore have added 370%, outperforming the FTSE 100 by around 310% over the same period. 

It looks as if, for both companies, these gains are set to continue. 

Further gains ahead

Melrose and Glencore continue to improve their outlook. Glencore’s recovery has been helped by rising commodity prices, along with management’s actions to pay down debt, cut costs and improve cash flows. Since the beginning of January 2016, its balance sheet has been stabilised and the business is now back on a sustainable growth trajectory. 

That being said, its growth potential does depend on commodity prices. Luckily, it looks as if prices are beginning to stabilise as China is shutting off excess production capacity of key commodities such as coal, iron ore and copper. Off the back of higher commodity prices City analysts are expecting it to report a staggering 963% rise in earnings per share for 2017 to 26p. Only a few months ago analysts were forcasting earnings per share of 9p for 2017 which shows just how quickly Glencore’s outlook has changed this year alone. 

If the company meets these earnings targets, the shares are trading at a forward P/E of 13.5. Based on how quickly analysts have updated the company’s outlook over the past year, I wouldn’t rule out further revisions and a higher share price as a result. 

Getting to work

Melrose buys struggling engineering businesses, turns them around and then sells them on, which means the company is more of a long-term focused private equity firm than anything else. With this being the case, it’s difficult to value Melrose on current earnings, so long-term cash return potential is probably a better metric. Unfortunately, the problem with this approach is that it’s impossible to tell what the company’s potential is until it divests assets, and by then it’s too late. 

Still, based on management’s past performance, it looks as if it will continue to produce impressive results for investors going forward. In 2013 for example the company sold five businesses acquired in 2008 for five times their acquisition value.

City analysts have pencilled-in a 119% growth in earnings per share for 2017 to 10.3p followed by growth of 15% for 2018. The shares support a dividend yield of 1.7%. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK owns shares of Melrose. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.