Today I want to look at two businesses where management have built impressive reputations by buying companies and then improving their performance.
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?
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.
Do you want to retire early and give up the rat race to enjoy the rest of your life? Of course you do, and to help you accomplish this goal, the Motley Fool has put together this free report titled "The Foolish Guide To Financial Independence", which is packed full of wealth-creating tips as well as ideas for your money.
The report is entirely free and available for download today, so if you're interested in exiting the rat race and achieving financial independence, click here to download the report. What have you got to lose?
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.