Updates from Melrose Industries (LSE: MRO) and Carillion (LSE: CLLN) both triggered share price gains this morning — but for very different reasons.
Melrose shares rocketed 30% higher after the company announced a major acquisition. Turnaround specialist Melrose makes money for shareholders by buying, improving and then selling industrial firms.
The firm said this morning that it will pay $1,436m to acquire the share capital of Nortek Inc, a US-listed firm. Nortek makes a wide range of products that are used to help heat, cool, ventilate, secure and automate buildings. The firm’s main market is the US residential sector and Nortek claims that 80% of US homeowners have at least one of its products in their homes.
Nortek also has about $1,400m of debt, which Melrose plans to reduce in order to improve the group’s cash flow.
Because Melrose returns surplus cash to shareholders after each major disposal, it needs to raise cash to fund the Nortek acquisition. This will be done via a £1,655m rights issue and with £598m of new debt.
The rights issue will give Melrose shareholders the right to buy 12 new Melrose shares at 95p each for each existing Melrose share they own. The company says that major institutional shareholders have indicated their support for the plan, so it’s pretty much certain to go ahead.
According to Melrose, shareholders who have backed all of their deals since 2005 have received cash returns of £9 for every £1 invested. With a track record like this, it’s not surprising that management has strong investor support.
Indeed, support for the Melrose chief executive Simon Peckham and his team is likely to be a key factor. Without carrying out in-depth research into Nortek, individual shareholders have no choice but to trust Mr Peckham.
I view Melrose as a solid buy for investors who are comfortable with the group’s lumpy returns and long-term view.
A super income opportunity?
One thing Melrose is unlikely to provide is a regular dividend income. One stock that may satisfy this need is outsourcing and construction firm Carillion.
Carillion’s share price has fallen by 18% over the last month, thanks to a post-referendum slump. Yet despite market caution, today’s update was broadly positive. The company confirmed that trading during the first half of the year was in line with expectations. In Carillion’s support services division, both revenue and profit margins are rising.
Carillion’s order book also remains strong, with orders and probable orders of £17.4bn at the end of June, unchanged from a year ago.
Revenue for 2016 is now 97% secure, which suggests to me that broker forecasts for full-year revenue of £4,533m are fairly credible. This would represent a 14.7% increase on last year, although analysts only expect earnings per share to rise by 7%.
Carillion shares now trade on a 2016 forecast P/E of 6.5, with a prospective dividend yield of 8.5%. It’s a tempting valuation, but I’m a little concerned about the group’s debt levels.
Average net debt is expected to be unchanged this year, at £539m. That’s four times last year’s profits, which is quite high for a low margin business. In my view, Carillion’s dividend could come under pressure if profit growth fails to accelerate over the next year or so.