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TEMPUS

Meggitt’s top-flight engineering comes at a cost

Aerospace firm Meggitt’s new factory being built in Ansty Parkrepresents one of the largest industrial projects in the Midlands in more than a decade
Aerospace firm Meggitt’s new factory being built in Ansty Parkrepresents one of the largest industrial projects in the Midlands in more than a decade
MEGGITT

Without its super-lightweight, ultra-heat-resistant composite components, Pratt & Whitney’s engines for the Lightning jets to be used on Britain’s two new aircraft carriers would not be the same. The company making those parts, unique in their advanced technology as they are for the composites used on Hornet fighters and Black Hawk attack helicopters, is Meggitt.

The British aerospace company, which is in the process of moving its headquarters to the Midlands, has the extraordinary knowhow to produce this kit. The problem is that it hasn’t been making sufficient amounts of money from doing it.

Tony Wood, the former Rolls-Royce executive who has been leading Meggitt for the past 20 months, talks of the business making parts that have to be right first-time and being on a learning curve in hitting the acceptance standards needed. As a result, it has had trouble, in his words, of “maturing the yield” from the operations because its first job is to deliver to the customer, profitably or not.

What that has meant is a 90 per cent crash in operating profits from its composites business in the first half of 2018, a business that accounts for about a fifth of the group. In turn, that has led to a 40 per cent fall in reported interim pre-tax profits, although Meggitt prefers that to be seen as underlying profits from its continuing business only 5 per cent in arrears. That is the bad news. The recent run-up in the shares, up more than a third since the spring and closing last night at 560¾p, not far shy of all-time highs, suggests that the City prefers to see the upside. That has as its base a 24 per cent increase in the order book in the past year to more than £1 billion and revenues from continuing businesses rising by 9 per cent.

Meggitt is a high-margin business because few make the parts that it does and thus few have the ability to provide the spares in the aftermarket, the lucrative long-tail part of the aerospace business. Those margins are likely to end this year sub-18 per cent. Mr Wood is promising as good as 20 per cent by 2021 to pile on the earnings. That is why, despite seemingly unflattering half-year results, the company has lifted the interim dividend by 5 per cent to 5.3p.

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Sandy Morris, at Jefferies, says that there are if and buts about Meggitt, but believes that the long-term story is a strong one. For its part, Meggitt says its portfolio of braking and cooling systems, sensors and seals and aftermarket servicing will benefit from the continuing 5 per cent growth in the number of passenger jets coming on to the market, the 6 per cent growth in the amount of flying time and the spending increases being signalled by the US Department of Defence.

The flipside, according to UBS, a seller of the stock, is strong pricing pressure from the big US contractors. It also argues there could be a surfeit of spares for passenger airliners and that another key market for Meggitt, business jets, is moribund.

So the question for potential investors is whether they have missed the flight. Morgan Stanley sees a 6 per cent dip in earnings per share this year to 32.9p before rising to 36p in 2019 and more than 40p in 2020. At present levels the stock is trading on 16 times next year’s earnings and 14 times the expected outcome for 2020, which is at the top end of the historic trading range.

Tempus has been a long-term holder of Meggitt, though as much for the prospect of it being taken out by a raider. With the dividend expecting to yield more than 3 per cent, there is no reason to get off.

ADVICE Hold
WHY A key supplier to the world’s biggest aerospace and defence businesses but one whose share price may have got ahead of itself

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Interserve
With nine columns and seventeen rows before you get to the profit before tax — or in this case, loss before tax — the condensed consolidated income statement of Interserve is truly an accountant’s work of art, the canvas flecked with words such as non-underlying, restated and impairment.

The top and bottom line is that half-year revenues at the public services contractor and construction company have fallen by 10 per cent to £1.4 billion and interim earnings have gone negative: -12.4p per share for the first half of the year against 14.8p in the same period last year.

Although similar in size and shape, don’t call Interserve another Carillion. The biggest difference is that the music stopped at Carillion at the turn of the year, when the government contractor collapsed with the loss of 2,800 jobs. Interserve has numerous issues of its own, most notably a catastrophic entry into the green energy incinerator game that has cost it nearly £200 million, but it has made it into high summer after a financial rescue of £291 million to prevent it defaulting with its banks.

Interserve offices are seen in Twyford
Interserve offers property services, from the BBC to railway stations and schools
PETER NICHOLLS/REUTERS

So while Interserve is still with us, the big number screaming out of the interim results is a debt level of £645 million, including the £31 million cost of its financial rescue. That is about eleven times its annual earnings (ignoring charges and provisions) and more than six times its stock market value of £100 million, where it has become a member of the 90 Per Cent Club — companies who shares are valued at less than one tenth of their high.

Debbie White has been chief executive for almost a year, brought in to clean up a company whose bread and butter is cleaning other people’s offices, from the BBC to railway stations and schools. She has said that it will be another six months before she can explain how that debt will come down and what a future Interserve might look like.

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She said she was certain, however, that British outsourcing was a good market to be in despite the geopolitical uncertainties, dysfunction of government procurement and general lack of money. That is a bold shout for a company whose finances remain precarious.

ADVICE Avoid
WHY It has a mountain of debt and is in unforgiving markets

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