Should I Buy Melrose Industries?

LONDON -- I'm window shopping for shares again, and the current market turbulence looks set to throw up a few bargains. Should I pop Melrose Industries (LSE: MRO  )  into my basket?

Engineering growth
So you can buy success after all.

Engineering group Melrose has risen rapidly on acquisitions, with a strategy of buying businesses, improving them, and selling them at a profit. Is there room for share-price improvement? And should I buy in?

Melrose is a relative minnow in FTSE 100 terms, but it has a big appetite. It likes to snap up manufacturing businesses that are failing to live up to their potential, change management focus, generate cash, and sell them on, ideally within three to five years.

Since launch 10 years ago, its private-equity model has generated £2 billion of shareholder value. Its most recent disposal was Truth Hardware, bought in 2008 and sold in May for $200 million cash, which Melrose will use to pay down debt. The company is in the early stages of offloading two other businesses, Crosby and Acco, which Investec analysts expect to be sold at a hefty premium, possibly by the end of this calendar year.

Revenue rising
Melrose enjoyed a 44% rise in revenue in 2012 to £1.55 billion. Profit before tax rose nearly 39% to £214 million, beating forecasts, which sent the share price up 7%. But after allowing for exceptional items and intangible asset and amortisation, profit before tax fell to £42.9 million, down from £110 million in 2011.

Diluted earnings per share were also lower at 4.3 pence, against 12.9 pence in 2011. However, the final dividend was hiked 4%, giving a full-year dividend of 7.6 pence per share, on a 2.9% yield. Covered 2.2 times, this suggests there is scope for further payout growth.

A 35% earnings drop in 2012 may look odd, but if you make your money from selling businesses, you can't expect a smooth stream of disposals. Management is particularly excited by its £1.8 billion acquisition of Elster in August 2012, where its improvement plan is one year ahead of schedule. 

Earnings are forecast to rise 6% in 2013, and 13% in 2014. By then, the yield is forecast to have risen to 3.3%.

Smelling of roses
Melrose's share-price growth has been strong, up 114% over the past three years, and up 180% over five years.

Brokers are keen, hanging a string of "overweight," "outperform," and "buy" garlands around the stock's neck in recent weeks, with typical price targets of between £2.90 and £3. Today, you can buy Melrose shares for £2.62.

The stock looks fully valued at 15.9 times earnings, so maybe this is one to buy on weakness. It can be volatile, so watch out for good entry points, because it looks a tempting buy to me.

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