LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.
To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.
Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.
So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at Melrose Industries (LSE:MRO), which aims to buy, improve and sell manufacturing businesses.
With the shares at 254 pence, Melrose's market cap. is 3,214 million pounds.
This table summarises the firm's recent financial record:
|Year to December||2007||2008||2009||2010||2011|
|Revenue (in millions of pounds)||289||895||1,299||1,035||1,154|
|Net cash from operations (in millions of pounds)||15||119||175||118||91|
|Adjusted earnings per share||5.63p||9.16p||9.44p||9.95p||14.97p|
|Dividend per share||3.84p||3.98p||4.38p||6.26p||7.39p|
Melrose raises money to buy businesses in the stock market, and by taking on debt, then returns the proceeds to shareholders when it sells a business, typically after three to five years of ownership. During the holding period, the company tries to improve its acquired businesses by such things as changing managements' focus, setting strategy and targets, driving operational improvements, investing capex in excess of depreciation, and focusing on operating cash generation.
Right now, the firm owns several businesses in the energy, lifting, and general industrial sectors and, last year, 40% of overall revenue came from North America, 25% from Europe, 17% from the U.K., and 18% from other areas. A typical acquisition occurred during 2012 with Germany-based Elster Group, a manufacturer of metering products sold worldwide, which Melrose financed with a 1.2 billion-pound Rights Issue and a new 1.5 billion-pound bank facility. Balancing transactions occurred with the sale of two businesses, Dynacast and MPC, and the associated return of proceeds to Melrose's shareholders.
At first glance, such transactions make it difficult to appraise Melrose's total-return performance. However, in last year's full-year report, the directors said that since Melrose's flotation in 2003, the firm has achieved investment break-even by paying back shareholders the 785 million pounds in capital raised for acquisitions. Indeed, at a Melrose share price similar to today's, the directors reckoned that shareholders had seen 1.5 billion pounds of value creation from operations.
So, on balance, an investment in Melrose seeks a total return via the level of the share price and the value of dividends paid, as with other investments. On that score, the firm's potential looks encouraging.
Melrose Industries' total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:
1. Dividend cover: adjusted earnings covered last year's dividend just over twice. 4/5
2. Borrowings: net gearing is around 50% with net debt just over three times earnings. 3/5
3. Growth: earnings have grown steadily against flatter revenue and cash flow. 3/5
4. Price to earnings: a forward 13 seems fair compared to growth and yield forecasts. 3/5
5. Outlook: satisfactory recent trading and a cautiously optimistic outlook. 4/5
Overall, I score Melrose 17 out of 25, which encourages me to believe the firm has potential to out-pace the wider market's total return, going forward.Foolish summary
There's good dividend cover, and debt seems under control. As might be expected, growth shows up best in the earnings figures as Melrose improves the efficiency of its underlying businesses. The valuation looks fair, given recent trading and the outlook. That encourages me to believe that, yes, I should invest in Melrose Industries, but I'm inclined to wait for share price weakness before taking the plunge.
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Kevin does not own shares in Melrose Industries. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.