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Meggitt – Driving Excellence By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

If the past two years have been about consolidating strong market positions, particularly on new commercial aircraft platforms such as the A320neo, A350XWB, Being 737MAX and Bombardier CSeries, together with relentless focus on product development processes, manufacturing capability and competitiveness, then the 2017 half year results to June 30th reported this morning and that show strong performance improvement should not have surprised.

True, a fall in the value of Sterling over the past year has also helped performance but the reality is that a combination of increasing scale, concentration of achieving greater efficiencies and boosting productivity together with rising sales in the commercial aerospace market are the primary drivers of the notably stronger performance disclosed.

Meggitt reported H1 results confirmed a 10% increase in revenue to £968.1 million during the period, a 7% increase in EBITDA, a 4% improvement in underlying pre-tax profits to £157.4 million and importantly, a huge improvement in free cash flow of £18.5 million compared to a negative £32.7 million a year earlier. Orders received during the period totalled £966.8 million which was very similar to revenue received.

With a strong balance sheet, net debt was down 12%, Meggitt is well placed to move forward and the dividend was also raised by 5%. Importantly, full year guidance and medium term targets for margin and cash were maintained.

The company told investors that it had made good progress on its key strategic objectives. The company has won an unprecedented number of parts and sub systems awards during the current development cycle and reducing fragmentation within the supply chain, reducing number of sites and paying huge attention to inventory are yielding benefits. Importantly, with an installed base of 68,000 aircraft worldwide, Meggitt has placed strong emphasis on further improving its Customer Services & Support (CSS) and where it has acquired additional MRO capabilities and secured long term agreements to support its airline customers.

New contract wins including the award of braking systems for the A321neo together with additional component requirements on the Boeing 777X and COMAC C919 are important gains and they once again highlight that Meggitt is a global company with massive reach across a wide variety customer base. I for one take the view that it is the very diverseness of the portfolio of business and customer base that is today one of Meggitt’s great strengths.

The period has seen several small but, from both a value and cost basis, important disposals being completed and worldwide the company has reduced the footprint of manufacturing sites to 48. The statement from CEO Stephen Young notes that not only were first half results in line with expectations but that the company expects to witness stronger growth in the second half with a corresponding improvement in margin – the target for this being between 19.1% and 19.4% – a figure that I might add is well above the industry average. Similarly, the emphasis on cash flow is also likely to continue.

Although a company that I have known since the 1990’s, this is ironically the first time to my knowledge that I have written on Meggitt since the company was on my list as an analyst back then. An FTSE 250 stock, having proved its ability to not promise more than it can deliver and by producing maintaining its full year guidance together with communicating well with its stakeholders and finally, as I mention above, accepting that the very diverseness of the group is one of its major strengths, it seems to me that Meggitt is very well placed for near, medium and longer term growth. Indeed, the positive long term outlook that had been emphasised strongly at the full year results presentation back in March combined with maintained positive guidance for near and mid-term having been reiterated in the first half results should leave little doubt of Meggitt’s ability to provide good shareholder returns over the coming years.

So who are Meggitt? This is a UK based global engineering company that specialises in smart engineering for extreme environments. Translated this means high performance components and sub-systems that provide critical functionality in challenging market applications for aerospace, defence and energy markets. Meggitt has, as I have already mentioned, a very broad base of diverse interests that in this case translate into being a well balanced portfolio.

Globally, Meggitt employs over 11,000 people within manufacturing facilities spread across Asia, Europe and North America. In addition the company has sales offices in Brazil, India and the Middle East. By revenue, civil aerospace products and services account for just over 50%, military 35% and the rest falling within energy plus a few other smaller yet still important specialist areas.

With an installed base of product on around 68,000 aircraft worldwide today, Meggitt civil aerospace interests cover a wide range of large commercial jets, regional aircraft, business jets, helicopters and general aviation products while those in military air encompass a large variety of aircraft types including Eurofighter Typhoon and F-35 Joint Strike Fighter plus land systems, naval platforms and scoring systems that are used for training and weapons systems development.

With Meggitt Civil Aerospace components accounting for around half of all revenue and with products and sub-systems including braking installed on almost every jet airliner, regional aircraft and business jet in service, this is no slouch in the world of global aerospace components. Worth noting too that the global aircraft fleet has grown significantly in recent years and today totals around 47,000 aircraft compared with little over 32,000 a decade ago. For Meggitt, new aircraft deliveries drive sales of original equipment but equally important is that aircraft utilisation generates demand for spare parts and repairs. The growth of the aircraft fleet is thus a strong indicator of future aftermarket revenue.

Military accounts for approximately 35% of Group revenue. Meggitt has equipment on over 21,000 military aircraft worldwide plus a variety of ground vehicles, naval vessels and training installations worldwide. During 2016, 63% of military revenue came from the USA, 26% from Europe and 11% from the rest of the world.

Energy accounted for 7% of Group revenue last year and the company is mainly involved in power generation and oil and gas markets supplying condition-monitoring, control valves and printed circuit heat exchanger technology. While, in common with bulk of the energy industry, this area has been more-patchy in terms of performance in recent years, growth potential is likely to be further enhanced by development of innovative new power generation technologies that depend on heat transfer engineering which enable turbines to operate at extreme temperatures and pressures, not possible with traditional heat exchangers.

Training also extends to law enforcement and security organisations and the company’s presence in energy is driven by the core capabilities it has established in control valves for industrial gas turbines, heat transfer engineering that used in oil and gas platforms and in offshore gas processing and storage together with a range of sensing and monitoring capability deployed in rotating power generation equipment. Meggitt energy products are designed to promote safety and reduce maintenance costs, fuel consumption and carbon emissions.

Meggitt is a long term business and winning contracts triggers significant investment. Designing and developing products in the energy and aerospace arena is complex, highly specialist and regulated in respect of certification requirement.

The company has in my view an enviable record on investing in its own future and the average research and development spend as a percentage of revenue over the past five years is close to 9%. Importantly, the transfer of Meggitt core technologies to other markets, this has included for instance sensing materials for breakthrough medical devices and the test and measurement industry worldwide.

Forward Strategy

The company aims to continue growing and developing leading market positions internationally with smart engineering for extreme environments and that are able to meet complex regulatory structures imposed and certification processes associated with safety- and mission-critical products. Meggitt has a long and excellent history of investing in operations excellence and this in my view is one if its core competitive strengths. The company has also invested in its people and skills and in the process developed the culture required to deliver a performance based strategy. Bolt on acquisitions are always possible and further disposals of peripheral activities are equally possible although timing of these will be crucial.

The bottom line is that Meggitt will continue to invest in high-quality, timely service and support wherever required in order to provide improved customer satisfaction while at the same time maximising the value of products throughout their individual lifecycles and in providing further benefit to its shareholders.

CHW (London – 1st August 2017)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon

hwheeldon@wheeldonstrategic.com

@AirSeaRescue

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