With underlying profits down 37% and having sensibly taken a large non-cash impairment write down hit on intangible and other assets, first half year results from Meggitt, an international engineering company that specialises in the manufacturing of high performance components and sub-systems for aerospace, defence and energy markets, are confirmation if it was needed of just how difficult life is for all companies engaged in and around the civil aerospace market. For all that, given rapid and decisive action taken to reduce cost, to protect cash and to resize the overall group cost base, Meggitt ended the first half period in very good heart and well positioned for recovery.
CEO Tony Wood ended the H1 results statement saying:
“We are still working through a difficult and uncertain COVID-19 environment, and while it’s too early to precisely predict the trajectory of the return to prior levels of activity in civil aerospace, we continue to focus on ensuring that the business is well positioned to benefit from the recovery. Based on the effective actions we’ve taken to strengthen liquidity and the resilience of the Group, underpinned by our diverse end market exposure and strong market positions, we believe we are well placed to benefit from the recovery and to continue the transformation of Meggitt to deliver long-term, profitable growth.”
In these uncertain times such remarks are to be regarded as realistic just as they are also showing confidence for the future. Meggitt has over the past few years invested heavily for that future and is in my view very well placed to benefit when recovery finally emerges. The fast and decisive action taken in order to position itself through COVID-19 reflects the strength of Meggitt management and if deemed necessary, further cost cutting action will be taken.
Thankfully Meggitt has a diverse portfolio of engineering-based interests and as the statement noted, revenues in the defence division accounted for 43% of the H1 group result. From a trading position, civil aerospace revenue declined 27% in H1 and there was a 6% decline in energy revenues. However, defence revenue increased by 7% on the back of increased activity in the US.
While group orders were not surprisingly down on the previous year and there can be little doubt that the second half of the year will be further impacted by the ongoing impact of COVID-19, Meggitt has at this stage sensibly based forward assumptions recognising that there could be a range of outcomes in the civil business in the last four months of the year.
However, the company is anticipating a gradual improvement in some segments of the commercial aerospace sector during H2 and of particular interest was the point made in the statement suggesting that the third (current) quarter was encouraging, particularly domestic travel and business jets.
While noting too that near term uncertainty in regard of the pace and shape of a recovery across the sector could well stretch into 2021, thereby limiting visibility on performance of the civil business, the base case scenario for civil aerospace is that new build rates remain at or near current levels and that a progressive recovery in air traffic will feed through into aftermarket revenue. In respect of Defence Meggitt expect outlays in the core US market to remain robust and for conditions in the energy division to remain stable. In terms of cash the company expects to be broadly free cash flow neutral for the full year.
Net debt at the 30th June stood at £1 billion, slightly down on the equivalent first half period in 2019. Free cash (outflow) during the period was £121.5 million, this being in line with guidance issue in July and driven by lower operating profits, higher working capital and an anticipated increase in cash tax and capital expenditure – the latter representing and an anticipated peak in the current investment cycle on strategic projects.
Setting the record straight following what I can only describe as having nonsense claims reported earlier this month by a US based newswire organisation suggesting that Meggitt was working with advisors to review equity and debt funding options and to that end was considering selling as much as $600 million of new stock, the company ended the first half period in a financially robust position and while the dividend has been suspended to save cash, there has been no call of shareholders for additional cash. Neither will there be in my opinion.
In terms of financing and given that unfortunate, spurious and damaging speculation, it’s worth noting that In April this year the Group was confirmed as an eligible issuer under the Bank of England and HM Treasury’s CCFF – a scheme under which the Group can draw up to £600m. Meggitt has issued commercial paper under this facility totalling £130m at 30th June 2020 and which is included within our committed facilities of £1,701m and the additional headroom of £470m under the CCFF as at that date.
On 11th May the company extended the duration of its debt by securing a forward start on a revolving credit facility, with the signing of a new one year $575m multi-currency facility maturing in September 2022. For the record, there are two main financial covenants in our financing agreements. The net borrowings/underlying EBITDA ratio, which must not exceed 3.5x, was at 1.8x at 30 June 2020 (June 2019: 1.8x) and interest cover, which must be not less than 3.0x, was 14.1x (June 2019: 15.0x). The Group has significant headroom against both key covenant ratios, and net borrowings/underlying EBITDA is well within our target range of 1.5x to 2.5x
CHW (London – 8th September 2020)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785