Melrose is one stock set to bloom for smart buyers

For Nickols, the initial spur had been that  the stock simply looked good value, as it was trading on a price to earnings ratio of 5x, he says.

While Nickols describes the business as ‘an out and out value situation‘ at such levels, he agrees with another key shareholder Artemis Income’s Adrian Frost who owns more than 3%, that the strength of the management team is an outstanding reason to buy in.

Nickols told Citywire: ‘They have a 20 year record of buying underperforming businesses and then sorting them out. Previoulsy FKI has struggled operationally and had an unsustainable balance sheet.’

Another key plus for Nickols is the book of business. Nickols agrees with the analysts that the order books of both the lifting and the energy divisions have strong visibility through to 2011.

‘We can look through to the end of next year with some comfort but the key point is that the margins of these two divisions are well ahead of what was thought capable. ‘

Nickols also agrees that Melrose can push those margins ‘towards 20%.’

The diversification of the business is another plus.

‘It has a broad spread of end markets with power generation, autos, construction and energy businesses and it is on undemanding valuations.’

Nickols says its 12x P/E ratio for this year should fall back to 10x in 2011 but he expects it to continue to outperform.

‘We expect the newsflow to sustain ongoing interest in it. Part of its rationale is to buy businesses and make them better. Once that has been achieved they crystallise the proceeds and move on.'

Other significant managers also own this stock below the disclosure limit. Tony Nutt holds 0.65% in the Jupiter Income trust while Derek Stuart, manager of the Artemis UK Special Situations fund, holds 0.8%.

Citywire Verdict

A significant double-dip for the British economy would of course hit this stock. But many of its divisions should do well late in the cycle. The ability and track record of the management team to deliver further operational synergies and revenue growth bodes well for future margin uplift. The visibility of the order book over the next 12 months is the icing on the cake, making this a strong buy.