November 16, 2017 / 1:16 PM / a month ago

Breakingviews - Audit defect throws wrench in GKN re-engineering

LONDON (Reuters Breakingviews) - An accounting malfunction has thrown a wrench into hopes for GKN’s re-engineering. Chief executive-designate Kevin Cummings is leaving the UK-based car parts and aerospace group with immediate effect after it unearthed more audit problems in the aerospace unit he ran. The mess reinforces the case for breaking the company into two, but also delays any retooling.

In October GKN shares fell nearly 10 percent after the group said it would have to pay out two large claims to customers and tweak its accounting for inventory at a plant in Alabama, which makes systems for military aircraft. Now it turns out those problems are not just in Alabama, and the charge has expanded to as much as 130 million pounds – equivalent to almost a quarter of the pre-tax profit analysts expected GKN to report this year. The stock fell as much as 8 percent on Wednesday morning.

The scandal reinforces the case for a bigger shake-up. There are a few direct synergies between making car parts and supplying fuselages and landing gear for aircraft. The accounting problems also suggest the two units would benefit from closer attention by top management. Analysts at Investec reckon tighter cost control could lift GKN’s operating profit margin, around 8 percent last year, by two percentage points. Splitting the businesses could also unlock stock market value. Even before the latest selloff, GKN’s enterprise value of around five times forward EBITDA was more in line with pure car-parts groups. That suggests the more promising aerospace business is under-appreciated. Meanwhile GKN’s auto technology, for example in all-wheel drive systems, should benefit from the growth of hybrid and electric vehicles.

Financial engineering will have to take a back seat, though. Selling or spinning off the auto unit looks harder when aerospace is facing problems. Finding a new permanent chief executive may take months, leaving the group in strategic limbo. True, an outsider might find it easier to break up the company. Even so, investors face a longer wait for a fundamental overhaul.

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