ii view: Melrose rallies amid demand for jet engine parts

Trading update from 1 July to 31 October

• Revenue up 7% year-over-year
• Continues to expect full-year adjusted operating profit of between £550 million to £570 million

Chief executive Peter Dilnot said:

"It's encouraging that we remain on track to deliver on our full year expectations, despite the industry-wide supply chain challenges.  

“As we move into 2025, we enter a period of significant and sustained growth in our cash flow for many years ahead.  I am confident that Melrose's established capabilities, technology leadership, and unique position on the world's leading aircraft and engines will create substantial value in the future."

• Invest with ii: What is a Managed ISA? | Open a Managed ISA | Transfer an ISA

ii round-up:

Aerospace component maker Melrose Industries (LSE:MRO) today reported strong demand for aircraft engine aftersales, particularly in relation to the defence sector. 

Revenues for the first four months of the second half to late October rose 7% year-over-year, driven by a 17% increase in engine related sales and a 1% rise for airframe structures. 

Shares in the FTSE 100 company climbed 8% in UK trading having come into this latest news down 14% year-to-date. That’s in contrast to an 80% rise for fellow aerospace related company Rolls-Royce Holdings (LSE:RR.). The FTSE 100 index itself is up 4% in 2024. 

Melrose aerospace was previously part of GKN, bought by Melrose in 2018 and with the automotive business subsequently demerged to become FTSE 250 company Dowlais Group (LSE:DWL).  

Aftermarket sales of aircraft engine components increased by almost a third from the same period a year ago, led by defence related demand. Original equipment volume demand remained constrained by industry-wide supply chain issues.

Demand at the structures business had been hindered by a cocktail of factors including supply constraints, customer destocking and a planned exit of non-core product items. Restructuring of the division continues and is expected to generate a significant reduction in associated cash spending come 2025.

Melrose continues to forecast operating profit in 2024 of between £550 million and £570 million, with a target of £700 million for 2025 on course. That’s potentially up from 2023’s £420 million.  

Full-year results to 31 December are scheduled for 6 March. 

ii view:

Started in 2003, Melrose has acquired and sold numerous engineering businesses including Dynacast, McKechnie, FKI, Elster, Nortek, and GKN. Today, its Engines and Structures divisions provide technology for more than 100,000 flights a day. Engines generated most of the group’s profit during 2023 at £310 million and a margin of 26%, with structures a balance of £110 million and a margin of 5%. 

For investors, the aerospace industry is historically cyclical and volatile, with passengers or consumers now subject to pressured disposable incomes given heightened borrowing costs. The pandemic was the aerospace industry’s biggest ever crisis with supply chain disruptions still being suffered. Costs for businesses generally, and including wages, are now heightened, while a price-to-net asset value above the three-year average may suggest the shares are not obviously cheap. 

• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis
• Insider: chiefs spend millions on these FTSE 100 shares
• ii view: BAE Systems stays on target for double-digit growth

More favourably, a track record of buying, selling, and turning around businesses includes returning more than £5 billion to shareholders since being founded in 2003. Diversity of both product, underlying customer, including both defence and commercial clients, to geographical region, exists. A restructuring of the business by management persists, while there is a dividend, albeit a modest 1.4%. 

On balance, and despite ongoing risks, a consensus analyst estimate of fair value above 600p per share is likely to generate interest in this aerospace and turnaround specialist.   

Positives: 

• A track record of previous acquisitions and value enhancing sales
• Continued restructuring

Negatives:

• Group strategy has previously created conflict with governments and trade unions
• Uncertain economic outlook

The average rating of stock market analysts:

Buy