Back in June, I got a bit excited about the Melrose (LSE: MRO) share price. Maybe a little too excited, wondering whether its prospects could match up to the incredible rally we’ve seen in Rolls-Royce shares.
Like Rolls, Melrose has fingers in both the civil and defence aerospace pies. Its Engines division earns over half of its revenue from the lucrative aftermarket phase, where margins are fatter and demand more stable. The group’s Structures arm, meanwhile, makes fuselage and electrical systems for all the major aircraft makers. It’s also doing solid business in defence as Europe re-arms and simmering global tensions threaten to boil over.
Flying FTSE 100 stock
The board had also set out ambitious 2029 targets, including £5bn of revenues, £1.2bn profit and margins of 24%. I spotted risks too, including a rising net debt pile, supply chain issues and restructuring costs. I eventually came back to earth, concluding: “I can’t imagine it can pull a Rolls-Royce-style moonshot… but still think it’s worth considering today.”
The wider mood in the City was more cautious ahead of today’s (1 August) results. On 26 June, analysts at Kepler Cheuvreux downgraded the stock to Hold, flagging negative free cash flow, ongoing restructuring costs and headwinds from a weaker dollar and higher interest costs. The note explicitly said to expect “no miracles” when the H1 numbers landed.
I’m not sure if we got a miracle, but today’s results were sparky enough to drive the shares up by 6.8% as I write this. While that doesn’t quite match Rolls-Royce’s 10% early jump yesterday, it’s still a strong response to a better-than-expected update.
Margins up, profits higher
Revenues rose 6% on a like-for-like basis to £1.72bn, with adjusted operating profit up 29% to £310m, beating expectations. Margins improved from 14.2% to 18%.
The Engines business is flying with 11% revenue growth and a juicy 33.4% operating margin. Melrose is clearly benefitting from its risk- and revenue-sharing contracts and a growing aftermarket services business. It also deepened ties with Pratt & Whitney and the Swedish Defence Administration, both long-term positives.
Structures was more mixed. Revenue rose just 3%, but profits jumped 32% and margins improved. The defence side is performing well, helped by a contract extension with BAE Systems and new deal with Lockheed Martin. Civil demand was flat, which wasn’t a surprise.
Free cash flow was still negative, with a £54m outflow, but that’s better than last year’s £145m negative number. Management remains confident of a positive £100m flow for the full year. Debt remains a concern though, edging up to £1.4bn, and guidance was trimmed slightly due to the stronger pound.
Valuation gap remains wide
The Melrose price-to-earnings ratio is just over 19, compared to Rolls-Royce at a lofty 53. But Rolls is now a special case, not a benchmark for others. Melrose is delivering steady progress, with restructuring nearly done and long-term defence exposure that should provide some resilience.
The 13 analysts covering the stock produce a median target of 615.8p, up more than 12% from today. Not a moonshot, but there’s potential growth here.
This latest set of results shows Melrose is moving in the right direction. It’s no Rolls-Royce, but I think it’s still worth considering for investors seeking diversification.
