Melrose’s revenue rose 8% in the first quarter, ignoring the impact of exchange rates. This was driven entirely by 21% growth in its Engines division, while revenue in its Structures division remained flat.
In the Engines division, aftermarket volumes (servicing and replacing engine parts) continue to increase, although growth is being constrained by industry-wide supply chain issues. Given the higher profitability of aftermarket work, margins are benefitting in line with prior group guidance.
Flat structures revenue reflects the decision to exit non-core work and destocking by a major customer.
Full-year guidance remains unchanged. Underlying operating profit is set to rise by around 33% to £560mn (at the midpoint and before £30mn of corporate costs), with performance weighted towards the second half of the year.
The shares rose 1.5% following the announcement.
Our view
Melrose is a pure-play, high-quality aerospace business. The group’s benefitted from strong ongoing growth drivers, which helped its Engines division grow revenue at double-digit rates in the first quarter.
The Structures division, which deals with building the body and wings of planes, took some shine off performance, with revenue remaining flat. This was expected though, and operational changes being made now should feed through to growth by the end of 2025.
While the aviation sector can be volatile, we think the current outlook for long-term growth is solid. Melrose's exposure to military as well as commercial customers provides a welcome layer of diversification.
Airlines are also looking to upgrade their ageing fleets after several years of Covid-related underinvestment. That's resulted in record order backlogs to supply components for more than 14,000 Boeing and Airbus aircraft, stretching all the way out to 2030 and beyond. We see the potential for high single-digit revenue growth over the next few years.
The group's Engines segment has multiple Risk and Revenue Sharing Partnerships (RRSPs) with engine makers - 17 out of 19 of which were in the cash-generation phase. The RRSPs require Melrose to contribute an agreed percentage of the total annual engine costs, and in exchange, it receives the same percentage of total annual engine revenue. Considering the long lifetime of an engine model (typically 30+ years), it means Melrose can continue to benefit from ongoing cash flows for decades after engine delivery.
Profitability in the Engines division continues to impress, with operating margins sitting north of 25% at the last count. Further improvements are expected, which is fuelling management expectations that total group margins can be ramped up to at least 17% in 2025. While this sounds attractive, it relies on trimming fixed costs, improving productivity, and resolving issues with unprofitable contracts. By no means a straightforward set of tasks.
And while there's been a steady uptick in air travel over the past couple of years, the potential for a recession hasn’t disappeared. Historically, aerospace has not been a particularly great place to hide when the economy enters a down cycle. And while supply chain disruptions have moderated, they're likely to remain a thorn in the group’s side.
Since the demerger of Dowlais, the historic multiples are no longer reflective of Melrose's current operations. The new, streamlined Melrose trades at 21.0 times expected earnings, which is towards the high end when compared to peers. With an improving market backdrop there may still be room for upside. But bear in mind, there are still plenty of operational challenges for Melrose to navigate, so buckle up for some volatility over the short term.
Melrose key facts
All ratios are sourced from Refinitiv, based on previous day’s closing values. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn’t be looked at on their own – it’s important to understand the big picture.
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