Melrose Industries plc (MRO) ORD 0.1p

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Melrose’s underlying revenue rose 6.7% to £1.7bn in the first half. The Engines and Structures divisions both saw growth, but performance in the latter was held back by supply constraints and customer destocking.

Underlying operating profit rose 55.3% to £247mn, largely driven by improved profitability in the Engines division as aftermarket activity increased.

There was an underlying free cash outflow of £60mn, compared to an outflow of £65mn last year. Net debt increased from £572mn to £976mn.

Full-year guidance remains unchanged. Underlying operating profit is expected to rise by around 33% to £560mn (at the midpoint and before corporate costs).

An interim dividend of 2.0p per share has been announced, up 33%.

The shares fell 7.5% following the announcement.

Our view

Melrose saw its underlying operating profit soar in the first half as margins improved, helping to keep 2024 guidance on track. But due to industry-wide supply chain issues, 2025 revenue guidance has been wound back from £4.0bn to £3.8bn, which spooked markets on the day.

Melrose is a pure-play, high-quality aerospace business. Its Structures division, which deals with building the body and wings of planes, took some shine off performance, growing at a more modest mid-single-digit rate. The ongoing restructuring programme, repricing of contracts, and new commercial agreements mean there’s room to step this up in the near-to-medium term.

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 29%, with further improvements expected. 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.

There are also some issues outside of Melrose’s control. Production trouble at Airbus and quality issues at Boeing have dented timelines, causing Melrose to lower its 2025 guidance. Supply chain issues are likely to remain a challenge for the industry, so we can’t rule out further setbacks.

Since the demerger of Dowlais, the historic multiples are no longer reflective of Melrose's current operations. The new, streamlined Melrose trades at 18.4 times expected earnings, at the high end when compared to peers. With an improving market backdrop there may still be room for upside. But with plenty of operational challenges for Melrose to navigate, there’s likely to be some volatility over the short term.

Environmental, social and governance (ESG) risk

The aerospace and defence sector is high-risk in terms of ESG. Product governance and business ethics are key risk drivers. Carbon emissions from products and services, data privacy and security and labour relations are also contributors to ESG risk.

According to Sustainalytics, Melrose’s management of ESG risk is strong.

It has board-level oversight of ESG issues and a very strong environmental policy. A part of executive remuneration is explicitly linked to sustainability performance targets, and there is a robust whistleblower policy in place. However, business is cyclical, depending highly on economic changes, which can lead to periodic layoffs.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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