Ahead of its capital Markets Day, Melrose issued 2025 guidance for its aerospace business. Revenue is expected to reach £4.0bn in 2025, compared to the roughly £3.4bn expected this year.
We'd already heard the group's underlying operating margin was expected to eclipse 14% in 2024, and that's now expected to rise to between 17-18% in 2025.
Underlying operating profit is expected to roughly double from around £350m this year, to £700m in 2025. That's before accounting for corporate costs which are expected to reduce by about 17% to £25m over the next two financial years.
Free cash flow margin is expected to reach 12% in 2025, then rise above 20% over the long term.
The shares rose 6.7% following the announcement.
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Our view
The completion of the Dowlais demerger marks the start of a new chapter for Melrose. The two businesses have become separate, publicly listed companies. Melrose has retained ownership of its Aerospace business, and shareholders now have shares in both companies.
Investors holding Dowlais shares will undoubtedly be curious about the outlook. We think the Automotive and Powder Metallurgy businesses have market-leading positions, alongside a now leaner cost base. There are also structural growth drivers to consider, such as legislation and the electric vehicle transition, which Dowlais looks to benefit from. With pre-demerger underlying revenue of £5.2bn and operating profit of around £332m, the current valuation of around £1.75bn doesn't look too demanding to us.
The separation means Melrose is now purely an aerospace play - giving it the potential to attract a valuation reflective of a high-quality aerospace business in an improving market backdrop.
2023 got off to a good start. In the first four months, the group's Engines and Structures divisions both saw revenue grow at double-digit rates, fuelled by strong growth drivers that look set to continue playing into the group's hands. That's led management to issue guidance out to 2025, highlighting the visibility that the group's lucrative Revenue and Risk Sharing Partnerships (RRSPs) provide - more on them later.
Whilst the aviation sector can be volatile, we think the 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 an order backlog to supply components for more than 12,000 Boeing and Airbus aircraft, meaning we see potential for revenue to continue growing at double-digit rates for the next couple years.
The group's Engines segment has multiple RRSPs with engine makers - 17 out of 19 of which are now 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, it means Melrose can continue to benefit from ongoing cash flows for decades after engine delivery.
Underlying operating profit margin rose to around 10% year-over-year, and management are expecting this to ramp to around 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.
There are some clouds on the horizon though. While there's been a steady uptick in air travel over the past couple years, the potential for a recession hangs heavy over the market. 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 side throughout this year.
Since the demerger, the historic price/earnings ratio is no longer reflective of Melrose's current operations. The new, streamlined Melrose trades at 23.5 times expected earnings, which is towards the high end when compared to peers. With an improving market backdrop and a management team that's now able to focus solely on one division, rather than juggling several, there may still be room for upside. But bear in mind, there's still plenty of operational challenges for Melrose to navigate, so volatility should be expected over the shorter-term.
Melrose key facts
All ratios are sourced from Refinitiv. 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.
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.
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