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Melrose - profit guidance upgraded as margins improve

Melrose saw its half-year underlying revenue rise 19.7% to £1.6bn.

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Melrose saw its half-year underlying revenue rise 19.7% to £1.6bn. This reflects like-for-like growth of 19.0% in the Engines division, while Structures grew 18.0%.

Underlying operating profit rose from £45m to £159m as margins improved in both Engines and Structures, with the latter returning to profitability.

Net debt grew from £487m after adjusting for items related to the Dowlais Demerger, to £553m. Underlying free cash flow improved from an outflow of £82m to an outflow of £65m.

Full-year underlying operating profit guidance has been upgraded by more than 8% to between £375-385m, due to improved Engine margins. This is before PLC costs which are expected to total £30m.

Melrose revealed that CEO, Simon Peckham, will step down on 7 March 2024. The current Chief Operating Officer, Peter Dilnot, will take his place.

An interim dividend of 1.5p per share has been announced, as well as a £500m buyback programme which is set to start in October and be completed within 12 months.

The shares rose 7.9% following the announcement.

View the latest Melrose share price and how to deal

Our view

Following the demerger of Dowlais earlier this year, Melrose is now a pure play on its high-quality aerospace business. And it's thriving. Half-year results brought with it guidance upgrades, a new £500m share buyback programme and set out a succession plan at the top.

Performance this year's got off to a flying start. The group's Engines and Structures divisions both saw revenue grow at rates in the high teens, fuelled by strong growth drivers that look set to continue playing into the group's hands. That's led management to upgrade full-year profit guidance, adding more stock to the group's 2025 targets. This highlights the visibility that the group's lucrative Revenue and Risk Sharing Partnerships (RRSPs) provide - more on them later.

While 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 stretching all the way out to 2029, 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 were in the cash-generation phase last we heard. 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 has more than doubled year-on-year to 10.7%, 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 other clouds on the horizon too. 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 24.1 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's still plenty of operational challenges for Melrose to navigate, so buckle up for some volatility 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.

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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Written by
Aarin Chiekrie
Aarin Chiekrie
Equity Analyst

Aarin is a member of the Equity Research team. Alongside our other analysts, he provides regular research and analysis on individual companies and wider sectors. Having a keen interest in global economics, he knows how macro-events can impact individual companies.

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Article history
Published: 7th September 2023