Melrose Industries Offers a Buying Opportunity for Growth in the Aerospace Aftermarket (OTCMKTS:MLSPF)

Melrose Industries (OTCPK:MLSPF) might not be a name many have heard of. However, if you’re an aerospace investor, you’ve probably heard of GKN Aerospace, which has a significant stake in commercial aircraft through its engine programs. That company is part of Melrose Industries, which makes the parent company a very interesting one to study for attracting investment.

Melrose has a huge motor market opportunity

Melrose currently has a market capitalization of $8.1 billion and its business is comprised of two aerospace divisions, namely engines and aerostructures. The engine end market is 74% civil aerospace and 26% defense aerospace, while the structures business is 67% civil aerospace and 33% defense.

Through the engine segment, the company is a supplier and key participant in the main engine platforms offering products and more importantly services, which can be very profitable, which it also becomes apparent as we consider 26% operating margin in 2023, with half of revenue coming from aftermarket sales.

The structures business provides electrical distribution, cockpit and cabin windows, fuselage sections, primary wing structures and gauges for civil aircraft, and for defense platforms it provides canopies, landing gear, electrical distribution systems, flapers and skins and doors. For reference, the company has 0.2 to 0.5 million pounds of components for single-aisle aircraft and 1 million to 2 million pounds for wide-body aircraft, while the Gulfstream G650 has around 2 million pounds of Melrose components and the F-35 has even 2.6 million pounds. So based on higher build rates for business jets as well as commercial jets, there is significant OEM revenue.

The company has a very attractive mix of commercial and defense activities, as well as OEM and aftermarket work. What I love about Melrose is the aftermarket exposure. Companies such as GE Aerospace ( GE ), Rolls-Royce ( OTCPK:RYCEF ), MTU Aero Engines ( OTCPK:MTUAF ) and Safran ( OTCPK:SAFRF ) also offer significant aftermarket opportunities, but Melrose is active on a wider range of engine platforms. through strategic partnerships, while the peers mentioned above are somehow exclusive to the platform they are suppliers or OEMs on.

Melrose Industries’ earnings show the strength of the business

The above slide looks boring. I’d say boring is good though. Total revenue rose 12% to £1.74bn, while profits rose 52% to £260m on a margin expansion of 14.9%. The engine business saw revenue rise 21% to £720m, with a strong 46% rise in profits to £212m, driven by the strength of aftermarket business. Structures sales rose 6% to £1bn as customers were drained as production rates consistently fell short of target levels, but profit rose 89% to £48m of pounds as costs are better passed on to customers.

So while the reality of the aerospace industry is that aerospace supply chains are currently the limiting factor for OEM sales growth, we see the strong aftermarket mix driving significantly higher revenues and margins. Looking at the growth rates, one would almost think that Melrose is not facing any pressure from the supply chain. They certainly are, and the current results really show how resilient the business is.

What are the risks and opportunities for Melrose Industries?

The clear risk for Melrose Industries is pressures on OEM production rates. However, at the same time, this provides increased demand for high-margin aftermarket sales. So there is an opportunity there as well. In addition, the company has a huge opportunity for aftermarket sales, which should see significant acceleration in the coming years, along with increased production rates once growth is sustained. For 2025, the company aims to expand Engines margins from 22% to >28% and Structures margins from 3% to 9%, with total margins of >18% on sales of £3.8bn by 2025, with significant cash generation in the years to come. on aftermarket sales, increased scope, higher production rates and repricing of certain contracts.

Melrose Industries stock has a multi-year upside

To determine multi-year price targets, we developed a stock analysis tool that uses a combination of analyst consensus on EBITDA, cash flows, and the latest balance sheet data. Each quarter, we revise those assumptions and stock target prices accordingly. This blog details our analysis methodology.

Melrose Industries has a lot of upside based on strong end market demand. EBITDA is expected to grow 15.7% annually between 2023 and 2026, while free cash flow will turn from negative to positive as growth materializes and aftermarket sales begin to pick up. The company also seems to have anticipated this free cash flow generation as it began buying back shares. The company already had a £500m share buyback program which will end this year, and in August it announced another £250m share buyback programme, which I modeled for 2025. Based on current expectations, the stock is undervalued given FY2024 earnings and even offers 26% and 47% upside for 2025 and 2026, and I think beyond that the company will see further growth in its sales aftermarket, which will lead to even greater cash flow generation.

For those interested in buying shares of Melrose Industries, it should be noted that volumes and liquidity in the stock are low, which could make it challenging to buy and sell in the desired quantities and at the desired prices. Therefore, for anyone looking to invest in Melrose Industries, I would recommend checking out the ticker symbol MRO on the London Stock Exchange.

Bottom line: Melrose Industries is a very attractive aerospace stock

Melrose Industries has a nice mix of commercial and defense exposure while also diversifying between OEM and aftermarket sales. The latter is extremely profitable, and as more engines require service in the coming years and decades, we see a significant cash flow opportunity for the company. As a result, I rate the stock a buy.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.