Melrose Industries PLC

Overview

This is a deep value and contrarian analysis of Melrose Industries PLC (LSE:MRO), a UK-based aerospace and defense company that has transformed from a 'buy, improve, sell' industrial turnaround specialist into a pure-play aerospace technology business following the demerger of its automotive division (Dowlais) in 2023. The company now operates through two divisions - Engines and Structures - with design-led positions on virtually all major aircraft platforms globally. Despite strong operational progress and a clear path to significant cash flow generation, the stock trades at what appears to be a substantial discount to intrinsic value, creating a potential opportunity for patient investors willing to hold through the company's cash flow inflection point.

The Bear Case

Wall Street's skepticism centers on several legitimate concerns: First, the company has been unable to generate positive free cash flow for three consecutive years as a standalone aerospace business, with heavy restructuring costs and GTF powder metal inspection payments creating persistent cash drains. Second, the high price-to-book ratio of 273x appears alarming on the surface, suggesting limited asset backing. Third, the Structures division operates in what analysts describe as 'one of the least attractive areas of commercial aerospace' with weak pricing power and complex supply chains. Fourth, currency headwinds have forced management to revise guidance downward - the FX translation from $1.25 to $1.335 reduced operating profit guidance by £30-40 million. Fifth, UBS maintains a 'sell' rating with a price target of just 410p (vs. current 610p), arguing the Engines RRSP 'cash mountain' is worth only half of management's estimate. Finally, the stock has underperformed the UK market and aerospace peers like Rolls-Royce, which has risen over 1,285% in three years while Melrose has struggled. Supply chain disruptions and tariff uncertainty add further operational complexity.

The Bull Case

The contrarian thesis rests on several powerful but underappreciated factors: First, 2025 marks a critical inflection point - management guides to £100+ million positive free cash flow, with restructuring cash outflows ending this year. The £91 million YoY improvement in H1 2025 FCF validates this trajectory. Second, the Engines division possesses an irreplaceable portfolio of 19 Risk and Revenue Sharing Partnerships covering ~70% of global flying hours, creating a multi-decade annuity stream. Six engines (V2500, CFM56, GEnx, XWB, GTF variants) drive 90% of future RRSP value. Third, the market ignores that 17 of 19 RRSPs are already in cash-generative phase, with the problematic GTF programs expected to turn cash-positive by 2028. Fourth, over 70% of revenue is sole-sourced, creating exceptional competitive moats. Fifth, the defense spending surge - NATO targeting 5% of GDP by 2035 and Europe's €800 billion ReArm plan - provides a significant tailwind not yet reflected in 2029 targets. Sixth, management's 2029 targets of £5 billion revenue, £1.2 billion+ operating profit, and £600 million free cash flow imply massive earnings growth (>20% CAGR) with the stock trading at just ~15x forward earnings. Seventh, Morningstar assigns a WIDE economic moat and an 800p fair value estimate - 31% above current price. Finally, the company is actively returning capital through £250 million buybacks and 20% dividend growth.

Fundamental Deep Dive

Sentiment & Technical Setup

Catalyst Analysis

Multiple catalysts could drive a re-rating: 1) Q4 2025 results (February 2026) should confirm £100m+ free cash flow achievement - the first positive FCF year as a standalone company. 2) Completion of restructuring program by year-end 2025 eliminates a major cash drain. 3) GTF powder metal resolution progressing well, with headwinds expected to fade in 2027 and programs turning cash-positive in 2028. 4) Defense spending surge from NATO/European rearmament not yet in 2029 targets - provides upside optionality. 5) Additive fabrication commercialization accelerating - 100% serial production on Fan Case Mount Ring by end-2025, with a growing pipeline of parts to certify. 6) Continued execution on 85% defense repricing achievement demonstrates management credibility. 7) Potential strategic review of Structures division could unlock value - Senior recently received a 'surprisingly generous payment' for its structures business. 8) Ongoing £250 million share buyback (£150 million remaining) provides price support. 9) Dividend growth of 20% annually signals confidence. 10) Any evidence of accelerating OEM production rates would boost sentiment.

Key Risks

Conclusion

Melrose Industries represents a classic deep value opportunity where near-term operational noise obscures exceptional long-term fundamentals. The market is pricing in perpetual cash consumption when the company is demonstrably at an inflection point - H1 2025 showed £91 million FCF improvement and management confidently guides to £100m+ for the full year. The Engines division's RRSP portfolio is essentially a toll booth on global aviation, collecting royalties on ~70% of flying hours for decades to come. At ~15x forward earnings versus peers like Rolls-Royce at 41x and GE Aerospace at similar multiples, Melrose trades at a substantial discount despite comparable quality assets. Morningstar's 800p fair value estimate implies 31% upside, while the company's own 2029 targets (if achieved) suggest the stock could trade significantly higher. The wide economic moat from sole-sourced positions, design-led relationships embedded for program lifetimes, and breakthrough additive fabrication technology are not adequately reflected in the current valuation. The defense spending surge provides upside optionality not in current targets. Key risks are real but manageable, and the company's conservative balance sheet (2.0x leverage with £693m liquidity headroom) provides margin of safety. This is a patient investor's opportunity to buy a high-quality aerospace compounder before the market recognizes the cash flow transformation.

Overview

This report analyzes Melrose Industries PLC (LSE:MRO), an aerospace and defense Tier‑1 supplier, using William J. O’Neil’s CAN SLIM framework. It synthesizes the latest company-reported results and guidance with market data to assess growth, quality, and timing for investors.

Financial and Business Overview

Business model: Melrose is now a pure-play global aerospace and defense technology group operating through two divisions: Engines (risk-and-revenue-sharing partnerships, non-RRSP OE, repairs, and governmental) and Structures (design-to-build aerostructures, EWIS, transparencies). It is a ‘Super-Tier 1’ partner with embedded, often sole-source positions across leading civil and defense platforms. Scale and profitability: 2025 guidance (at $/£ 1.335) calls for £3.425–£3.575bn revenue and £620–£650m adjusted operating profit with Group margins ~18% for 2025; H1 2025 adjusted operating profit rose 29% YoY to £310m with margin up 380 bps to 18.0% (Engines margin 33.4%, Structures 6.7%). Adjusted diluted EPS in H1 2025 was 15.1p (+30% YoY). Cash and leverage: Free cash flow is guided to £100m+ for 2025; H1 free cash outflow improved by £91m to £54m due to higher earnings and lower restructuring. Net debt at 30 June 2025 was £1.404bn (2.0x ND/EBITDA), within covenant headroom. Buybacks of £250m are underway (c.£91m completed by H1 2025). Balance sheet snapshot (FY 2024): Total assets £7.44bn, liabilities £4.59bn, equity £2.84bn; book value per share ~£2.21. Working capital was negative (FY 2024 working capital -£171m) reflecting typical aero program cash dynamics and customer advances. Valuation and trading: Price 634.6p (GBp), trailing P/E ~25.4x on TTM EPS ~25p; P/B ~2.9x (price ~£6.35 vs book ~£2.21). Dividend ~6.0p (≈1% yield). Average analyst rating: Buy.

Market Position & Competitive Advantages

Position: Embedded, life-of-program content across 19 engine RRSPs (≈70% of global flight hours coverage) plus broad Structures content with >70% sole-source civil/defense positions. Structural tailwinds include record civil backlogs (narrowbody/widebody) and accelerated defense outlays (NATO/EU), driving OE ramps and aftermarket growth for decades. Moats and advantages: - High switching costs: Design-led, certified content integrated into platforms for program life. - Aftermarket annuity: Mature engines (e.g., V2500, CFM56) plus growing fleets (GEnx, XWB, GTF) provide multi-decade cash flows; Engines margin already >33%. - Technology leadership: Breakthrough additive fabrication (first and only certified major structural engine component in serial transition by end-2025), participation in next-gen engines (CFM RISE, next-gen GTF), and advanced composites/EWIS. - Operational transformation: Multi-year footprint consolidation (52 to 32 sites), repricing (85% of defense portfolio sustainably repriced 6 months early), lean ‘Brilliant Basics’ driving safety/quality/productivity gains. Key risks (be honest): - Tariffs/supply chain: US tariff regime and aerospace casting/forging constraints create complexity and working capital friction (mitigations in place but residual risk persists). - Concentration & program risk: GTF powder metal remediation costs (~£70m in 2025/26) and pacing of OE build rates can affect variable consideration timing and cash flows. - Leverage and cash conversion: Leverage ~2.0x; FCF inflects in 2025 but remains modest this year; variable consideration accounting and negative working capital require disciplined execution. - Governance optics: Shareholders rejected the directors’ remuneration report at the 2025 AGM (non-binding), highlighting sensitivity to pay alignment.

Stock Performance

Price: 634.6p; 52-week range 376p–682.6p; currently ~7% below the 52-week high and ~35% above the 52-week low. 50-day average ~607p; 200-day average ~542p, indicating an established uptrend. One-year total price change ~+34.9%. Average daily volume ~3.6m shares. The share has been resilient on improving margins, clearer cash inflection, and buyback support, with episodic volatility around tariff headlines and FX.

CAN SLIM Analysis

Conclusion

Melrose aligns well with CAN SLIM: accelerating quarterly EPS and margin expansion (C), improving annual earnings and a credible 5-year profit/FCF roadmap (A), multiple new product/technology and contract catalysts plus recent new highs (N), buybacks and strong platform demand (S), leadership characteristics and relative strength (L), robust institutional coverage (I), and a favorable sector trend despite macro crosswinds (M). Risks—tariffs/supply chain, GTF remediation cash flow, and leverage ~2.0x—are acknowledged but manageable with mitigations in place and cash generation inflecting in 2025. Tactically, consider adding on a constructive pullback toward the 50-day (~607p) or on a high-volume breakout above ~683p in line with O’Neil’s rules.