Melrose Industries (LSE: MRO) was stinking out the FTSE 100 today (23 August). As I write, it’s down 9.1% to 464p. The overall Footsie was actually up, so this one stuck out like a sore thumb.
With today’s drop, the stock’s year-to-date decline has now deepened into double digits (around 18%). Could this present a golden opportunity for me to buy the dip? Let’s dig into the details.
Why is the Melrose share price down?
Shareholders in the aerospace company have analysts at UBS to thank for today’s share price slump. The broker double downgraded the stock to ‘sell’ from ‘buy’ and cut its price target to 400p from 770p. Ouch.
Downgrades aren’t necessarily anything to fret about, but the reason here is noteworthy. That’s because UBS estimates that the firm’s revenue and risk-sharing partnership (RRSP) portfolio is overvalued. And not by a couple of quid, but actually less than half the £5.7bn cited by Melrose’s management on 1 August when discussing its half-year results.
This RRSP business includes collaborations on engines with Rolls-Royce, General Electric, and Pratt & Whitney. These provide a steady income from the lucrative aftermarket following engine sales.
UBS said its lower value is based on differing cash-flow estimates, discount-rate assumptions, and timing effects. As I write, Melrose hasn’t replied to this.
Strong results
This comes after the company recently trimmed its 2025 revenue estimates to £3.8bn from a previous forecast of £4bn. This is related to the “ongoing industry-wide supply chain challenges” across the aerospace industry.
Rolls-Royce reckons these issues could persist for another 18 to 24 months. So there’s a risk things could get even could worse.
That said, Melrose’s results for the six months ended 30 June were strong. Revenue rose 12% year on year to £1.74bn, driven by strong performance in its engines and structures divisions. Adjusted operating profit soared 55% to £247m.
It also announced a new £250m share buyback programme to run over the next 18 months. And the interim dividend was hiked 33% to 2p per share. These are hardly the signs of a struggling company.
My move
The stock’s forward price-to-earnings (P/E) ratio is around 18.5. That’s expensive compared to the FTSE 100, but cheap for its sector. Then again, a lot of aerospace firms linked to the booming defence industry have surged in value since the war in Ukraine.
Even after the dividend increase, I note the yield is still puny at 1.1%. That’s not attractive from an income perspective.
I already have holdings in BAE Systems and Rolls-Royce, both bought at much lower prices. Although Melrose has its own distinct business model, I think my portfolio has enough exposure to the industrials sector.
Still, investors might want to dig further into this falling FTSE 100 stock. I’d imagine the company will eventually respond to the reason for today’s drop. The share price could be due a rebound.
Long term, the company is exposed to the lucrative engine aftermarket, while the stock is far cheaper than Rolls-Royce. It may well prove to be a bargain at today’s price.
This post was originally published on Motley Fool
