OEM, Decarbonization And Trade Pressures Will Crush Margins

Key Takeaways

• Heavy dependence on key aerospace customers and challenging labor dynamics threaten revenue stability and could lead to sustained margin pressure amid industry disruptions.
  
• Navigating regulatory, technological, and geopolitical changes will require large investments, with risks around cost management, sales growth, and long-term profit performance.
  
• Strong market positioning, operational efficiency gains, and advanced technology investments support resilient margin growth and rising shareholder returns in both civil and defense aerospace.

Catalysts

Designs and delivers aerospace components and systems for civil and defence markets in the United Kingdom, rest of Europe, North America, and internationally.

• Melrose's heavy reliance on major aerospace engine OEMs like Rolls-Royce, GE, and Safran exposes the company to significant revenue concentration and negotiation risk; should any of these customers cut production rates or aggressively renegotiate contracts in response to supply chain disruptions or restructuring, future revenue growth and earnings stability could be materially undermined.
  
• The accelerating need for decarbonization in aviation is likely to force Melrose to commit to major investments in unproven, capital-intensive green technologies and next-generation propulsion systems. As aviation regulatory pressure grows, failure to achieve technological leadership or pass on sharply higher research and development and capex costs may sharply erode net margins across both civil and defense aerospace segments.
  
• Geopolitical instability-including tariff disputes and increasing trade protectionism in aerospace-remains an ongoing threat to the efficiency and cost base of Melrose's globally distributed manufacturing footprint. Any escalation in tariffs, loss of exemptions, or restrictions on cross-border trade may drive structurally higher operational costs and limit international sales, permanently impairing long-run profit margins and cash generation.
  
• Long-term labor shortages in engineering and advanced manufacturing, combined with the need to execute production ramp-ups and complex new product launches, risk forcing Melrose to contend with escalating wage bills and persistent execution delays. This dynamic is likely to drive higher operational costs, weaker productivity gains, and ultimately sustained margin compression over the next decade.
  
• As Melrose's buy, improve, sell model matures and the global M&A environment becomes less favorable, the company may struggle to identify and acquire new accretive targets at attractive valuations. Without ongoing portfolio optimization to drive fresh growth, organic revenue expansion could fall below expectations while returns on invested capital plateau, putting long-term earnings growth and shareholder returns at risk.

Melrose Industries Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Melrose Industries compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Melrose Industries's revenue will grow by 6.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 9.2% today to 6.6% in 3 years time.
• The bearish analysts expect earnings to reach £273.6 million (and earnings per share of £0.22) by about August 2028, down from £316.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 22.2x on those 2028 earnings, down from 24.0x today. This future PE is lower than the current PE for the GB Aerospace & Defense industry at 25.0x.
• Analysts expect the number of shares outstanding to decline by 3.03% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.32%, as per the Simply Wall St company report.

Melrose Industries Future Earnings Per Share Growth

Risks

• Strong long-term secular demand for both civil and defense aerospace, with record aircraft order backlogs and decades of runway for fleet growth, drives steady increases in Melrose's OE and aftermarket aerospace revenues, creating a foundation for future earnings expansion and potentially supporting a higher share price.
  
• Deeply embedded, design-led and largely sole-source positions on major commercial and defense platforms provide recurring revenue streams and substantial pricing power, which, combined with successful repricing of the defense portfolio, position Melrose for robust and resilient margin growth over time.
  
• The completion of a comprehensive, multi-year transformation and restructuring program yields significant cost reductions, operational efficiencies, and an optimized manufacturing footprint, enabling substantial operating leverage as market volumes recover and further supporting net margin and earnings growth.
  
• Accelerated investments and technological leadership in additive manufacturing and advanced engineered components open up avenues for premium-margin growth and long-term relevance in next-generation aerospace programs, which may lead to enhanced return on capital and higher profitability in future years.
  
• Increased exposure to high-margin engine aftermarket services, growing proprietary technology adoption, and strong global customer relationships across both defense and civil aerospace contribute to a visible, rising free cash flow profile, supporting improved capital returns to shareholders and potentially underpinning share price appreciation over the long term.

Valuation

• The assumed bearish price target for Melrose Industries is £4.12, which represents two standard deviations below the consensus price target of £6.5. This valuation is based on what can be assumed as the expectations of Melrose Industries's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £8.25, and the most bearish reporting a price target of just £4.05.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be £4.2 billion, earnings will come to £273.6 million, and it would be trading on a PE ratio of 22.2x, assuming you use a discount rate of 8.3%.
• Given the current share price of £5.97, the bearish analyst price target of £4.12 is 44.7% lower.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.