Just over a month ago, I wrote about how the FTSE 100 defence giant Melrose Industries (LSE: MRO) is gearing up for growth. At the time, it had just begun a mild recovery after hitting a yearly low of 417p.
Fast-forward 32 days and it’s now up 40% since! Buying the shares then would have netted me some decent returns. But as a risk-averse investor with a long-term view, I made a decision that best fits my strategy.
So have things changed?
In my previous article, I spoke of the Risk and Revenue Sharing Partnerships (RRSPs) that ignited a price recovery.
The market’s reaction to the RRSPs seems even better than expected but Trump’s election win no doubt helped push the price up even further. Melrose is a key supplier of aerospace components to civil and defence companies globally, with the US being a big customer.
The US stock market has been on a record run since the election announcement. However, Trump’s recent trade tariff plans have thrown a spanner in the works, rocking global markets.
Revaluating metrics
Naturally, the rapid price growth has pushed up its price-to-sales (P/S) ratio. Now at 2.2, I suspect this number will continue to rise until the next earnings call.
Earnings per share (EPS) for the second half of 2024 are expected to rise to 14p (currently 11p). This is down slightly from previous forecasts, with the earnings growth rate now reduced to 99.5% from 106% last month.
One risk I’ve identified is debt. At £1.17bn, it’s quite high in comparison to fairly low cash reserves of £190m. This puts some strain on its balance sheet, as it may struggle to cover interest payments.
Overall, growth potential remains strong and Melrose is likely to regain profitability next year. But that doesn’t mean it’ll be plain sailing.
US trade tariffs
Despite the positive developments and price action, analysts don’t expect much growth in the coming year. The average 12-month price target’s only 10% up from today’s price.
I believe the key reason for this is fear of potential US trade tariffs dampening profits in 2025.
So far, President-elect Trump’s outlined his plans for tariffs on Canada, Mexico and China and many analysts fear Europe could be next. Some feel the UK is at a disadvantage since leaving the EU. The Guardian‘s William Keegan recently said: “If we were part of a European Union trade negotiating team, we should be in a far stronger position.”
By contrast, Business and Trade Secretary Jonathan Reynolds told lawmakers last week that “Britain would not shy away from making the case for free trade to the Trump administration“.
As I mentioned in my previous article, RRSPs promise solid cash flows for Melrose until at least 2050. But without a beneficial deal in place, unfavourable trading expenses could eat into those revenues.
Even if tariffs are imposed on the UK, there could be concessions for certain industries like defence. Until Trump takes power in January, we simply won’t know.
While I may have missed out on some gains, I won’t be buying the shares until there’s more clarity regarding tariffs.
