When a top FTSE 100 growth stock on my watchlist suddenly takes a beating, I perk up. Is this my opportunity to get in at a discount?
Shares in aerospace specialist Melrose Industries (LSE: MRO) have plummeted almost 25% over the past week. They’re down 20% over 12 months.
Their sharp decline is striking given that sector peers BAE Systems and Rolls-Royce climbed 11% and 7% respectively last year, benefiting from renewed interest in defence stocks as Western Europe adjusts to Donald Trump.
Melrose derives 25% of its revenue from defence, with the rest from civil aerospace. Its shares were powering along quite nicely until full-year results landed with a bump on 6 March.
Why are Melrose shares plunging?
Underlying operating profit grew 42% to £540m, driven by a strong performance from its Engines division. Full-year underlying revenue grew 11% to £3.5bn but that fell short of market expectations, while free cash flow more than halved from £113m to £52m.
Net debt rose from £600m to £1.3bn, although that’s largely due to £500m worth of share buybacks. The board hiked the full-year dividend by 20%, which makes me think markets have been a little harsh on Melrose. I often think that. Maybe I’m too soft.
The board gave an optimistic outlook, setting itself a five-year target of more than 20% annual earnings per share growth, while predicting free cash flow would top £600m by 2029. Instead, markets fixated on poor second-half 2024 performance, with group sales 5% short of consensus at £1.73bn.
Ten analysts offer a median one-year share price forecast of just over 705p. If accurate, that suggests a 45% increase from today’s levels. However, these forecasts will have been made before last week’s dip. Brokers may take a less optimistic view today.
There are two ways of looking at a stock: short-term and long-term. At The Motley Fool, we favour the latter. Private investors have one big advantage over the experts – we can afford to be patient.
How bumpy will this FTSE 100 stock be?
That allows us to take advantage of falling share prices to build a long-term position without having to report progress every quarter. We only answer to ourselves. We can bide our time and wait for the investment case to come good. So will it?
I’d say yes, but maybe not yet. Markets hate surprises, and the unexpected sales shortfall hit hard. Further disappointment will bring further punishment.
I like to think of myself as a patient investor, but it isn’t easy. Quite a few of my recent turnaround plays have gone from bad to worse, notably Diageo, Glencore and JD Sports Fashion. I bought them on bad news too. Do I need another potential troublemaker in my portfolio?
Some factors are beyond the board’s control, including production trouble at Airbus and quality issues at Boeing. The aerospace and defence sector has also come under fire from ESG investors, though that may change.
A price-to-earnings ratio of 18.2 is lower than before, but not dirt cheap. With a long-term view, I think Melrose shares are worth considering. But given political and economic uncertainty, they could offer a bumpy ride for a year or two.
