FTSE 100 aerospace specialist Melrose Industries (LSE: MRO) is one of those firms whose businesses are better known than the parent.
For many UK investors, its GKN Aerospace arm will be the name they know best.
Yet despite being a top-tier supplier to civil and defence markets, the shares still look undervalued.
So, how good a growth prospect is it, and what is the true worth of the stock?
Strong recent results?
The engine for any company’s stock price is earnings (or ‘profits’) growth. This builds up cash that can be used to expand the business to create new opportunities and value.
This certainly seems to be the case with Melrose’s recent results. Its H1 2025 numbers released on 1 August saw operating profit jump 26% year on year to £310m, lifting margins to 18%. Profit before tax increased 22% to £248m.
The firm said it is on track to deliver £100m+ of free cash flow this year.
This guidance was reaffirmed in its 14 November trading update that covered the four months to 31 October. Elsewhere in the figures, the firm reported revenue growth of 14%, with the Engines division up 28% and the Structures division up 5%.
It added that it expects a revenue range of £3.425bn-£3.575bn this year. It forecasts adjusted operating profit of £620m-£650m.
A risk to these figures is bottlenecks in the supply of aerospace components and raw materials. These can delay deliveries, inflate costs and pressure margins.
That said, analysts forecast that Melrose’s earnings will grow at an average 7.8% a year to end-2027.
Comparative share valuations
Comparisons of key share price measures with its competitors highlight a major undervaluation in Melrose shares.
Its 22.9 price-to-earnings ratio is bottom of these peers, which average 31.7. These firms comprise BAE Systems at 26, Safran at 28.5, RTX at 35, and GE Aerospace at 37.4. So, it looks a bargain on this basis.
The same is true of its 2.1 price-to-sales ratio against its competitors’ average of 3.9.
And it is also the case on Melrose’s price-to-book ratio of 2.5 against a peer average of 8.5.
The key valuation test
The acid test of valuation in my experience is the discounted cash flow (DCF) model for two reasons.
First, it gives a ‘clean’ standalone valuation that is unaffected by any over- or undervaluations across a sector. And second, it pinpoints the price at which any stock should trade, based on underlying business fundamentals.
This in turn clearly shows if a gap exists between the price and value of the stock. The former is simply being whatever the market will pay for a share, while the latter reflects the true worth of the business’s fundamentals.
Being able to spot this gap and quantify it accurately is crucial for long-term profits. The reason is that all asset prices tend to converge to their ‘fair value’ over time.
The DCF for Melrose shows the shares’ fair value is 44% higher than their current price of £5.59.
On that basis, they should be trading closer to £9.98.
My investment view
I already hold BAE Systems and Rolls-Royce, so adding another defence‑aerospace stock would upset my portfolio’s overall risk-reward balance.
However, for investors without that constraint, Melrose looks well worth considering in my opinion.
