Prediction: this UK share could outperform Rolls-Royce between now and 2030!
In the world of UK shares, few have come close to delivering the phenomenal returns of Rolls-Royce. The rapid turnaround of the once-struggling aerospace giant has enabled shareholders to reap a jaw-dropping 935% return since the start of 2023. To put that into perspective, a £1,000 initial investment is now worth close to £10,000 in just over two years!
The next five years continue to look promising for this enterprise, given its vast order book and interesting pipeline of medium-to-long-term projects. Sadly, another 10x return doesn’t seem likely. After all, the group’s market-cap now stands close to £80bn. And with its valuation getting overstretched by increasingly lofty growth assumptions, I wouldn’t be surprised to see momentum slowing.
But there’s another aerospace business that’s seemingly falling under the radar. And if my hunch is correct, it could vastly outperform Rolls-Royce over the next five years.
A hidden opportunity
Melrose Industries (LSE:MRO) has undergone a massive restructuring in recent years. The group recently transitioned from an engineering turnaround specialist to an aerospace pureplay. And it now executes a unique strategy revolving around Risk and Revenue Sharing Partnerships (RRSPs).
An RRSP is a way for aerospace companies to spread the risk of engine development by agreeing to cover a fixed percentage of development costs. In exchange, they share the lifecycle returns, which include both the low-margin initial engine sale and high-margin aftermarket services like maintenance.
Melrose currently has a stake in 17 RRSPs, granting it the equivalent of a royalty on around 70% of widebody and narrowbody aircraft. And when combined with efficiency gains from its ongoing corporate restructuring, underlying margins have more than doubled, allowing earnings to more than triple since 2023.
That’s certainly giving off some Rolls-Royce vibes. And yet, the Melrose share price hasn’t moved all that much. Why?
Hesitant investors
Dissecting Melrose’s financials is a complex task. Transitioning from a previously highly acquisitive and diversified engineering enterprise creates a lot of one-time restructuring expenses and gains. This has translated into complicated accounting practices that have obscured the true improving performance of this business.
Yet, with the restructuring process nearing completion, the gap between underlying and reported figures could soon start to close. And as investors start to recognise the quality of this enterprise, shares could quickly correct upwards, especially since its underlying price-to-earnings ratio currently sits at just 11.3. By comparison, Rolls-Royce is at 32 with smaller profit margins.
The bottom line
Having already added Melrose shares to my portfolio, I’m confident the company can deliver strong results over the next five years. However, it’s important to recognise that every investment, even the promising ones, carries risk.
For Melrose, the firm’s highly sensitive to supply chain disruptions. Even if it can manufacture its components uninterrupted, constrained aircraft production for customers like Airbus and Boeing could significantly hamper growth. That’s bad news considering the group’s ambitious growth targets over the next five years, and could significantly delay the time it takes for investor sentiment to shift.
Nevertheless, at today’s unreasonably cheap (in my opinion) valuation, these are risks investors may want to consider taking.
The post Prediction: this UK share could outperform Rolls-Royce between now and 2030! appeared first on The Motley Fool UK.
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Zaven Boyrazian has positions in Melrose Industries Plc. The Motley Fool UK has recommended Melrose Industries Plc, and Rolls-Royce Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
