On Friday, UBS has downgraded Melrose Industries (LON:MRON) PLC (MRO:LN) (OTC: MLSPF) from Buy to Sell, adjusting the price target to £4.00 from the previous £7.70. The firm has shifted its valuation methodology for Melrose Industries from profit and loss (P&L) to free cash flow (FCF)-based tools, aligning it with the approach used for comparable companies such as Rolls Royce (LON:RR).
The downgrade comes despite acknowledgment from UBS of the management's successful efforts in enhancing the efficiency of GKN (LON:GKN)'s assets, which Melrose acquired. However, UBS expresses concern that the market may be overestimating the potential of Melrose's Revenue & Risk Sharing Partnership (RRSP) portfolio.
UBS's reassessment of Melrose's stock value is influenced by the change in management's performance metrics. The previous management team had their incentives tied to the company's share price performance leading up to May 2024. The new management, on the other hand, is evaluated based on different criteria.
The reevaluation to a Sell rating reflects UBS's new approach to the company's valuation. By moving to a FCF-based valuation, UBS suggests that there might be a significant discrepancy between Melrose's cash flow and profit recognition over extended periods, which has prompted the adjustment of the price target to £4.00.
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