That’s hardly surprising, given what’s been happening in the stock market lately.

• High inflation is driving up costs causing consumer spending to drop.
• Rising interest rates are making access to external capital more expensive.
• Supply chain disruptions are causing global manufacturing delays.
• Labour shortages are hurting profit margins.
• Volatility in currency exchange rates is damaging earnings.

With all of these problems happening simultaneously, it’s no wonder the FTSE 100 index has been tumbling. However, it’s important to remember that these issues are ultimately short-term in nature. And there are some early indicators that the current situation is slowly improving.

In other words, the index may be primed for a comeback in the coming months. As such, the window of opportunity to capitalise on low stock prices may already be closing. With that in mind, here are two leading shares that I believe are primed for an impressive long-term recovery before reaching new heights.

Footsie’s top generics pharma giant

Hikma Pharmaceuticals (LSE:HIK) has had a pretty rough year, with its shares basically being slashed in half. Part of this adverse movement is likely just general stock market volatility. But another reason why investors seem to be bearish is the state of its Generics division in the US.

Following increased competition, this part of the company has been underperforming. Fortunately, its Injectables and Branded segments continue to steal the show. And that’s pretty encouraging, given this is where management’s long-term strategy is focused.

The Generics division is responsible for around a third of sales, so seeing a double-digit slowdown is concerning. However, the group is launching a series of new products that are expected to turn things around in the coming months.

Assuming this is successful and its other segments continue to outperform, then this business could be trading at quite an attractive discount today. Of course, there’s no guarantee. And the share price may tumble further if the group fails to meet expectations.

With all that said, I believe the risk is worth the reward for my portfolio. Hikma has a solid track record of successful product launches, and given the continued double-digit growth in its other divisions, the collapse in share price makes this business look like a bargain buy if I had capital at hand to invest today.

Return to darling status?

For years Melrose Industries (LSE:MRO) was considered a top-tier engineering business. As a reminder, the group acquires struggling enterprises and attempts to turn them around before selling them later for a higher price.

Unfortunately, engineering was one of several industries to be absolutely decimated by the pandemic. And even today, the FTSE 100 firm continues to endure disruptions that have decreased its share price by another 37% in the last 12 months.

But following some swift business restructuring, Melrose appears to be on the mend. Profitability is still a shadow of its former self but is significantly higher than in 2020.

Management has taken on debt to fuel its recovery, which does add additional risk, especially with interest rates on the rise. Yet in my opinion, the worst has already passed for the company. And assuming no more spanners get thrown into the works, I believe Melrose remains an excellent stock to have in my portfolio.

Well, I do think growth shares still face short-term risk. And I reckon some falls, in part, represent long overdue price corrections. But I have my eye on a few growth prospects this month.

Buy Nasdaq?

When I think growth shares, the US Nasdaq index comes to mind. That index has slumped from a high of 16,212 in November 2021 to 10,575 as I write. That’s a whopping 35%. But how can we take advantage?

The clear choice for me is Scottish Mortgage Investment Trust (LSE: SMT). Scottish Mortgage shares have crashed by an even bigger 52% over the same timescale.

Falling further than the US technology index, the investment trust is now on a discount to net asset value of 12.4%. That means we can buy Scottish Mortgage shares for that much less than the value of the investments it holds.

The top 10 holdings currently include Moderna, Tesla, Amazon, and NIO among other popular Nasdaq and worldwide technology stocks. There’s clearly a risk of further short-term falls. But I think Scottish Mortgage is an attractive way to invest in a basket of global growth stocks.

Cybersecurity

I’ve been intrigued by cybersecurity specialist Darktrace (LSE: DARK) ever since it crossed my radar.

Darktrace hit the headlines and soared. But it looked very much like a hot growth stock that was overhyped and overvalued. Some short sellers took note and joined the party, and a number of analysts were very critical.

But moving forward to today, we see a 70% share price fall since last year’s peak. And the short sellers are gone. Darktrace shares did jump briefly in August when a possible offer for the company emerged. But that came to nothing and the price fell back again.

Would I buy now? I really don’t know. The company is only just into profitability, and financial ratios don’t mean much now. Forecasts, for example, put the shares on a price-to-earnings (P/E) multiple of over 110.

Revenue growth looks strong, and I am tempted. But I’ll probably wait until I can convince myself that profit is sustainable.

Engineering

I’ve watched Melrose Industries (LSE: MRO) on and off quite a lot over the years, but have never bought.

Melrose buys up struggling engineering firms, turns them around, and then sells them. But engineering is not the most in-favour sector with UK investors at the best of times.

And after the latest stock market downturn, the Melrose share price has now fallen 40% in 12 months.

Due to the nature of the business, with long cycles between acquisitions and disposals, year-on-year earnings can be erratic. And analysts don’t expect another annual profit until 2024.

But we’re looking at a price-to-book ratio of only around 0.6 now, valuing the company at just 60% of its assets. But there is a good bit of risk in going for engineering investments when facing the possibility of a painful recession.

[Just beginning your investing journey? Check out our guide on how to start investing in the UK.]

GSK 

What it does: GSK is one of the world’s top 10 largest pharmaceuticals producers thanks to drugs like Tivicay and Advair. 

By Royston Wild] 

The GSK (LSE: GSK) share price has plummeted during the past month amidst fears over stinging legal action in the US. It is believed a swathe of lawsuits related to its Zantac heartburn treatment could cost it billions of dollars. 

However, I believe the threat of such colossal damages is now well baked into GSK’s share price. I’d buy the FTSE 100 business owing to its exceptional defensive qualities. The essential nature of its operations should help profits to remain robust even as the global economy toils. 

In fact, latest financials show that the pharma giant is actually going from strength to strength. Total sales rose by almost a fifth between April and June, to £6.9bn. 

City analysts have been upgrading their profits forecasts following the news. They now think GSK’s earnings will rise 10% year on year in 2022 and 8% next year, too. 

This means that today GSK trades on a forward P/E ratio of just 11.4 times. I think this represents super value for money for this growth stock. 

Royston Wild does not own shares in GSK. 

Melrose Industries

What it does: Melrose Industries is a holdings business that seeks to acquire and improve struggling engineering firms.

By Zaven Boyrazian. Melrose Industries (LSE:MRO) is a holdings company. The group acquires underperforming engineering businesses intending to turn them around before selling them on at a higher price. But the engineering sector, especially aerospace, hasn’t exactly had a great time since early 2020.

Fortunately, now that the travel sector is ramping back up, Melrose’s future looks much brighter. The company has an excellent track record of delivering successful turnarounds. And assuming it hits its margin targets, earnings should be set to swell over the coming years.

There is an undesirable £1.7bn of debt equivalents on the balance sheet that is likely to become more expensive to service as interest rates get hiked. But with just over £470m of cash in its war chest, I see no immediate solvency risk.

That’s why I believe Melrose stock has some solid growth potential as it recovers to its former glory.

Zaven Boyrazian owns shares in Melrose Industries.

JD Sports Fashion

What it does: JD Sports Fashion sells sports fashion and outdoor footwear and apparel. 

By Paul Summers: I can understand retail stocks not being popular with investors right now. Even so, the near-halving of growth stock JD Sports Fashion (LSE: JD)’s share price in 2022 feels a bit overdone. 

Yes, not many people will be loading up on pricey trainers in the current environment. And, yes, being forced to sell Footasylum for less than half the price it paid to acquire it due to concerns from the UK’s competition watchdog won’t have boosted investor confidence. New CEO Regis Schultz has his work cut out.

Still, I reckon there’s a good brand here. A price-to-earnings (P/E) ratio of nine could also prove excellent value if JD meets its own conservative earnings estimates when half-year numbers are announced on 22 September. Encouragingly, there’s no interest from short sellers as things stand.

I suspect JD will deliver the goods again once confidence returns.

Paul Summers has no position in JD Sports Fashion

Sage

What it does: Sage is a leading provider of cloud-based accounting and payroll solutions for small- and mid-sized businesses.

By Edward Sheldon, CFA. My top growth stock is Sage (LSE: SGE). To my mind, it offers growth (and quality) at a reasonable price.

Sage’s most recent trading update, for the nine months to 30 June 2022, showed that the company is generating solid growth right now. For the period, recurring revenue was up 9% to £1,330m while organic total revenue was up 6% to £1,412m. Looking ahead, the company said that it now expects organic recurring revenue growth for this financial year to be towards the top end of its guidance range of 8-9%.

As for the valuation, Sage currently trades on a price-to-earnings (P/E) of around 26 (using next financial year’s projected earnings). That is higher than the average FTSE 100 P/E ratio. However, I don’t think it’s excessive given that Sage is a high-quality software company with recurring revenues.

Of course, this company is not without risk. One issue to consider is that new competitors are popping up. Overall, however, I think the stock has considerable appeal right now.

Edward Sheldon owns shares in Sage.

Rolls-Royce Holdings

What it does: Rolls-Royce is a British-based multinational aerospace and defence company that’s been struggling since the pandemic.

By Dylan Hood. Rolls-Royce (LSE:RR) shares have struggled to gain any real momentum since the onset of the pandemic. Currently sitting at 80p, they have fallen 37% year-to-date and 30% over the past 12 months. However, earlier this year, Rolls released results which highlighted the firm had turned a profit for the first time since its £4bn loss in 2020.

In addition to this, its more recent H1 2022 results revealed a record order intake for Power Systems and a momentous £1.1bn improvement to cashflows. The firm is also leading the charge in small to medium nuclear reactor technology and has already signed contracts with governments around the world to implement this technology after their approval (expected in 2024).

Finally, as the threat of the pandemic becomes less prevalent, flying hours will continue to increase. Already in 2022, they have climbed 42% compared to 2021. Rolls makes most of its money servicing jet engines, so this is another big plus.

Dylan Hood does not own shares in Rolls-Royce.

Watches of Switzerland

What it does: Watches of Switzerland is a British luxury retail group that specialises in selling Swiss watches and jewellery. It also offers insurance and repair services.

By John Choong. With inflation expected to continue heading upwards, I’m turning my attention to luxury goods. This is because luxury goods tend to have inelastic demand and are catered to a niche market that either benefits from high inflation or isn’t very much affected by it.

This was evident in Watches of Switzerland’s (LSE: WOSG) latest trading update which showed positive numbers. The FTSE 250 firm saw its revenue grow by 31% while many other retailers continue to suffer declines on a year-on-year basis. The outlook given by management was also generally positive as it expects to ends it financial year with 17% to 21% revenue growth, while expanding its offices, showing confidence that demand for its products are still hot.

While revenue growth slowed exponentially from its pandemic highs, I think a reasonable price-to-earnings (P/E) ratio of 19 and an average price target of £13.37 makes this stock a lucrative one for my portfolio. As such, I’ll be looking to add Watches of Switzerland to my portfolio in the near future.

John Choong has no position in Watches of Switzerland

S4 Capital

What it does: S4 Capital is a digital marketing agency network.

By Christopher Ruane. It has been a brutal few months for shareholders in S4 Capital (LSE: SFOR), with the growth shares trading for less than a fifth of where they stood a year ago.

Revenue growth remains strong and I think that even in an economic downturn, demand for digital marketing should stay high. The problem for S4 is its business model. Growing costs threaten to delay the path to profitability. Internal control systems have been found wanting, leading to delays in publishing results.

Many investors have abandoned the shares. But directors have been buying and I think the basic business model remains promising. There is work to be done in scaling quickly without letting costs balloon, as well as restoring investor confidence. I expect chairman Sir Martin Sorrell to address those concerns fast.

Meanwhile, I think the huge fall in the S4 Capital share price presents a buying opportunity for my portfolio.

Christopher Ruane owns shares in S4 Capital.

The London Stock Exchange Group

What it does: the company runs the London Stock Exchange. It also provides data and clearing services via its subsidiaries.

By Stephen Wright. In my view, The London Stock Exchange Group (LSE:LSEG) is one of the most interesting companies in the FTSE 100. I was very impressed with its most recent trading update and that’s why the stock is my top UK growth stock for September.

The company has three major segments – capital markets, data and analytics, and clearing services. Each of these reported solid results. As a result, profits this year are 21% higher than they were a year ago.

Until recently, I’ve found the London Stock Exchange Group difficult to value. Its recent acquisition of Refiniitv made its accounts a little complicated.

More recently, though, things have settled down. I think that the stock is trading at a price-to-earnings (P/E) ratio of around 20 and I think that it’s good value at those levels.

Stephen Wright does not own shares in The London Stock Exchange Group.

Harbour Energy

What it does: Harbour Energy is a UK-based oil production firm that operates across the North Sea, Asia, and Central America.

By Andrew Woods. In the past month, the shares in Harbour Energy (LSE:HBR) are up 25%. Recently, the company has been benefiting from higher oil prices, with Brent crude currently trading above $100 per barrel.

For the six months to 30 June, the business reported that pre-tax profits grew to $1.5bn, up from $120m for the same period in 2021. What’s more, its guidance range for full-year production increased from between 195,000 to 210,000 barrels, to between 200,000 to 210,000 barrels.

Furthermore, the firm stated that it was embarking on a $300m share buyback scheme, up $100m from previous announcements.

Financially, the company has a cash balance just under £600m, and total debt of £3bn. This debt would be something I’d like to see fall in coming months, because it appears to be quite large.

Overall, though, production is solid, and the broader economic situation seems to be favouring the company, hence it may have scope to grow.

Andrew Woods has no position in Harbour Energy.

So what’s the best way to take advantage of that, if and when it happens? I’m looking for FTSE 100 companies that I think could benefit from any renewed investor bullishness. I think I’ve found three.

Investor sentiment

When investor sentiment is shifting, I reckon it can be a good time to invest in the mechanics of investing itself. I’m thinking of FTSE 100 investment management companies like M&G (LSE: MNG).

The share price is down 15% over the past 12 months, putting it on a forecast price-to-earnings (P/E) ratio of around 10.

The danger this year is that M&G will see profits falling due to investors withdrawing funds. And I think that’s pretty much inevitable in today’s market. But I expect they’ll come back when conditions improve, and this could give us a cheap buying opportunity now.

Meanwhile, the dividend yield looks set to beat last year’s 9.2%. If the dividend should dip, that could hit the shares. But M&G is in the middle of a share buyback, so it appears to have cash to spare.

Takeover specialist

Melrose (LSE: MRO) specialises in acquiring underperforming businesses, turning them around, and selling them.

Investors went off that idea when Covid struck, and the Melrose share price fell like a brick. The company is heavily into aerospace, after all. But it’s been picking up a bit in 2022.

There are clearly risks with this kind of business model. Given the time it can take to restructure a takeover target, profits are very erratic. That makes annual metrics like the P/E ratio largely useless.

I admit I don’t really know how to put a meaningful valuation on a company like Melrose. But it has cash to spare, and is currently on a £500m share buyback programme.

As conditions improve, I think new acquisition targets could show up. This one’s on my speculative list.

Advertising crunch

WPP (LSE: WPP) went through a troubled patch after the departure of founder Sir Martin Sorrell.

But after a pandemic slump, the WPP share price had been starting to pick up. Then the Russian invasion of Ukraine sent the shares into reverse again.

Advertising and marketing spend is one of the first areas to cut in tough times. And the global economic crisis has pushed it down in priority. It’s a tricky business to evaluate though, and we could see many more rocky months ahead.

But in good times, WPP’s services form an essential part of any business. With the stock on a forward P/E of around 10, I see it as a good buy for long-term investors.

Oh, and WPP has recently reported a new acquisition in Australia. Tough conditions like today’s can help companies with the cash to expand.

Manufacturing and industrial business

Melrose owns manufacturing and industrial businesses across a number of geographical regions and sectors. The main ones are aerospace, automotive, powder metallurgy, and other industrial. It also acquires under-performing businesses with a view to improving them.

So what’s happening with the Melrose share price currently? Well, as I write, the shares are trading for 115p. At this time last year, the shares were trading for 179p, which is a 35% decline over a 12-month period. Melrose shares are up 5% from 109p on 8 March, which was its stock market correction low. The stock market correction was caused by macroeconomic headwinds and geopolitical issues and saw many FTSE 100 shares drop.

For and against investing

FOR: Prior to the pandemic, Melrose had a good record of performance but this took a hit due to a slow down in many of its aforementioned sectors. While there are credible threats to performance returning to pre-pandemic levels, final results for the year ending 31 December 2021 made for positive reading, in my opinion. Reported at the beginning of March, Melrose confirmed that revenue, profit, and earnings per share all increased compared to 2020 levels. Net debt and overall leverage significantly reduced, which is a major plus for me as a potential investor.

AGAINST: Macroeconomic headwinds coupled with geopolitical tensions due to the tragic events in Ukraine remain a real risk that could hinder Melrose’s performance. Soaring inflation and the rising cost of raw materials could impact the bottom line and profit margins. This could affect shareholder returns. The global supply chain crisis, such as the shortage of semiconductors for new cars that sits under the automotive sector of Melrose’s operations, is causing a slowdown of sales and growth too.

FOR: Melrose shares look cheap at current levels on a price-to-earnings ratio of just four. The FTSE 100 average is 15. Furthermore, the shares could boost my passive income stream. Melrose shares offer a current dividend yield of 1.5%. It is worth noting that dividends are not guaranteed and can be cancelled at any time.

AGAINST: Melrose’s business model involves acquiring under-performing businesses and turning around their fortunes. I am always wary of businesses that undertake lots of acquisitions. There is always the risk that these acquisitions could be costly financially and otherwise. For example, a business may be overpriced, or it may not integrate into the existing group of companies.

A FTSE 100 stock I’d buy

Overall, I think Melrose shares have come under pressure in recent times due to macroeconomic issues out of its control.

These issues are short to medium term issues, in my opinion. I think Melrose is a good business with a decent track record and is priced cheap. I would be willing to add a small number of the shares to my holdings. In the short term, I would expect some pain, but in the longer term, there are positive signs and I would not be surprised to see regular and consistent returns from the shares.

A British manufacturing powerhouse

Melrose Industries (LSE: MRO) made headlines in 2018 when it bought venerable British automotive and aerospace group GKN. Melrose’s business model is based on buying underperforming industrial groups, improving them, and then selling them on.

Since taking control of GKN, Melrose has eliminated the deficit on the group’s pension schemes and repaid £3.4bn of debt used to fund the acquisition. Operationally, profit margins in the aerospace business have risen by 4% and inventory levels have fallen, freeing up cash.

However, sales slowed in the automotive business last year, due to the global chip shortage. GKN makes parts for car manufacturers, who were cutting their orders to GKN because they couldn’t produce as many cars as planned.

There are obviously still some risks here. Problems with new vehicle supply seem likely to stretch well into 2022. If the war in Ukraine leads to a wider economic slowdown, new orders could also fall.

A FTSE 100 share with growth potential

However, the latest update from Melrose suggests market conditions may already be improving. Sales during the final quarter of last year were said to be “almost back to levels” seen during the first half of 2021.

Looking further ahead, Melrose says that GKN won £5bn of new automotive business in 2021. More than one third of this relates to electric vehicles. This suggests to me that GKN is increasing its share of this fast-growing market.

Broker forecasts price Melrose shares on 15 times 2022 earnings, falling to just 10 times earnings in 2023. There’s also a useful 2.3% dividend yield. I’d be happy to buy the shares as a long-term investment at this level, as I think they’re likely to perform well over time.

A recovery opportunity?

The second FTSE 100 share on my list is DIY investment platform Hargreaves Lansdown (LSE: HL). Hargreaves benefited from the lockdown trading boom, but profits fell last year as market conditions turned calmer.

As the market leader in the UK, Hargreaves is very profitable, but faces growing competition. In an effort to protect its profits and generate new routes to growth, the company recently launched a plan to upgrade its technology and provide new forms of insight and advice for clients. Hargreaves also plans to add 19 new funds to its investment product range by 2024.

These changes seem logical to me. The big risk is that this plan will require Hargreaves to spend an extra £175m over the next five years. So we won’t know whether these investments will be successful for several more years. If they’re not, Hargreaves could end up bloated and less profitable than it is today.

Hargreaves’ share price has fallen by more than 30% over the last year. In my view, this slump has probably gone far enough. This financial business is still one of the most profitable on the UK market and Hargreaves stock now offers a useful 4% dividend yield.

I’m looking at this FTSE 100 share as a potential buy for my ISA portfolio.

FTSE 100 retailer

The first blue-chip business on my list is JD Sports (LSE: JD). This retailer occupies a strong niche in the UK sports footwear market. It is also expanding rapidly around the world. It is one of the few UK retailers that has been able to take market share in the US, a traditionally difficult market for these businesses. 

Of course, there is still a risk that the firm could hit a wall. It could end up overexpanding, and this might lead to losses for investors. 

Management has outlined its plans to expand further in the years ahead by pushing into new markets and opening more stores. While the stock is a bit on the pricey side, I think it is worth paying a premium to buy into JD’s growth over the next few years. These are the reasons I would buy the business for my portfolio. 

International expansion

I would also acquire FTSE 100 business Ashtead (LSE: AHT). The equipment rental sector can be fantastic. The initial capital costs can be demanding, but after the equipment is acquired, a company can lease it out again and again, earning a high return on investment.

Ashtead has been reinvesting its profits back into growth over the past decade, and it now has a strong footprint in both the UK and US.

Unfortunately, the nature of this market means the firm is highly exposed to the economic environment. A sudden downturn in construction activity could significantly impact the business and its growth potential.

Management may have to re-evaluate growth plans in this scenario, and the company’s expansion may not live up to my expectations. 

Despite this risk, I believe there will always be demand for equipment rental services in the UK and US. That is why I would acquire the stock right now. 

Buy, build, sell

The final company I believe has the potential to grow my wealth significantly over the next couple of years is Melrose Industries (LSE: MRO). The engineering group has a strong track record of buying, improving and selling engineering enterprises. Its most recent acquisition was engineering conglomerate GKN. 

This strategy has produced strong returns in the past, although there is no guarantee this will continue. There will always be the chance Melrose could find itself over its head and unable to manage an acquisition. In this scenario, the FTSE 100 company may have to ask shareholders for additional cash. 

Still, with the outlook for the economy improving, I believe the engineering group has scope to grow substantially over the next couple of years. 

Let’s explore what happened throughout last year.

 Spring: results and disposal of Nortek

Delivered early in the year, the 2020 full-year results for this FTSE 100 stock were as bad as expected. Excluding its Nortek Air Management division, aerospace, automotive, powder metallurgy, and other industrial segments all saw revenues tumble courtesy of the pandemic. Overall, the group’s revenue fell from £10.9bn in 2019 to £8.8bn. And because of operational disruptions as well as changes in strategy, margins also suffered. The result was after-tax income dropping from a gain of £55m in 2019 to a loss of £523m the following year.

However, management’s focus in 2020 shifted from profit generation to cash generation. The change in strategy was to reduce the risk of becoming over-reliant on debt financing, and this plan appears to have worked. Free cash flow for the year increased by 6% to £628m while net debt fell to £2.8bn from £3.3bn.

In April, the leadership informed investors that it had signed a deal with US firm Madison Industries to sell its Nortek Air Management business for £2.62bn. Melrose acquired the company back in 2016 for £2.2bn and has received around £700m of cash inflow since then. That places the total return from its 2016 acquisition at 78%. On an annualised basis, that’s a return of 21.2% each year – something seemingly not reflected in the FTSE 100 stock’s share price.

The deal was closed in June, with most of the proceeds used to pay off debt. However, £100m was used to reduce the pension deficit of GKN – an aerospace business acquired in 2018. And £730m was returned to shareholders through a special dividend.

Overall, the mixed performance didn’t satisfy every investor, and the stock ended up falling around 20% by mid-July. 

September: FTSE 100 stock starts to look healthier

As the disruptions of the pandemic started winding down, operations once again ramped up. Total revenue for the first six months came in 5% higher at £3.8bn. However, £832m of this originated from its recently disposed Nortek Air Management. Obviously, that income will no longer be generated moving forward.

The bottom line stayed in the red, albeit by only £151m versus £585m the previous year. But thanks to the surge in cash provided by the recent sale, net debt fell drastically from £2.8bn at the start of the year to £300m. This jump in financial health seemed to give investors confidence in the recovery process since the share price jumped over 10% within a few days.

What’s next for Melrose?

In October, management reported further improvements within its aerospace segment with a 16% revenue growth. But its automotive and power metallurgy divisions continue to suffer from supply chain disruptions. Combining this uncertainty with the spread of the Omicron variant pushed the share price even further down, bringing the full-year loss to 18%.

A clearer picture will form when the full-year 2021 report is released in March. If the impact is less severe than expectations, the FTSE 100 stock could start recovering quickly. But the reverse is also possible.

Looking at the positives

I’ve looked at this business before. But as a quick reminder, Melrose is essentially a holdings company that acquires struggling engineering firms. It then installs new management teams and attempts to turn these ventures around so that they can later be sold at a much higher price.

Historically, its ability to identify lucrative opportunities within the sector has been quite impressive. Unfortunately, the pandemic decimated much of the once-thriving aerospace industry, which the group has quite a substantial stake in. In fact, this is what caused the Melrose share price to collapse last year.

Since then, things have improved. Looking at the recently published trading update, aerospace markets appear to be recovering nicely. Revenue between July and September this year increased by 16%. And management now expects this growth rate to accelerate further throughout the rest of 2021. So why is the stock still falling today?

The catalyst behind the falling Melrose share price

Unfortunately, its Automotive and Powder Metallurgy divisions haven’t experienced the same luck. The underlying demand for both of these sectors remains high. However, due to the ongoing semiconductor shortages worldwide and other supply chain disruptions, Melrose is simply unable to deliver orders in a timely fashion.

Consequently, the level of order cancellations has skyrocketed from the typical 1% each month to between 20% and 25%! To make matters worse, there doesn’t appear to be any clear timeline as to when these problems will be resolved as they are largely outside of the company’s control.

But the problems don’t end there. With inflation on the rise, the price of raw materials, especially metals, continues to climb higher. While the business can try to pass on these costs to customers, its pricing power remains limited given the competitive nature of the industries it operates in.

With all that in mind, I’m not surprised to see the Melrose share price take a hit.

The bottom line

These problems are undoubtedly frustrating. However, they are ultimately a short-term nuisance rather than a long-term disaster. Melrose has been actively restructuring the firms in its portfolio to reduce expenses that should help mitigate the impact of rising material prices. In the meantime, the supply chain disruptions will eventually sort themselves out as new businesses emerge to try and profit from the situation by resolving it.

Therefore, personally, I think the recent weakness in the Melrose share price presents an excellent opportunity for me to increase my existing position.

How the company operates

The FTSE 100 company has the slogan of “buy, improve, sell”. This sounds simple on paper, as do some of the previous acquisitions. For example, in 2012 it bought a metering company called Elster for $2.3bn (£1.67bn). It turned the business around, increased the value and sold it three years later for £3.3bn. 

The usual timeline for turnaround is three to five years, with the main area of focus being engineering and manufacturing businesses. One drag that it had seen recently was with GKN, a business it bought back in 2018. Issues with pension contributions and a general slowdown in demand had pushed Melrose as a whole into a loss of £80m during H1 2020.

However, the stock saw a share price gain last week as its fortunes have reversed. In the half-year results just released, Melrose reported a profit of £109m.

Another point noted in the report was the £729m due to flow back to shareholders. This equates to 15p per share, with the report noting that the “Melrose balance sheet has spare capacity for a significant further capital return next year”.

A positive outlook for the FTSE 100 stock

From a technical point of view, I wouldn’t be buying the stock now in order to get a slice of the £729m payout. The date has already passed on which I would have needed to own Melrose in order to get this payment next week.

What I would be buying shares now for is any future potential payouts associated with businesses within the group. Melrose is seeing improving performance and mentioned in the report that further capital returns are possible next year.

Another positive for the company is the reduction in net debt. After the £729m is paid out, leverage would be at 1.5x, versus 3.4x at the end of H1 2020.

So the thinking here is that the FTSE 100 stock could give me income potential next year and beyond from either conventional dividends or special payouts. 

One risk here is that the sector has slim profit margins. The aerospace division reported an operating profit margin of 3.4%. Automotive wasn’t much better either, coming in at 6.2%. This means that only a small increase in costs could reduce profit significantly.

But overall, I think that this FTSE 100 stock has plenty of promise looking forward. I’m considering buying the shares now as an income investor for future payouts and share price growth.