BA - AAR Corp.: Bullish As Aircraft Maintenance Business Remains Strong

2023-03-28 15:32:43 ET

Summary

• AIR reported its Q3 earnings which beat expectations driven by strong demand for its aircraft parts supply and maintenance business.
• An ongoing expansion into new product and service categories supports an outlook for firming margins.
• The stock has been a winner within the ongoing industry recovery and we still see more upside going forward.

AAR Corp. ( AIR ) is a leading aircraft parts supplier and maintenance contractor for major commercial and government customers. The story here has been the ongoing recovery of the airline industry compared to the disruptions during the depths of the pandemic. Indeed, the company released its latest quarterly results highlighted by solid growth in what has been a strong industry environment.

Several initiatives to expand the business into more value-added categories should be positive for margins and add to the long-term potential. Even with shares trading at an all-time high, we see room to stay bullish on the stock with more upside potential.

AAR Earnings Recap

AAR reported its 2023 fiscal Q3 earnings on March 21st with an adjusted EPS from continuing operations of $0.75, up 19% year-over-year. Total sales at $521 million climbed by 15% y/y and came in above estimates. The momentum this quarter was driven by a 28% sales increase in the commercial business.

The business of maintenance, repair, and overhaul ((MRO)) activity has been strong. Within the product portfolio, used-serviceable material ((USM)) and new parts distribution led the performance .

The gross margin of 18.1% improved from 17.8% in the period last year. Part of the dynamic is based on several cost savings initiatives implemented in recent quarters made to improve efficiency. Separately, management cited favorable improvements to the global supply chain conditions compared to a more challenging environment since 2021.

An important development this quarter was the company's acquisition of "Trax", a leading provider of fleet management software and aircraft for a total consideration of approximately $140 million. The addition of the group highlights AAR Corp's strategy to expand into not only peripheral service lines but also into the digital side. Beyond the cross-selling advantages of entering new categories, the tech-type services should lead to higher margins over time.

While the company did not offer financial guidance or targets for the year ahead, management projected optimism during the conference call . The recovery in international travel, for example, has directly translated into the demand for commercial aircraft parts along with the use of company hangars. There are also new multiyear contracts that add to the operating environment as part of the growth runway.

On the balance sheet, AIR ended the quarter with $135 million in net debt which took the net leverage ratio to around 1.35x from 0.88x in the prior quarter considering the impact of the Trax deal. The expectation is that continued cash generation and climbing adjusted EBITDA will normalize the leverage ratio back under 1x while leaving flexibility for future opportunities.

Is AIR a Good Stock?

There's a lot to like about AIR which is well-positioned to continue growing and consolidating its market share. The company benefits from overall solid fundamentals supporting a positive long-term outlook.

One of the interesting dynamics in the aviation industry is that between Boeing Co ( BA ) and Airbus AE ( OTCPK:EADSF ), new aircraft deliveries are still well- behind peak pre-pandemic levels even as the order backlogs grow. This means that the demand for parts supply and MRO services as it relates to AAR Corp's business is likely more important than ever as customers attempt to extend the lifecycle of existing equipment.

By this measure, the operating backdrop should be strong for the foreseeable future with a further runway as new aircraft enter operation. All these factors tie into what has been a well-executed growth strategy that has further opportunities with several moving parts.

According to the consensus estimates, the forecast is for revenue growth into fiscal 2024 to trend around 5% while EPS has more upside in the 17% range. In our view, a scenario where macro conditions at least remain resilient in terms of global travel demand can set the stage for AIR to outperform expectations.

On the side of valuations, we note that AAR trading at 11x EV to EBITDA and 20x as a forward P/E represents a discount to its historical average for those key multiples. Recognizing that the fiscal year ends in May, the valuation spread looks even more compelling looking out to next year where the one-year forward P/E multiple is lower at 16x. In other words, there is a case to be made that AIR is still undervalued even with shares trading at an all-time high.

AIR Stock Price Forecast

We rate AIR as a buy with a price target of $70.00 representing a 21x multiple on the current consensus fiscal 2024 EPS estimate. The unique aspects of the aviation industry in the current environment work as a bullish tailwind for the company's core operating segments. The strong points here are the earnings momentum and expansion opportunities into more differentiated value-added products that ultimately support higher margins.

On the downside, we see the $50.00 share price level as a near-term area of support that AIR will need to hold. Indications of a sharper global slowdown as a deterioration in the macro environment would open the door for a correction lower in the share price. Monitoring points over the next few quarters including the operating margin and cash flow trends.

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