BA - AAR Corp.: Limited Upside For FY2024 But Eyes Are On FY2025

2023-09-19 18:04:33 ET

Summary

• AAR Corp. is a provider of aviation services, with a strong revenue mix from government and commercial sales.
• Growth drivers for the company include the increasing demand for aftermarket parts and maintenance in the commercial market, as well as the growing defense budgets in the government services segment.
• Analysts expect sales growth of 13.7% and earnings per share growth of 12.6% for Q1 2024. There is a potential 20% upside for AAR Corp. stock based on FY2025 results.

As I am continuously expanding my coverage in the aerospace industry as well as closely related industries, I have now arrived at AAR Corp. ( AIR ), which is a provider of Aviation Services. In this report, I will be discussing what the company does, the growth drivers, have a brief look at the recent and upcoming earnings, and most importantly I will assess whether the company has any appreciable upside.

What Does AAR Corp. Do?

AAR Corp. is a diversified provider of services and products to the commercial aviation, and government and defense markets. The Company’s segments previously included: Aviation Services , which consists of aftermarket support and services offerings that provide spare parts and maintenance support for aircraft operated by its commercial and government/defense customers; and the Expeditionary Services segment, which consists of primarily manufacturing operations with sales derived from the design and manufacture of pallets, shelters and containers used to support the United States military’s requirements for a mobile and agile force, including engineering, design and system integration services for command-and-control systems.

AAR provides customized inventory supply chain management, customer fleet management and operations and aircraft component repair management services. The Company also offers eMRO, a Web-based enterprise software solution for managing aircraft maintenance and fleet management.

Beginning in the first quarter of FY2024, the company will change its reporting segments to four:

1. Parts Supply
2. Repair & Engineering
3. Integrated Solutions
4. Expeditionary Services.

The company has quite an appreciable revenue mix by end-market deriving 33% from government sales and 67% from commercial sales. AAR Corp. has a business model I would consider to be smart and strong, as its Parts Supply, Repair & Engineering and Integrated Solutions are connected with data collection in segments to be used across the business to provide solutions.

What Are The Growth Drivers For AAR?

While defense and commercial are two different end-markets with different growth figures, the growth drivers are somewhat similar. The commercial market and the government services segment both are expected to grow. The former will grow due to a continuously growing base of installed commercial airplanes that need parts and maintenance, with the current shortage of airplanes due to the inadequate OEM production at Boeing ( BA ) and Airbus ( EADSF ) providing a boost to aftermarket demand. The latter will likely see growth due to increasing defense budgets, which will also see an increased demand for servicing. So, both end-markets should be growing in the years to come.

On top of that, AAR Corp. is increasing its market share and leverages its data collection for development of proprietary parts. ESG is something that is generally considered a bad thing in terms of financials for companies, but it also brings new value creation chains. With its paperless solutions, the company can support the ESG efforts of its customers while demand grows. In the years to come, more and more technicians will be required to service the installed base, and the deployment of inspection drones as offered by AAR Corp. can cut down the number of technicians required.

Earlier this year, AAR acquired Trax which provides MRO and fleet management software for commercial and government customers bolstering the company’s data backbone.

The AAR Corp. Financial Results

For the fourth quarter of FY2023, AAR reported EPS of 0.83, beating estimates by $0.05, on revenues of $553.3 million, up 16.2% year-on-year and beating estimates by $19.2 million driven. This was driven by growth in commercial after-market demand, while aviation services sales to government and defense customers declined 12.9% due to contract completion. Adjusted EBITDA grew 23% to $53 million, with adjusted operating margins expanding to 7.8% from 7%.

What Are Analysts Expecting For Q1 2024 Earnings For AAR Corp.?

For Q1 2024, analysts are expecting 13.7% sales growth, which is in line with the management comments. Earnings per share are expected to be $0.69 indicating 12.6% growth.

When Does AAR Corp. Announce Earnings?

AAR Corp. is expected to announce earnings on the 26th of September after the closing bell.

Is AIR Stock A Buy?

While the consensus among SA analysts is a buy rating for AAR Corporation, and even Strong Buy among Wall Street analysts and the Seeking Alpha Quant , after filling in the numbers for AIR stock my model shows that there is only 4% upside for the FY2024 earnings. However, if we consider that compared to its FY2023 the stock was somewhat richly valued closer to the FY2024 target price, I believe it is appropriate to value the stock based on its FY2025 results. With that in mind, there is 20% upside, which makes the stock a buy.

Conclusion: AAR Stock Is A Buy

I consider AAR Corp. stock a buy due to its appreciable business model coupled with end-market growth, though it should be kept in mind that the company is now leaning on incremental capacity growth to unlock further growth in its MRO business, as the hangar spots are almost fully loaded. From a valuation perspective, there is upside of around 20%. The discount at which you can buy the stock compared to its FY2024 earnings is not a juicy one, but there still is 20% upside keeping in mind that the stock usually trades a year ahead on its earnings, meaning at this point investors will start pulling the FY2025 upside into the stock price.

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