AIR - AAR Corp.: Supply Chain Optimization Creating Operational Efficiencies

2023-07-03 00:47:05 ET

Summary

• AAR has recently experienced strong growth due to solid earnings.
• The company holds a strong balance sheet to remain resilient and capitalize on future growth when necessary.
• AIR's supply chain optimization will enable margin expansion due to reduced costs and customer satisfaction.
• Assuming my DCF figures, AAR is currently slightly undervalued resulting in a buy rating.

AAR Corp. ( AIR ) has recently demonstrated a significant surge in share price due to strong earnings. I believe that AAR is currently a buy due to its strong future performance, solid balance sheet, slight undervaluation, and supply chain optimization fostering growth in the long-term.

Business Overview

AAR Corp. offers a variety of goods and services in the international commercial aviation, government, and defense markets. The business's Aviation Services division specializes in engineering solutions, distribution, inventory management, aftermarket support, and MRO services. Within this market, AAR Corp. sells, leases, and repairs engine and airframe parts and components while also providing supply chain logistics programs, inventory and repair programs, and warranty claim management. The U.S. Department of Defense, other governments, and numerous other clients are supported by their services. The business also offers engineering, line maintenance, refurbishing, and inspection services for airframes, as well as repairs and overhauls for parts including landing gears, wheels, and brakes.

The Expeditionary Services division of AAR Corp. is responsible for meeting the transportation requirements of non-governmental groups, as well as domestic and foreign governments. This market segment includes engineering and system integration services for command and control systems in addition to specializing in the design, manufacture, and maintenance of transportation pallets, containers, and shelters.

AAR Corp. provides services to a wide range of clients, including domestic and international passenger airlines, cargo airlines, regional and commuter airlines, operators in business and general aviation, OEMs, leasing firms for aircraft, aftermarket aviation support firms, and both domestic and international military clients. Through its own workers and overseas sales associates, the corporation primarily markets and sells its goods and services.

Financials

AAR Corp., with a market capitalization of $1.97 billion and a steadily increasing return on invested capital of 7%, showcases its financial robustness. Currently trading at $57.76, the stock price is close to its 52-week high of $58.36. While AAR's P/E GAAP ratio of 23.03 may appear relatively high, the company outperforms its industry peers in various metrics, justifying its premium valuation as demonstrated below.

Although AAR does not pay out a dividend, the company is able to capitalize on core business expansion in order to outpace the competition and expand shareholder value through stock appreciation along with no shareholder dilution in times of profitability declines as shown below.

Earnings

AAR Corp. has experienced a remarkable surge in its share price, reaching unprecedented levels, thanks to its outstanding Q3 2023 earnings . Despite challenging macroeconomic conditions characterized by price volatility and high rates, the company has demonstrated resilience. AAR surpassed earnings expectations by $0.05 per share, reporting an impressive $0.75, and exceeded revenue projections by $33.59 million, with total revenues reaching $521 million, marking a substantial 15.2% year-over-year growth. These exceptional results, combined with a cash flow of $17 million from operating activities, highlight AAR's ability to outperform and set a clear path for future success.

AAR's positive earnings estimates, driven by sales growth and margin expansion, exemplify the benefits of implementing long-term strategies and cultivating patience for sustainable success.

Outperforming the Broader Market

Over the past three years, AAR has demonstrated exceptional performance, surpassing the S&P 500 index. This success can be attributed to the recovery of AAR's margins and the rebound of the travel industry following the pandemic, which has mitigated the impact of fixed costs on the company's operations.

Analyst Consensus

AAR is currently rated as a strong buy by analysts in the last three months. Considering the recent share price appreciation driven by strong earnings, the average price target of $60.50 with a 4.74% upside seems conservative in light of the new growth prospects for the company.

Balance Sheet

AAR's balance sheet is strong, characterized by decreasing debt even in a high-interest rate environment. Additionally, the company boasts an impressive interest coverage ratio of 18x, showcasing its ability to withstand macroeconomic challenges and utilize its assets for growth during expansionary periods. With a current ratio of 3.22 and an Altman Z score of 4.51, AAR is well-positioned to maintain its relevance for many years to come.

Valuation

To conduct a thorough analysis, it was essential for me to calculate AAR's Cost of Equity and Weighted Average Cost of Capital using the Capital Asset Pricing Model. Taking into account a risk-free rate of 3.84% based on the 10-year treasury yield , my calculations indicate that AAR's Cost of Equity is estimated to be 8.47%. This figure represents the anticipated return that investors demand to offset the risks associated with holding AAR's equity.

Using the figures mentioned above, I determined that AAR's WACC was 7.84%, which is less than the industry average of 10.59% .

After an extensive analysis employing an Equity Model DCF approach, with a particular emphasis on Free Cash Flow to Equity, it has been ascertained that AAR is currently undervalued by approximately 3%. This evaluation incorporates a fair value estimate of around $59.8. The valuation was conducted using a discount rate of 8.47% over a 5-year timeframe. Furthermore, the analysis assumes consistent revenue and margin growth, attributable to operational efficiencies, resulting in increased cash flow for expanding operations and fostering compounded growth.

Supply Chain Optimization Creating Operational Efficiencies

Predictive analytics are used by AAR Corp to improve operational efficiency in its maintenance, repair, and overhaul activities. AAR Corp can predict and optimize maintenance schedules, recognize probable equipment breakdowns, and proactively plan for maintenance tasks by utilizing advanced data analytics and machine learning algorithms.

For instance, to find patterns and trends, AAR Corp gathers and examines real-time data from aircraft sensors, old maintenance logs, and other relevant sources. As a result, they are better equipped to predict maintenance requirements and plan maintenance actions to minimize downtime and maximize operational effectiveness.

Long-term financial gains from this strategy will be substantial for AAR Corp. AAR Corp can reduce unplanned maintenance incidents and associated expenses by managing maintenance schedules. They can prevent equipment failures before they happen by taking preventive measures, which lowers the possibility of significant outages and high repair costs. Additionally, AAR Corp can expand the number of flights and revenue-generating opportunities for its clients by increasing aircraft availability and cutting downtime, which will enhance client satisfaction and boost profitability. AAR will be able to further use its core business to scale growth thanks to this improvement in financial performance, while also bolstering its balance sheet to weather economic challenges.

Furthermore, AAR Corp is able to improve their inventory management through the use of predictive analytics for MRO operations. They can eliminate excess inventory and prevent stockouts by precisely forecasting maintenance requirements and part requirements. As a result, carrying costs are reduced, waste is reduced, and supply chain efficiency is generally increased. It will be easier for AAR to outperform rivals and boost customer satisfaction if it has more cash on hand and incurs lower inventory expenditures and fixed costs to maintain that inventory.

Risks

Industry Competition: The aviation sector is extremely competitive, with a wide range of firms providing comparable services. Both established businesses and up-and-coming competitors could have an effect on market share, price, and profitability for AAR.

Regulatory Environment: Regulating authorities enforce stringent rules and safety requirements in the aviation industry. AAR may face difficulties and higher operating costs as a result of compliance with these standards and any modifications or revisions.

Technological Advancements: Technology that is advancing quickly, like digitalization and aviation automation, has the potential to upend established business structures. In order to stay competitive, AAR must keep up with new technologies and spend money on R&D.

Conclusion

To summarize, I believe that AAR is currently a buy due to its strong future performance, solid balance sheet, slight undervaluation, and supply chain optimization fostering growth in the long term.

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