TGI - AAR: Making A 'High' Deal For Triumph Product Support

2023-12-25 03:43:55 ET

Summary

• AAR Corp. has experienced a recovery in its business and shares, driven by improved prospects for defense activities and a recovery in the commercial side of the business.
• Shares have continued to rise, reaching $70 per share, but the high valuation and increased leverage make me cautious about getting involved.
• AAR announced a $725 million cash deal to acquire Triumph Product Support, which will add specialized maintenance, repair, and overhaul services to its portfolio.
• The deal adds a lot of leverage and little immediate earnings accretion, making me cautious here.

In September, I concluded that AAR Corp. ( AIR ) was flying high again. This came after the business experienced some turbulence during the pandemic, the business and shares that is. Driven by improved prospects for the defense activities and a recovery on the commercial side of the business, AAR has seen quite a recovery and started to fly high again.

Shares have moved another leg higher in recent months as multiples have expanded. Amidst an interesting deal (which involves some leverage), I am taking a wait-and-see approach here, with the intention to acquire on substantial dips.

On AAR - Aviation Aftermarket Services

AAR is a large and independent provider of aviation after-market services. Typical products and services to think of include parts, repair & engineering, expeditionary services and other integrated solutions. Such services are provided to a wide range of aviation customers, with a pretty balance between commercial and defense markets.

Pre-pandemic, or actually for the year which ended in May 2020, AAR generated about $2 billion in sales with earnings reported at $2 and change per share, as the impact of the pandemic was seen in the final quarter of the year.

The full impact of the pandemic was seen in 2021, when sales fell to $1.65 billion while earnings fell to $1.31 per share, as shares quickly rebounded to pre-pandemic levels in their forties. The performance recovered during 2022 and 2023, as AAR posted revenues of $1.99 billion for the fiscal year 2023 (as released in July of this year) and earnings reported at $2.56 per share.

2024 Set To Become Strong

With the recovery in the 2023 results being evident, it is noteworthy that the company ended the year on a high note, as fourth quarter sales jumped by 16% to $553 million, trending at $2.2 billion per annum. Fourth quarter earnings power of $0.66 per share, trends at around $2.64 per share, with the advancements held back by some additional interest expenses introduced following a $104 million deal for Trax earlier this year. With shares of AAR trading around the $60 mark in September, a 24 times earnings multiple based on the 2023 earnings power looks a bit demanding, even as the company guided for double-digit sales growth for the first quarter.

Flying Higher

Since September, shares of AAR have seen a continued move higher to the lower seventies here, as shares trade at $70 per share (after hitting a high at around $73 in recent weeks).

Later in September, AAR reported a 23% increase in first quarter sales to $550 million with adjusted earnings per share advancing by seventeen cents to $0.78 per share, although flattish GAAP results were announced with the discrepancy due to pension settlement charges and legal charges in Russia.

Just ahead of Christmas, AAR reported a 16% increase in second quarter sales, as the news broke after the market trading session. Adjusted earnings for the quarter came in at $0.81 per share, up twelve cent from the year before. With topline growth slowing down, shares initially moved lower in after-hours trading, although they recovered during the conference call as well.

The roughly 35 million shares outstanding value equity of the firm at $2.45 billion at $70 per share, or just over $2.66 billion if we factor in net debt of $210 million.

Right now it is clear that despite softer sequential year-over-year revenue increases, adjusted earnings of $3 per share and change provide greater support for the shares, although this still results in a low twenty times multiple at $70 per share.

A Big Deal

While the second quarter earnings report was released after the trading session, AAR announced a $725 million cash deal to acquire Triumph Product Support, part of Triumph Group ( TGI ) ahead of the trading session that day.

The transaction involves tax benefits with an estimated present value of $80 million and once these benefits are included, AAR believes that it pays an 11.7 times EBITDA multiple, suggesting that a $55 million EBITDA contribution is seen. This multiple will drop just below 10 times if, and once synergies of $10 million per annum, are priced in.

With the deal, AAR will add a global provider of specialized maintenance, repair, and overhaul services to commercial and military customers. The activities involve some 700 workers which generate $280 million in annual sales and post solid margins, with EBITDA margins seen around 20% of sales.

I peg pro forma net debt around $935 million, as AAR itself expects to operate with a 3.0 times net leverage ratio upon closing.

On the conference call , management indicated that some equity issuance would be needed to keep net leverage at 3 times EBITDA. Without an equity issuance, leverage ratios were seen at 3.6 times, which suggests that AAR is considering a $150 million equity issuance, or a number thereabouts. Despite the substantial deal and leverage implications, shares of AAR hardly reacted to the deal announcement.

And Now?

Despite the struggles in other parts of its business (in the case of Triumph), it seems that the seller fetched quite a nice multiple for its divested activities, and AAR paid a more than fair price at just over 2.5 times sales, with its own business trading just over 1 times sales. That is the wrong metric to look in isolation, as operating margins of the acquired activities surpass those of AAR by around 10 points.

That said, leverage will tick up a bit and near term accretion is not guided upon. In fact, earnings per share accretion is seen, but that is only seen in the fiscal year 2025, with the accretion number not being quantified. Synergies alone should be worth $0.20 per share here, or a few pennies less after the equity issuance goes through, which will cause a bit of dilution here.

Amidst all this, I am leaning a bit cautious here. On top of the fact that the business trades at a premium of around 23 -24 times (adjusted earnings here), the leverage profile has jumped from about 1 times to 3 times. Moreover, there is little immediate earnings per share accretion to show for it, making me a bit cautious here.

I am keeping a close eye on AAR, which I regard as a great operator. While the Triumph deal makes sense, I am cautious to get involved here at a premium valuation while leverage is high, as I feel no urge to get involved at this point and level in time.

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