alvarez/E+ via Getty Images
At the end of 2021, I concluded that it was time to fly high for AAR Corp. (NYSE:AIR) as it has seen a solid recovery in recent times. This was achieved despite the ongoing pandemic, as AAR has managed to deleverage its balance sheet while it has improved the operational performance. All that and a retreat from its highs earlier in the year created a decent set-up in my eyes.
Going Back
AAR is a large and independent provider of aviation aftermarket services which includes parts supply, repair & engineering, integrated solutions and manufacturing expeditionary services. These are provided to a broad range of aviation customers, including a well-balanced allocation between commercial and defense markets.
The integrated model and global operations means that the company services global commercial airliners, regional airliners, cargo airliners and government customers, as typically the commercial activities are a bit bigger than the defense operations.
The company posted flattish sales of just over $2 billion in the year 2020, but that fiscal year ended in May, with the pandemic only impacting the final quarter of the year, in which revenues were down a quarter. This triggered a pullback in adjusted earnings from $2.44 per share in 2019 to $2.15 per share.
Despite 20%-30% year-over-year revenue declines in the first three quarters of the fiscal year 2021, the company maintained profitability, even as it was trending at just $1.50 per share. In the end, the company posted sales at $1.65 billion in 2021 with adjusted earnings down to $131 per share, but that was not too bad in my book even given the set of circumstances faced by the business.
First quarter sales for 2022 rose 14% to $455 million as adjusted earnings came in at $0.52 per share, with net debt cut to just $80 million. With net debt equal to just 0.6 times “pressured EBITDA”, and earnings trending above $2 per share already, a $38 valuation by year-end looked quite compelling, certainly as second quarter sales rose 8% to $437 million, and earnings improved a penny to $0.53 per share. Furthermore, the board announced a huge $150 million buyback program, equivalent to more than 10% of the outstanding share base.
Re-Rating Happened, And Now Reversed
After trading at $38 in December, shares rallied to the $50 mark in March, and traded at a high of $53 in recent weeks, before a substantial pullback was seen to $40 right now.
Other than some smaller corporate news flow, relatively little news has been announced other than the release of the third quarter results in March. Reported revenues rose 10% to $452 million, yet adjusted earning improved further to $0.63 per share. Management sounded upbeat despite the geopolitical issues as net debt was very modest at $64 million, allowing for more capital allocation decision to be made in the near term.
With earnings power trending closer to $2.50 per share, I was not surprised to see the shares run to a high of $50 per share, as this translated into a reasonable 20 times earnings multiple given that the company was still trailing its peak/normal performance and the balance sheet has been quite strong.
There have been some other issues in the mix of course, as greater geopolitical uncertainty will likely boost defense spending, but the contrary is the case as well, as certainly inflationary and economic growth pressures will likely hurt the commercial aviation market, something discounted in recent weeks.
Final Thought
Truth is that I was more constructive on AAR at $38 in December than I am today. Of course, we have seen a retreat with the pandemic and stronger third quarter performance than anticipated, all of which is positive. And while it is even the case that defense activities should have a rosier outlook, the commercial aviation market has been hit by high fuel prices, inflationary pressures and labor shortages, all having a huge impact in all likelihood as the pandemic remains still a wildcard.
In the meantime, markets have taken a step lower as well, so flat performance year to date marks quite an outperformance. All of this makes me still upbeat on the long-term prospects for the name, but I am not yet willing to buy the most recent dip.
Be the first to comment