AAR Corp. (AIR), a provider of aerospace and defense aftermarket solutions to commercial and government operators, MROs, and OEMs globally, is set to release financial results for its second quarter of fiscal year 2024, which ended November 30, 2023, after the NYSE trading session close on Thursday, December 21, 2023.

Analysts expect the company’s revenue and EPS for the fiscal 2024 second quarter to increase 18.9% and 15.6% year-over-year to $558.65 million and $0.80, respectively. Moreover, AIR topped the consensus revenue and EPS estimates in the last reported quarter.

The aviation services company posted first-quarter sales of $549.70 million, beating analysts’ expectations of $507.26 million. This is compared to $446.30 million in the same period of 2022. AIR witnessed solid growth across all its commercial activities.

In particular, AIR’s Parts Supply revenue rose 40% year-over-year due to investments made in previous quarters in expectation of strong demand. In addition, in Repair & Engineering, the company’s hangers were primarily full throughout the summer and flight hours continued to recover worldwide, which drove growth in Integrated Solutions.

Furthermore, the company’s EPS came in at $0.78, compared to the consensus estimate of $0.69 and up 27.9% year-over-year.

“We are proud to have delivered another quarter of year over year sales growth and record first quarter adjusted earnings.  Our commercial businesses are capitalizing on the favorable aftermarket trends and we expect that to continue in the quarters to come,” said John M. Holmes, Chairman, President and CEO of AAR Corp.

“We believe our pipeline of commercial and government opportunities, our strong balance sheet, and our ability to execute quickly will drive further growth across our parts and services offerings,” Homes concluded.

However, the company could face regulatory and industry-wide challenges. A significant portion of AIR’s revenue comes from government contracts, making the company vulnerable to changes in government expenditure and budget allocations. Also, it operates in a very competitive market, facing rigid competition from large aviation and defense companies and smaller industry players.

Shares of AIR have gained 7.7% over the past month and 30.8% over the past six months to close the last trading session at $72.28. Also, the stock has gained 62.1% over the past year.

Here are the factors that could affect AIR’s performance in the near term:

Positive Recent Developments

On December 11, AIR added distribution support of select Woodward, Inc. parts under its Supplier Capability Contact with DLA Aviation. Under this multiple-year deal, AAR Corp. will supply DLA with spare parts from Woodward’s fuel control product family.

AAR will offer comprehensive and integrated supply chain management support and perform associated functions to maximize the parts availability to DLA. Last year, AIR was the first non-OEM to be awarded the 20-year base Supplier Capabilities Contract with the Defense Logistics Agency (DLA), forming a strategic relationship to offer global supply chain support to the DOD and U.S. allies.

On December 7, AIR signed an agreement to extend the company’s existing airframe MRO services with Alaska Airlines through 2030 and expand its heavy maintenance partnership. The company has been committed to growing its dedicated airframe narrowbody capacity to provide Alaska Airlines with a minimum of six lines of maintenance support.

To support this, AAR Corp. plans to add a new three-bay hangar adjacent to its existing seven-bay facility at Will Rogers World Airport in Oklahoma City, pending final approval by the Oklahoma City Airport Trust. The proposed new hanger will offer AAR an additional 85,000 square feet of MRO space to accommodate all 737 variants.

Mixed Financials

For the fiscal 2024 first quarter that ended August 31, 2023, AIR’s revenue increased 23.2% year-over-year to $549.70 million, while its gross profit rose 23.7% from the year-ago value to $101.30 million. However, its operating income declined 18.9% year-over-year to $25.30 million.

AIR’s adjusted EBITDA rose 24.6% year-over-year to $52.10 million. The company’s adjusted income and adjusted earnings per share from continuing operations were $27.30 million and $0.78, up 23.5% and 27.9% year-over-year, respectively.

The company’s adjusted cash used in operating activities from continuing operations was $19.40 million versus an adjusted cash provided by operating activities of $7.10 million in the prior year’s period. As of August 31, 2023, AIR’s net debt was $236.70 million, compared to $70.70 million as of August 31, 2022, and its net leverage was 1.18x.

Mixed Historical Growth

Over the past fixed years, AIR’s revenue and EBITDA have increased at CAGRs of 2.9% and 4.7%, respectively. Its net income has grown at a CAGR of 27.2% over the same time frame. However, the company’s earnings from continued operations have declined at a CAGR of 3.9% over the same period.

Favorable Analyst Estimates

Analysts expect AIR’s revenue for the fiscal year (ending May 2024) to come in at $2.29 billion, indicating an increase of 15.2% year-over-year. The consensus EPS estimate of $3.45 for the ongoing year reflects a 20.6% year-over-year improvement. Also, the company has surpassed the consensus revenue and EPS estimates in all four trailing quarters.

For the fiscal year 2025, the company’s revenue and EPS are expected to grow 5.6% and 22.4% year-over-year to $2.42 billion and $4.22, respectively.

Mixed Valuation

In terms of forward EV/Sales, AIR is currently trading at 1.22x, 33.3% lower than the industry average of 1.83x. Its forward Price/Sales of 1.09x is 22.6% lower than the industry average of 1.41x.

However, the stock’s forward non-GAAP P/E and EV/EBITDA of 20.95x and 12.16x are 9.2% and 4.1% higher than the industry average of 19.18x and 11.68x, respectively. Also, its forward EV/EBIT multiple of 17.06 is 4.1% higher than the industry average of 16.40.

Decelerating Profitability

AIR’s trailing-12-month gross profit margin of 18.60% is 39% lower than the 30.49% industry average. Moreover, the stock’s trailing-12-month EBITDA margin and net income margin of 7.91% and 3.19% compared unfavorably to the respective industry averages of 13.72% and 6.09%.

Furthermore, the stock’s trailing-12-month ROCE, ROTC, and ROTA of 6.12%, 6.35%, and 3.42% are lower than the industry averages of 12.30%, 7.09%, and 4.99%, respectively. Its trailing-12-month levered FCF margin of negative 1.17% compared to the industry average of 5.98%.

POWR Ratings Reflect Uncertainty

AIR’s mixed fundamentals are reflected in its POWR Ratings. The stock has an overall rating of C, translating to Neutral in our proprietary system. The POWR Ratings are calculated by considering 118 different factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. AIR has a C grade for Growth, consistent with its mixed historical growth and mixed financial performance in the last reported quarter. Also, the stock has a C grade for Value, consistent with its mixed valuation.

In addition, AIR has a C grade for Stability, justified by its 24-month beta of 1.07.

AIR is ranked #42 out of 72 stocks in the Air/Defense Services industry.

Beyond what I have stated above, we have also given AIR grades for Sentiment, Momentum, and Quality. Get access to all the AIR Ratings here.

Bottom Line

AIR delivered another quarter of year-over-year sales growth and record fiscal 2024 first-quarter adjusted earnings. In addition, the company’s long-term prospects look bright, driven by solid demand for its aerospace and defense aftermarket solutions and a strong balance sheet.

However, regulatory compliance, fierce competition, and macroeconomic and geopolitical risks could pose challenges to the company’s growth in the near term. Given its declining profitability, mixed valuation, and uncertain near-term outlook, it could be wise to hold AIR and wait for a better entry point in this defense stock.

Stocks to Consider Instead of AAR Corp. (AIR)

Given its uncertain short-term prospects, the odds of AIR outperforming in the weeks and months ahead are compromised. However, there are many industry peers with much more impressive POWR Ratings. So, consider these three A-rated (Strong Buy) stocks from the Air/Defense Services industry instead:

Huntington Ingalls Industries Inc. (HII)

Brady Corporation (BRC)

Cadre Holdings, Inc. (CDRE)

For exploring more A and B-rated defense stocks, click here.

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AIR shares were unchanged in premarket trading Wednesday. Year-to-date, AIR has gained 60.98%, versus a 26.05% rise in the benchmark S&P 500 index during the same period.

Mangeet’s keen interest in the stock market led her to become an investment researcher and financial journalist. Using her fundamental approach to analyzing stocks, Mangeet’s looks to help retail investors understand the underlying factors before making investment decisions.

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