Aircraft fleets are racking up a growing number of passenger miles as the global economy recovers. Travel demand is booming, especially among the rising middle class in Asia, which increasingly is getting the urge to travel. At the same time, these aging aircraft are in pressing need of maintenance that has been put off for years.
These trends spell blue skies for AAR Corp. (AIR), which provides maintenance, repair and overhaul (MRO) to civilian and defense aircraft operators. As the largest public company of its type, AAR is a growth stock play on aviation’s multi-year resurgence.
During the Great Recession, considerable MRO work was deferred and now it’s getting tackled as good times return. What’s more, the implementation of stringent “green” regulations in aviation as a response to Global Warming is forcing companies to step up maintenance to lower carbon footprints, as well as to reduce noise and fuel consumption.
The clear winner in this space is AAR, which purchases, sells, leases, repairs and overhauls airframe parts, including avionics and engines. With MRO shops spread across the United States, AAR is the leader in a field with high barriers to entry. And considering the capital costs and customer networks required to compete, the emergence of new rivals to an entrenched company such as AAR is greatly unlikely.
What AAR Is Doing Right
AAR has been enhancing its competitive edge by streamlining its supply chain processes to make the procurement and provision of spare parts as efficient and cost-effective as possible. The company also has been training its mechanics to handle the consequences of strict, new environmental rules that require the use of leading edge substances that are fuel efficient and emissions-reducing.
Chief among these aircraft manufacturing innovations: carbon composites, which are increasingly pervasive in all new aircraft. They’re flexible and light but also difficult to maintain; AAR is a specialist in handling carbon composites.
Consolidation is wracking the aviation industry, as manufacturers (including MRO companies) join forces to generate economies of scale. AAR has kept up the pace in the consolidation frenzy through a continual series of mergers and acquisitions that have made the company a formidable competitor on price.
In its fiscal first quarter 2015 (ending Aug 31, 2014), AAR reported earnings per share (EPS) of 36 cents, a drop of 20% from the EPS of 45 cents reported in the same period a year ago. First-quarter revenue was $469.2 million, a year-over-year drop of 8.8%.
Investors weren’t happy, but they’re losing sight of the big picture. AAR’s first-quarter decline in earnings and revenue was mostly due to the U.S. withdrawal of aircraft in Afghanistan, a temporary impediment to maintenance demand that was offset by a 7% jump in revenue from commercial customers. AAR’s operating performance should hit takeoff speed in coming quarters, as the military drawdown in the Middle East finishes and the commercial sector continues its higher flight path.
Meanwhile, you can pick up this long-term growth stock on the cheap. AAR stock currently trades at a trailing 12-month price-to-earnings ratio (P/E) of 13.8. compared to a P/E of 19.2 for its peers in aerospace/defense.
As of this writing, John Persinos did not hold a position in any of the aforementioned securities.
