Aerospace Services Will Benefit From Strong Demand, Expansion, And Integration

Key Takeaways

• Strong demand for AAR's aftermarket services and fleet aging will likely drive revenue growth.
  
• Hangar expansion and a strategic acquisition are set to boost margins, revenue, and financial stability.
  
• Settlement of a major investigation and decreased margins, combined with costly interest expenses and limited pricing power, threaten AAR's future profitability and growth.

Catalysts

Provides products and services to commercial aviation, government, and defense markets worldwide.

• AAR is experiencing strong demand for its aftermarket aircraft and engine services, driven by elevated levels of consumer air travel and an aging fleet. This is expected to continue through 2025, potentially boosting revenue.
  
• The integration of the Product Support acquisition is on track to realize $10 million in cost synergies by fiscal Q1 2026, which is anticipated to improve net margins.
  
• Expansion of hangar capacity in Miami and Oklahoma City, set to complete in fiscal 2026, is expected to generate $60 million in incremental annual revenue, enhancing future revenue streams.
  
• The sale of the Landing Gear Overhaul business is expected to be accretive immediately upon close in early 2025, improving margins and earnings.
  
• There is potential for significant cash generation enabling continued deleveraging, projected to achieve a net leverage target of 2x within two years, which is anticipated to enhance earnings and financial stability.

AAR Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming AAR's revenue will grow by 9.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 2.6% today to 6.7% in 3 years time.
• Analysts expect earnings to reach $212.4 million (and earnings per share of $4.61) by about January 2028, up from $64.2 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.5x on those 2028 earnings, down from 33.9x today. This future PE is lower than the current PE for the US Aerospace & Defense industry at 33.2x.
• Analysts expect the number of shares outstanding to grow by 9.38% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.97%, as per the Simply Wall St company report.

AAR Future Earnings Per Share Growth

Risks

• The company resolved a multi-year Foreign Corrupt Practices Act investigation by paying a $55.6 million settlement, which has impacted cash flows and potentially damaged its reputation with stakeholders, affecting future earnings.
  
• Adjusted EBITDA margin in the Parts Supply segment decreased from 13.2% to 12.4%, and adjusted operating margin decreased from 12.5% to 11.5% due to lower-margin whole asset sales, which could impact profitability if this trend continues.
  
• The sale of the Landing Gear Overhaul business may lead to a noncash pretax loss of approximately $60 million, affecting net income figures for the third quarter.
  
• The company has a relatively high net interest expense of $18.8 million due to recently financed acquisitions, which could further impact net margins if interest rates rise or cash flow generation is lower than expected.
  
• There is a mention of limited upward pricing pressure for legacy engine assets like CFM56, which, if continued, could limit revenue growth opportunities in the high-margin used serviceable material (USM) market.

Valuation

• The analysts have a consensus price target of $81.0 for AAR based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $3.2 billion, earnings will come to $212.4 million, and it would be trading on a PE ratio of 21.5x, assuming you use a discount rate of 7.0%.
  
• Given the current share price of $61.75, the analyst's price target of $81.0 is 23.8% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.