Aftermarket Services Set To Thrive On Air Travel Surge And Aging Fleets

Key Takeaways

• Structural tailwinds from air travel and aging fleets are expected to boost AAR's aftermarket services, increasing revenue.
  
• Investments and acquisitions are set to enhance AAR's growth, efficiency, and profitability, with notable impact on net margins.
  
• Risks include tight USM supply, expansion challenges, volatile air travel demand, acquisition integration, and government contract dependencies impacting revenue and margins.

Catalysts

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

• Structural tailwinds from elevated levels of air travel and an aging fleet schedule to drive ongoing demand for AAR's aftermarket services, positively impacting revenue across its operating segments.
  
• Investments in Parts Supply, Repair & Engineering, and Integrated Solutions segments are expected to enhance growth, efficiency, and margins, directly boosting net margins and profitability.
  
• Expansion and acquisitions, such as the TRAX and Product Support acquisitions, are set to contribute meaningfully to sales growth and operating margin expansion, enhancing revenue and earnings.
  
• Plans for capacity expansions in Repair & Engineering in Miami and Oklahoma City are anticipated to add approximately $60 million of annual sales, positively affecting revenue and margins upon operation commencement.
  
• The company's strategy to gain market share via a strong pipeline of opportunities in the new parts distribution alongside recovery in government volumes is likely to significantly increase revenue.

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 December 2027, 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 21.4x on those 2027 earnings, down from 34.4x today. This future PE is lower than the current PE for the US Aerospace & Defense industry at 34.2x.
• 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 6.87%, as per the Simply Wall St company report.

Risks

• The lack of availability of whole assets, predominantly engines, impacts the USM (Used Serviceable Material) segment's sales, which could affect revenue growth and margins in this area, particularly if the tight supply situation persists.
  
• Execution risks associated with expansion plans, such as the hangar capacity expansions in Miami and Oklahoma City, could impact revenues and margins if there are delays or challenges in ramp-up and staffing.
  
• Dependence on economic and industry-specific factors, such as elevated levels of air travel and fleet aging benefiting aftermarket services, poses a risk if there's a downturn in air travel demand or changes in fleet replacement strategies by airlines.
  
• Integration risks and achieving expected synergies from recent acquisitions like TRAX and Product Support could impact profitability and expected margin improvements if not realized as planned.
  
• Government contract dependencies, as highlighted by the significant business wins in government programs, add risk due to the potential for contract protests or changes in government spending priorities, impacting expected revenues.

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 2027, revenues will be $3.2 billion, earnings will come to $212.4 million, and it would be trading on a PE ratio of 21.4x, assuming you use a discount rate of 6.9%.
• Given the current share price of $62.8, the analyst's price target of $81.0 is 22.5% 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.