Boeing Gives AAR a Begrudging Acknowledgment

I suppose we can all breath a collective sigh of relief to the news that Boeing (NYSE: BA) has “officially” cleared AAR Corp. (NYSE: AIR) of any wrongdoing in their purported FAA violations in painting certain model landing-gear truck beams in ways that were not kosher.

On March 25th, the FAA issued a Unapproved Parts Notification (UPN) letter that stated that during a multi-year investigation, which lasted from the start of 2001 through Nov. 26, 2007, the FAA found that the AAR landing gear service center in Miami “improperly maintained and approved for return to service” parts used in Boeing 707, 747, 757 and 767 planes.

The part in question is called a landing-gear truck beam.

The truck beam is the main component of the landing gear. It goes across the entire component from axle to axle, and looks like an upside-down T.

This vertical bar acts as a shock absorber and is very important in terms of landing stability and strength of the entire mechanism.

The FAA’s notice refers to an enamel paint applied to the inside, or “bore,” of the horizontal bar, and the potential for that paint to obstruct a drainage hole in the beam, thus masking potential corrosion and preventing proper drainage.

You can read my entire take on the situation, including some possibly disturbing news on a plane that collapsed while refueling that was serviced using one of the AAR’s truck beams here.

Boeing Gives The All Clear…Sort Of

Parts Deemed Acceptable by Manufacturer

In a letter to its customers on April 8th, Boeing reconfirmed that the enamel applied by AAR as a top coat to the inner diameter of landing gear truck beams “…to be equivalent to drawing finish requirements and can be considered acceptable subject to all other standard overhaul processes and applicable CMM (Component Maintenance Manual) instructions being followed at the time of the overhaul.”

Boeing also stated in the letter that while the preferred finishing method described in the applicable truck beam CMMs for 747, 757 and 767 aircraft does not require an enamel top coat “…the presence of enamel top coat is not detrimental and is equivalent to the design finish and hence type design.” for these aircraft models.

Umm…ok, that sounds like a ringing endorsement to me.

AAR stated in their press release:

“In deference to Boeing’s preferred finishing method, AAR Landing Gear Services discontinued applying the enamel top coat to internal truck beam surfaces of 747,757 and 767 landing gear earlier this year. “

So basically, AAR has known about this possible infraction for quite some time, and had already instituted a change in their repair and overhaul specs. for these parts well before any news of this got to the media.

Bottom Line

Stock Takes a Wallop on News, Yet to Recover

The good news for us is that AAR doesn’t expect any liability claims or financial penalties from the FAA for the perceived oversight, and this news should have little to no bearing on their earnings, revenues, and overall business.

Tell that to investors however, as they sent AAR’s shares down to the dumps this past week.

As I stated in my last post about this subject, if it weren’t for all the hype and recent attention being paid to various airlines and their maintenance problems, the Wall Street Journal, which originally broke the story, probably would never have even pounced on this news, as this type of parts oversight and incorrect application of a manufacturer’s standards happens every now-and-then.

It would be foolish to sell AAR’s shares now that their valuation has come down so much further than where I originally recommended them, but some rough times could be in the cards especially since there are no positive catalysts for the stock anytime soon (AAR just recently had their earnings and conference call), and the continued negative sentiment caused by this story could continue to weight heavily on the stock price for some months to come.

I will stay on top of the situation and monitor it closely, but as of right now, I don’t see this as a long term negative for the company or the stock, and I believe the market has grossly overreacted, and this is probably a wonderful opportunity for you to get some shares of AAR for a price that is approaching book value, and needless to say, a price that is WAY below what AAR is worth using any metric out there.

My take: If I weren’t already fully invested in AAR (I have over a full position), I would be re-recommending purchase of AAR at a valuation and price that will look downright laughable in the months to come.

• Click here to read the complete AAR Corp. research report and buy recommendation

*Variables You Should Know About AAR Corp. (NYSE: AIR)
Current Recommendation:	BUY
The Company:	AAR Corp. provides products and services to the aviation, aerospace, and defense industries worldwide. It operates in four segments: Aviation Supply Chain; Maintenance, Repair, and Overhaul (MRO); Structures and Systems; and Aircraft Sales and Leasing.
Why Buy Now:	Excellent risk/reward profile at current price Margins are improving US military and defense spending will continue and could possibly increase in the foreseeable future Diversified company, operating in 4 primary segments with no segment representing more than 50% of total revenue and each one showing double digit growth The beauty of their operations lies in the synergies that exist between all their business segments There are no direct competitors that do exactly what AAR does Seasoned management
Market Cap:	$805.75
Revenue (TTM):	$1,299.6
Cash/Debt:	$40.1/ $368.6
Current Price:	$21.00
Risk Rating (?):	5 (Average)
Position Size (?):	1/2 (10-22-07), 1/4 (1-8-08), 1/4 (1-9-08), 1/4 (3-3-08)
Buy Around Price (?):	$30.00 (10-22-07), $34.00 (1-8-08), $31.25 (1-9-08), $26.00 (3-3-08)

*As of 4-15-08. Except share price, all values in millions.