AAR Corp Research Report
- Quick Take (5 Minute Pitch)
- What the Company Does
- A Look at the Defense/Aerospace Industry
- AAR’s Business Trends and Outlook
- Possible Risks
- Management
- Insider/Institutional Ownership
Fly Away With AIR:
I. Quick Take - The 5 Minute Pitch
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Variables You Should Know: |
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| Risk Rating: | 5 (Average) |
| Position Size: | 1/2 (as of 10-22-07) |
| Buy Around Price: | $30.00 |
Note: Updated through 2Q/2008 reporting period (November 30th, 2007). See PeakStocks.com for up-to-the-minute information on AAR Corp.
Quick Quote:
“I believe that as long as AAR keeps doing what they are doing: improving margins, growing sales and running a tight ship in terms of shareholder dilution and acquisitions, we will see returns from here on out from 15-30% per year, with less risk than some of the other picks in my portfolio.”
Chris Fernandez
AAR Corp. (NYSE: AIR)
By Chris Fernandez, PeakStocks.com
As you sit back in your cozy airplane seat (ok, maybe not so cozy sometimes!), a brief thought enters your mind:
“I wonder who leases and maintains these planes and how much work is involved in keeping the airplane in good working order?”
“Everything from making sure that the hull is structurally sound and landing gear are operating properly, to the basic maintenance and parts that are needed to keep it running smoothly, safely and within FAA guidelines?”
Then, as the plane backs up from the tarmac, you look out your window and notice a cargo plane used by FedEx that is loading large storage containers into the plane that fit perfectly within its hull, and take up every inch of the plane’s interior to maximize space and safely deliver whatever needs to be delivered.
“That’s pretty cool.” You say to yourself.
As you are taxiing down the runway and preparing for takeoff, you look out your window again and notice some military personnel loading a large plane with supplies on heavy-duty pallets that you’ve never seen before, in addition to some large structures that can only be described as movable bedrooms or offices.
“Huh”, you say to yourself, “I didn’t know there was so much that went into supplies and troop housing and movement…interesting.”
Your flight is about to take off, and you think to yourself how cool it would be if you knew who made those clever looking pallets, storage containers, and structures that house our troops.
“Well, time to get some rest.” You say to yourself.
You recline your seat at 30,000 feet, and right before you drift soundly off to sleep, you also think to yourself: “Man, I wonder who the heck supplies all these parts and maintains all these airplanes in good working order?”
As you enter a dreamlike state, those thoughts leave your mind as quickly as they entered…
Wake Up!
I have good news for you. There IS a company that does ALL these things at the same time! Welcome to AAR Corp. (NYSE Ticker: AIR).
AAR Corp. is a diversified company that provides products and services to the aviation/aerospace/defense industry, which includes airlines such as Southwest, and the military and its contractors like Northrop Grumman.
A Diversified Company in Multiple Expanding Fields
4 Business Segments
AAR Warehouse
- Aviation Supply Chain (50% of sales): In this segment AAR does everything from parts trading and arbitrage (buying and selling parts), to supply chain management and stand- alone parts repair for the aerospace and defense industry.Within this segment AAR takes care of everything a customer needs from finding and locating parts, to buying and selling those parts, to refurbishing them, and finally, managing and storing them for customers until they need them.
- Maintenance, Repair and Overhaul (MRO) (20% of sales): AAR provides major maintenance inspections, line maintenance, aircraft modifications and upgrades to the world’s major regional and cargo airline fleets, and for the U.S military and government agencies.
Broken down further, these MRO checks and repairs are done every year (shorter maintenance 10 day checks), with heavy airframe maintenance every 4-5 years (30 day checks). The heavy checks are the granddaddy of MRO, which entail basically stripping down the airplane and building it back up. AAR sends the engines out for repair, but do all other maintenance on the airframe, and source the parts from the parts group of their business.
- Structures and Systems (25% of sales): This business segment is heavily weighted towards defense with over 88% of sales coming from the government and defense contractors, and only 12% to commercial entities.
Cargo Systems
Mobility Systems, in which AAR manufactures, designs and repairs pallets and a wide variety of containers and shelters in support of military and humanitarian tactical deployment activities.
Cargo Systems, in which AAR designs, manufactures and installs in-aircraft cargo loading systems.
Composite Structures in which AAR designs and manufactures advanced composite materials for commercial, business and military aircraft as well as advanced composite structures for the transportation industry.
- Aircraft Sales and Leasing (about 5-10% of sales): This segment accounts for the smallest slice of their revenue pie and profit, but is a core part of their business, and often can lead to higher margins when they sell an older airplane from their fleet. Activities in the Aircraft Sales and Leasing segment include the sale or lease of used commercial jet aircraft.
Why I Invested In the Company:
- AAR Corp. represents a good risk/reward profile when you take into account its current share price, the continued growth of the company and the overall industry, and the improving fundamentals.
- Specifically, when I look at the valuation of AAR corp. compared to its peers, there is a significant discount with the shares trading around $38. By my calculations based on forward earnings, improving margins and cash flow, AAR is trading at about a 15-30% minimum discount to where it should be. We are still getting a value stock here with little downside and a ton of upside potential. (See: Valuation section below)
- Margins are improving. Aside from a slight hiccup this year, margins have been steadily improving and are expected to do so over the next few years. This represents a sweet spot for us as we can buy a company that is starting to really scale their business and squeeze more and more profit out of it, which in turn, creates more value for us as shareholders. (See: Margin Trends section below)
- US military and defense spending will continue and could possibly increase in the foreseeable future. In addition, the aerospace industry is growing like gangbusters with more and more people flying, and countries like China and India increasing demand for more planes and specifically, the types of services that AAR offers when those planes need to be repaired. There are 18,000 airplanes today, and that number is expected to double in the next 20 years!
- AAR is a diversified company, operating in 4 primary segments as outlined above, with no segment representing more than 50% of total revenue, and each one showing double digits growth. AAR is a diversified company that does not depend on any one segment of their business to remain functional.
- At the same time, the beauty of their operations lies in the synergies that exist between all their business segments. If you are using them for MRO, you are probably also going to be using them for parts, and supply chain management.Likewise, if you are getting parts from them, you are probably also using them to refurbish, store and maintain your parts.Also, if you are leasing airplanes from AAR, you are probably using them for MRO AND Supply Chain management.The only segment that doesn’t overlap is the Structures and Systems segment, but this is a good thing, as it ads another layer of protection and diversification to their business portfolio if the other segments underperform.
- There are no direct competitors that do exactly what AAR does. Although there are companies that compete with AAR within each segment, there is no apples-to-apples comparison because no one is as diversified as AAR is within the aerospace and defense industry.
- AAR is expected to grow earnings about 25% for the next 2 years and about 18% over the next 5, with total revenue growing at a high teens rate, far outpacing the industry average. I think these numbers are conservative because AAR is using capital to make acquisitions and expand their business. In addition, acquisitions are made with cash, and NOT stock, so shareholder value is not diluted.
- Seasoned management. The CEO owns about 2% of the company (a large number at a company this size) and has been at the company for over 28 years and has been CEO for over 11 years. The rest of the management team is just as tenured and focused and in total own about 4.25% of the company.
Potential Risks:
- The war in Iraq and other military operations. Obviously, the very first thing you need to worry about with any company that relies on the government for 30% of their income, is that it will eventually dry up.
- Adverse affects in the aviation industry. After September 11th, 2001, the aviation industry took a big hit that took years to overcome. If something like that happens again, less people will travel, there will be more unused planes, and less need for repairs and parts for those planes. AAR’s sales will be immediately affected in a negative way.
- Hiring enough skilled workers. This is a bigger concern than you might think. Finding skilled, trained and qualified workers in this industry is easier said than done, and competition is fierce. In fact, AAR has had to turn down business as a result of not having enough workers on staff!
- Dependence on debt to finance the business. AAR has not had a free cash flow positive year since 2005. This is a disturbing trend and fact.This last quarter however, Q1/08, they did become cash flow positive, but not free cash flow positive.I’m ok with this for the most part, because you have to spend money to grow a business, and with a big business like AAR Corp., it can take years to see the fruits of your labor, but this is definitely something to keep an eye on.
- Other risk factors. Things like options scandals, margin deterioration, losing business, losing customers, increased costs, overall market volatility, etc. Pretty much anything that can go wrong within a business is a risk factor, but the ones listed previously are the main risks to the business, with these being secondary, and possibly primary, risk factors going forward that all businesses need to worry about.
Business Outlook
AAR Corp. is a well-diversified company that is trading at a significant discount to the market and its peers. In fact, because AAR has no direct peers, it should always deserve a premium valuation to the sector and industry in which it operates.
The fact that it doesn’t is good news for us as it presents an excellent buying opportunity for a stock that we can hold on to for years to come.
Further, AAR is one of the leaders in the Parts and Supply Chain segment for Aviation/Aerospace and Defense contractors.
No one does it better.
If you need someone to handle your airplane or other vehicle parts (AAR now is doing supply chain management for non-airplane parts as well), you come to AAR Corp. From start to finish, from finding the parts to refurbishing them, storing them and maintaining them, AAR has been doing this for over 50 years, and there are few companies that can even come close to the total package of services, logistical operations and expertise that AAR has.
In terms of their Maintenance, Repair and Overhaul (MRO) segment they are rapidly expanding this unit, and making acquisitions as well as contemplating more acquisitions to further bolster their place among the better MRO companies around.
More and more airlines are outsourcing this segment of their business as they don’t want to deal with the added logistical headache that it causes, and focus more on their core enterprise of getting people from point A to point B.
As this trend plays out, AAR will be there to further service these individual companies through added capacity, acquisition, or other strategic partnership/relationship that should see them grow and expand this area of their business.
In their Structures and Systems segment, demand continues to be strong on the military front, as well as civilian needs from different states, and governments from not only the U.S., but from around the world as well.
The only thing that will slow this segment down is a change in the war status. (See Risks below for more information on the potential risks that AAR faces.)
Finally, more and more airplanes are being needed for the increasing travel around the world. The growth in China, India and other countries for more planes is voracious.
As a result of this need, AAR will be called upon going forward to supply more and more airplanes for lease within their niche of 10-15 year old planes, and then be able to tie in all their business segments into this: supply chain for the parts for the planes, MRO to fix the planes.
AAR is a diversified company that does not depend on any one segment of their business to remain functional.
At the same time, the beauty of their operations lies in the synergies that exist between all their business segments.
If you are using them for MRO, you are probably also going to be using them for parts, and supply chain management.
Likewise, if you are getting parts from them, you are probably also using them to refurbish, store and maintain your parts.
Also, if you are leasing airplanes from AAR, you are probably using them for MRO AND Supply Chain management.
The only segment that doesn’t overlap is the Structures and Systems segment, but this is a good thing, as it ads another layer of protection and diversification to their business portfolio if the other segments underperform.
If there was a negative with their business, it’s their debt. They are carrying over 300 million in debt, and they haven’t had a free cash flow year since 2005 because of all their growth and expansion. I’m ok with this, as long as we see some return within the next year or so.
Put it all together, and you get a well-oiled machine that has been doing this stuff for over 50 years, and slowly expanding their business through smart acquisitions and expansions, while letting under performing segments go.
Steady management, as well as consistent returns on capital and financials, has allowed AIR to average 100% returns in their stock for the last 5 years.
While we don’t pay for past performance, I believe that as long as AAR keeps doing what they are doing: improving margins, growing sales, running a tight ship in term of shareholder dilution and acquisitions, we will see returns from here on out of anywhere from 15-30% per year, with less risk than some of the other picks in my portfolio.
That being said, I believe AAR corp. is a steady and greatly run company that should be added to your portfolio as a buffer to more risky stocks, not to mention the out performance against the overall market that is to come going forward.
II. What The Company Does
AAR’s 4 Business Segments Are:
1 - Aviation Supply Chain (About 50% of AAR’s total sales):
warehouse
warehouse
There are basically 3 ways in which AIR makes money from the Aviation Supply Chain segment:
1) Parts Trading/Arbitrage (About 50% of sales within Aviation Supply Chain):
AIR looks for a wide variety of new, overhauled or repaired engine and airframe parts and components from their suppliers or other sources, like decommissioned airplanes. It then purchases theses parts and either sells them or refurbishes them to use in their other business segments, as outlined later.
This also includes the repair and overhaul of a wide variety of avionics, electrical, electronic, fuel, hydraulic and pneumatic components and instruments and a broad range of internal airframe components.
AIR acquires aviation parts and components for this sub-segment from domestic and foreign airlines, original equipment manufacturers, independent aviation service companies and aircraft leasing companies.
Bottom line: AIR is pretty much interested in anything within an airplane that can be used again or sold for a profit, and they’ll get it through any means available provided it makes sense economically for them to do so.
2) Supply Chain management programs (About 25% of sales within Aviation Supply Chain):
The second sub-segment within their Aviation Supply Chain segment is providing customized inventory supply and management programs and performance-based logistics programs for engine and airframe parts and components in support of airline and defense customer’s maintenance activities. This also ties in to their other business segment, as outlined later.
The types of services provided under these programs include program and warehouse management, parts replenishment and parts and component repair and overhaul.
Bottom line: AIR manages the parts supply chain for customers that don’t want to waste valuable time and resources doing something that AIR is already good at.
These time and money saving logistical duties include things such as forecasting demand for parts, supplying their customers with the parts when they need them, finding the parts, purchasing inventory, warehousing the inventory, managing the supply chain, repairing the parts, etc.
AIR is basically managing everything from start to finish for their customers relating to any parts they might need for their airplanes whether immediate, or in the future.
3)Stand alone component repair business (About 25% of sales within Aviation Supply Chain):
This one’s easy: Anything that can be taken out of an airplane and repaired, they fix or refurbish, except engines.
2 - Maintenance, Repair and Overhaul (MRO) (About 20% of AAR’s total sales):
AAR provides major maintenance inspections, line maintenance, aircraft modifications and upgrades to the world’s major regional and cargo airline fleets, and for the U.S military and government agencies.
This can include any of the following services: aircraft inspection and repair; major airframe modifications; avionic service and installations; structural repair; exterior and interior refurbishment; and complete engineering service and support.
Broken down further, these MRO checks and repairs are done every year (shorter maintenance 10 day checks), with heavy airframe maintenance every 4-5 years (30 day checks).
The heavy checks are the granddaddy of MRO, which entail basically stripping down the airplane and building it back up.
AAR sends the engines out for repair, but do all other maintenance on the airframe, and source the parts from the parts group of their business.
This includes: pulling out the seats, checking the airframe, applying new sheet metal where necessary, checking the fuel tanks, electronics, power units, flaps, tail, etc. EVERYTHING, including cracks in the airframe.
Aren’t you glad the FAA makes airlines do this! I sure am, and AIR gets to benefit from that maintenance schedule.
The customers in this segment are 85% commercial aircraft and 15% defense.
AAR operates 3 MRO facilities, with a 4th facility specializing in repair and replacement of landing gear only, and a final segment within this one that deals with aircraft storage and teardown. These facilities are located as follows:
- AAR Aircraft Services - Indianapolis
Located at Indianapolis International Airport, this is a 1.6-million-square-foot, state-of-the-art facility comprised of 12 bays specially designed to reduce maintenance cycle times and keep aircraft in service longer. Five of ten temperature-regulated hangar bays utilize innovative permanent dock structures that make aircraft maintenance more efficient, providing easy access to all parts of the aircraft.This is by far their largest, best-equipped and newest facility. It was not yet operating at full capacity, which is good news for future revenue.
- AAR Aircraft Services - OklahomaLocated at Will Rogers World Airport, this is a 300,000-square-foot, full-service facility featuring seven hangers supporting five “nose-to-tail” narrow-body aircraft maintenance lines that provide services for 727, 737, DC-9, MD-80/90 and regional aircraft. In 2004, AAR’s Oklahoma operation, among others at AAR, received the FAA’s highest award for aviation maintenance technician training, the FAA Diamond Award.
- AAR Aircraft Services - Hot SpringsIn January 2007, AAR acquired Reebaire Aircraft, Inc., a regional aircraft MRO provider in Hot Springs, Arkansas. The addition of this facility more than doubled their capacity for regional aircraft MRO. AAR Aircraft Services - Hot Springs is ideally suited to serve the maintenance needs of the rapidly growing regional aircraft market and can handle as many as five ‘nose-to-tail’ maintenance lines.
- AAR Landing Gear Services
AAR Landing Gear Services is a self-contained, full-service aircraft landing gear, actuator, and wheel and brake overhaul facility strategically located in Miami.At their FAA-certified Shop, AAR repairs and overhauls landing gear, wheels and brakes, and actuators for 43 different types and subtypes of commercial and military aircraft. This is a huge 128,000 square foot facility that houses all the machinery, equipment, systems and personnel needed to perform the maintenance work for landing gear.AAR also entered recently into a new joint venture with Malaysian MRO provider, AIROD, which will provide turnkey landing gear services to commercial and military customers throughout the Asia Pacific Region.This new facility is located near Kuala Lumpur’s Subang Airport, which is a great way to bring high-quality, cost-effective landing gear services to one of the fastest growing aviation markets in the world and should reap great benefits in the future.Finally, repairing and overhauling landing gear is not as labor intensive as typical MRO operations, and is usually done on site where the aircraft is located.AIR simply pulls it off the aircraft, puts a new one in, quickly, and then sends the old one off to repair, and finally, can sell it back to someone else. Thus the aircraft is repaired quickly and remains in service.
- AAR Aircraft StorageAAR Aircraft Services - Roswell offers aircraft storage, maintenance services and teardown operations.
Their hardened aircraft parking can accommodate in excess of 300 aircraft and this facility allows AIR to not only store planes, but also to provide certain maintenance checks and all associated maintenance.Further, according to their website, they can meticulously remove, identify and tag parts, using the most current technology to track, preserve and package them for shipment or storage.In addition, they offer indoor warehousing for aircraft parts and aircraft records as well as climate controlled, anti-static storage for sensitive electronic components. And they help maximize the return on investment with on-site metal reclamation of the remaining hull and provide credits to customers for precious metals reclamation.Essentially, they can either repair planes at this facility, but not to the extent of the other MRO facilities, or tear them down completely, and share the profit with the owner of the plane.
3 – Structures and Systems (About 25% of AAR’s total sales):
The third segment that AAR is involved in is Structures and Systems. This business segment is heavily weighted towards defense, with over 88% of sales going towards the government and defense contractors, with only 12% to commercial entities.
The Structures and Systems segment is divided into 3 primary sub-segments as follows:
1) Mobility Systems business (About 75-80% of sales within Structures and Systems):
AAR manufactures, designs and repairs pallets and a wide variety of containers and shelters in support of military and humanitarian tactical deployment activities.
The pallets are made out of lightweight aluminum and balsa wood composite that is lighter and stronger than a regular pallet.
In addition AIR makes pallets that are designed for anything from regular loading and unloading of goods, to actually palletizing seats so that military aircraft can be quickly converted from cargo holding vehicles to people transporting vehicles.You can read more about these specialized pallets here:
http://www.aarcorp.com/gov/Mobility/Pallets/pallets_seat.htm
and here:
http://www.aarcorp.com/gov/Mobility/Pallets/pallets_air.htm
In addition to the high-tech pallet manufacturing, AIR also makes containers for the military for everything from helmets to weapon, to highly specialized containers that contain dog kennels, and refrigerated containers as well! Really cool stuff.
You can read more about these specialized containers here:
http://www.aarcorp.com/gov/Mobility/Containers/containers_specialty.htm
and here:
http://www.aarcorp.com/gov/Mobility/Containers/containers_standard.htm
Both the containers and pallets that AAR manufactures are their own proprietary technology that has yielded ongoing contracts for a couple of decades with the government.
The shelters that AIR creates are also unique in that they contain benches, rack systems, mobile kitchens, bunks and workstations to support such field operations as electronics and vehicle repair, supply management and intelligence planning.
AAR delivers the units with basic HVAC, lighting and electrical infrastructure in place.
You can read more about these specialized shelters here:
http://www.aarcorp.com/gov/Mobility/Shelters/shelters_mobile.htm
and here:
http://www.aarcorp.com/gov/Mobility/Shelters/shelters_truck.htm
Just by looking at the images I enclosed here and the links, you can easily see why AIR is the leader in this field, and has had ongoing contracts with the military and its defense partners for decades.
2) Cargo Systems (About 10-15% of sales within Structures and Systems):
AAR designs, manufactures and installs in-aircraft cargo loading systems and has been at the forefront of innovative cargo handling and logistics systems for commercial and military applications for more than 40 years.
Their customers include package and heavy freight fleet operators, military customers, original equipment manufacturers (OEM) and aircraft conversion shops.
They are the OEM for the C130 transport aircraft, helicopter platforms, and systems for a commercial airliner to be turned into a military transport aircraft and have won OEM status for several contracts. Their cargo systems are also used by the likes of FedEx for their aircraft to load and unload cargo on rollers that take up the most space, with the least amount of wasted space.
3) Smaller Composite Structures Business (About 10% or less of sales within Structures and Systems):
AAR Composites serves the aerospace market with the highest quality composite solutions offering every type of composite fabrication process available today.
They also design and manufacture advanced composite materials for commercial, business and military aircraft as well as advanced composite structures for the transportation industry. This is the smallest sub-segment of the Structures and Systems segment.
4 – Aircraft Sales and Leasing (About 5% of AAR’s total sales):
The final piece of the AAR revenue puzzle is their Aircraft Sales and Leasing segment. It accounts for the smallest slice of their revenue pie and profit, but is a core part of their business, and often can lead to higher margins when they sell an older airplane from their fleet.
Activities in the Aircraft Sales and Leasing segment include the sale or lease of used commercial jet aircraft, and are comprised of 2 primary sub-segments:
1- Direct Sale and Lease of Aircraft:
AAR views this segment as a core part of what they do, and as an extension of their Supply Chain Segment.
Here’s how this works: AIR goes out and identifies aircraft that are underutilized and purchase them with the lease intact.
They then hold it for a modest amount of time (3-5 years), and when they meet their economic benchmarks within the company such as Return on Invested Capital (ROIC), etc., they sell it, getting not only the lease payments while they held the plan, but also the final selling price of the plane as well.
AAR sources the planes from bigger lessors, or from carriers that want to lease their planes.
They go about this buy partnering with certain investors that put capital up-front for the lease of the plane with AAR, and in exchange, AAR leverages its expertise with finding the airplanes, repairing them if needed, maintaining them while under contract, and generally leveraging their years of expertise in the aerospace industry to put less capital up-front and thus protect their cash flow and working capital while still benefiting from the leasing, buying and selling of these aircraft.
Competition in this sector is fierce, but AIR has committed itself to a target, niche business by only purchasing mid-life aircraft that are 10-20 years old and therefore don’t directly compete with Aircastle, Babcock and Brown and other similar aircraft leasing companies.
As of their fiscal period ended August 31, 2007 when they just reported earnings, AAR had a portfolio of 40 total aircraft, 31 they own with joint ventures, 9 on their own.
Further, each sale or lease is negotiated as a separate agreement which includes term, price, representations, warranties and lease return provisions. Leases have fixed terms and early termination by either party is not permitted except in the event of a breach.
Also, the customer that pays the lease also sets up a reserve for MRO payments.
Most leases usually run 3-5 years and at the end AIR can choose to renew the lease, give it to someone else, sell the aircraft, or strip it down at their chop shop.
In some rare instances, some companies sell them the planes to strip down because they don’t want to deal with them anymore and the plane is worth more for parts than actively running.
In other rare instances, they flip the plane by purchasing it and having a buyer already lined up to sell it to, acting as the middleman.
2- Advisory Services:
When an aircraft undergoes a change of operator - planned or unplanned - there are dozens, if not hundreds, of different tasks that need to be organized and completed. That’s where AAR Advisory Services comes in.
AAR works as the intermediary between aircraft owner and operator to ensure that all tasks are completed quickly, correctly and 100% reliably.
AAR provides an extensive range of value-added services to help manage the many complexities in remarketing aircraft and buying engines.
Their experienced professionals work with the customer to source and evaluate aircraft for acquisition, facilitate aircraft or engines trades, perform or manage required maintenance, upgrades and conversions, structure operating leases, purchase existing leases, and arrange innovative financing solutions.
When its all said and done, AAR delivers a comprehensive range of innovative sales/leasing/financing programs, value-added services and follow-up customer satisfaction tools that help their customers take advantage of leasing opportunities and turn around a project quickly.
III. A Look at the Defense/Aerospace Industry:
The defense, aviation and aerospace industry is poised for future and sustained growth for a couple of reasons: the US military is initiating new operations and/or keeping operations steady in foreign countries; more and more people are traveling and demand is rising quickly in countries like China and India where demand is far outstripping supply for airplanes.
US Military and Defense Operations:
It’s no secret that the US is heavily involved in military operations around the world.
Regardless of how you feel personally about the situation, the reality is that it will be some time before a major troop withdrawal takes place in Afghanistan and Iraq.
As a result of this, the US military will continue to rely heavily on AAR and others to supply troops with supplies, structures and systems, and heavy maintenance overhaul for their military fleet of airplanes.
Although no one wants to see the US expand their forces or enter into any new conflicts, continued deployment, or any future deployment into any other theatres will mean continued and increased dependence on AIR and the products that they produce for the US military its subsidiaries, and to military forces from other countries as well.
Visibility in this area leads me to believe that for at least the next 1-2 years, revenues and business coming from the government (which represents about 30% of AAR’s overall sales), will continue in a steady fashion.
There is a silver lining in this, however, according to the Aerospace Industries Association (AIA) taken from their annual report on the industry:
“… sales to the Defense Department will show modest gains in 2007 from funds already appropriated. Obviously a new Congress, events in Iraq, and new management at DoD will affect the composition and value of defense programs in fiscal ‘08 and beyond.”
Of course we’ll need to monitor the situation closely for any changes, but it looks like defense spending is leveling off, which is good in a way, because it means future growth and sales from the DoD will become a smaller slice of AAR’s revenue pie, thus reducing their exposure to the government and military sales in the event of a troop withdrawal or cut-backs in military spending.
Growth in the Aerospace/Aviation Industry:
The air travel industry is growing at a break-neck pace in the US, Europe, and to a much larger degree, in Asia.
In fact, growth is pegged at about 50% for transatlantic travel by 2013, with similar increases in the US and Europe alone, and almost double in Asia!
According to the Aerospace Industries Association (AIA), the US aerospace industry was highly successful in 2006, with total deliveries surpassing $184 billion, up more than 8% from last year’s $170 billion. While sales increased across the board for nearly all product and customer categories, most notable was a 21% surge in the civil aircraft sector.
The AIA projects that aerospace industry sales will grow another $11 billion to over $195 billion this year, as the Defense Department’s purchases and the space sector increase slightly while commercial aircraft, engines and parts deliveries jump another 15%.
AIA also reports:
“As for exports, foreign sales of aerospace products jumped sharply for a second year, totaling nearly $85.2 billion, an increase of $18 billion over the previous year’s $67 billion. The increase is dominated by civil aircraft exports, particularly commercial transports, which increased from $28 billion to nearly $38 billion. General aviation aircraft exports also enjoyed another good year, increasing by a third to $3.2 billion, again setting a new record. Military aircraft exports experienced a healthy 40% increase to $3.4 billion, although in absolute terms military exports only account for 15% of total aerospace exports.”“Looking beyond 2007, the current backlog of commercial aircraft orders gives us confidence that the civil aircraft sector will continue on an upward trajectory for at least an additional three or four years.”
In fact, AAR’s results support this notion:
“AAR’s sales to commercial and defense customers in Europe grew 22 percent year over year and currently account for 18 percent of the company’s overall sales,” Timothy J. Romenesko, president and chief operating officer of AAR Corp., tells AMT. “We see significant opportunity for AAR in European markets as regional carriers become more prevalent and as new and existing commercial carriers and defense forces look to operate more efficiently and effectively.”
This all points to growth across the board for AAR Corp. as they take advantage of the growing demand for not only airplanes, but more importantly for them, the need to service and repair those airplanes, and yes, the need for parts to service and repair those airplanes.
AIR’s growth has outpaced the industry rising anywhere from the high teens to mid 20’s growth rate, which is exactly what I like to see.
In fact, there are about 18,000 airplanes in the air today, and that number is expected to double in the next 20 years, which is exactly what you want to see since those older planes will need service and parts for years to come.
In addition, the possible expansion overseas, and within the US presents opportunities for AAR to grow much faster than this, and take advantage of the growing trend of large aircraft carriers, such as United, to completely outsource their MRO operations, not to mention the potential growth in Europe, and Asia as more and more airplanes come on line and need servicing and repair.
IV. AAR’s Business Trends and Outlook:
AAR Corp. has been on a tear in the last few years as their business has expanded into new markets, while they have also grown their current market base with new clients, new business segments and expansion of current business segments.
The question for us now is, not what AIR has done in the past, but what they will do in the future.
Financial Performance:
AAR Corp. has been on a tear in the last few years as their business has expanded into new markets, while they have also grown their current market base with new clients, new business segments and expansion of current business segments.
The question for us now is, not what AIR has done in the past, but what they will do in the future.
Let’s take a look at the growth trends within each segment of AAR’s business over the last 3 years, and the total for the business:
2005-2007 Sales/Gross Margin Per Segment (In Millions):
As we can see from this table, AAR’s sales in each segment has seen steady growth, aside from the Sales and Leasing segment because the inherent nature of buying and selling aircraft creates a more “lumpy” earnings and margin story.
Let’s now take a look at each segment’s growth year-over-year as reported in the company’s latest earnings release on December 18th for their Q2/’08 period ended November 30th, 2007:
Q2: 2007-2008 Sales / Gross Margin Per Segment Comparison (In Millions):
Gross margin increased in 2 segments and decreased in 2 segments.
But those margin decreases were more than offset by the gains in their MRO segment, and their Aviation Supply Chain segment, leading to an overall gross margin increase from 18.8% to 19.4% which is huge for a mature business like AAR.
In addition, their sales increased an incredible 27.2% year over year, while also expanding margins! This is a sign of a healthy business.
The bulk of this gain was in their MRO division because the new facilities in Indianapolis was brought up to speed, and all the problems ironed out to yield better turnover and higher margins.
Now, let’s take a look at the Income Statement for the same reporting period.
Q2: 2007-2008 Sales/Income/EPS Figures Comparison (In Millions):
Again, comparing year-over-year increases from Q2 2007/2008, AAR has across the board, increased all their important metrics.
In addition, top and bottom line are growing at about the same rate, which is good to see. It means AAR isn’t falling behind in their capital structure and also that expenses are being kept under control while sales grow, thus allowing AAR to keep their margins intact.
In other words, AAR isn’t sacrificing margins for higher sales, they are doing both at the same time, growing total sales, and keeping the profit from those increasing sales the same year over year.
Finally, shares were hardly diluted at all from year to year, which is another positive I like to see.
However a word of caution on this note: as previously stated, because of AAR’s debt, and recent acquisition strategy, it is more than likely that they will need to issue more debt and/or shares to increase their capital position, so this metric might deteriorate in the near future, but be sufficiently offset via the gains made through these acquisitions and accretive gains that these acquisitions will make to their top and bottom line.
So for the coming year, I see it as a wash between increasing number of shares and dilution, and increased revenue and earnings per share.
Here’s a look at AAR’s Income Statement and growth percentages from 2005-2007, with 2008 estimates where applicable:
2005-2007 Sales/Income/EPS Figures:
(Note: All figures are in millions, except for EPS, and Diluted Shares.)
Once again, we don’t care necessarily where AAR Corp. has been in terms of numbers, but where they are going.
It’s obvious that sales are still growing nicely, and are expected to do so this year, acquisitions notwithstanding. On top of that, AAR is still growing net earnings.
But the laws of large numbers always catch up to companies, and that’s what’s happening to AAR.
As they make more money and earnings, it’s also harder to grow the top and bottom line by the same amount from year to year. The question for us then becomes, are the shares fairly valued for the potential growth from here on out, and obviously, they are, or else I wouldn’t have even gotten this far in my analysis.
What does need to be watched though, are the margins.
Now, one good or bad quarter does not make or break a company, but I will be watching these trends going forward.
Also, any acquisitions that AIR makes, will determine whether these numbers increase or decrease, but if history is any guide, AAR is great at buying small companies that they can easily incorporate into their business, and are accretive to earnings without diluting shareholder value.
Margin Trends:
Looking at a company’s margins is critical to understanding their past performance and future prospects. Usually, businesses start out with smaller margins and they expand over time as the business becomes more efficient, and scales.
Let’s take a look at AAR’s margin trends and outlook for 2005-2008:
Here are the margin trends for the last 6 quarters:
AAR is doing a great job of expanding their margins. The slight blip in this trend in Q1/08 was because of one-time problems in their MRO division that have since been remedied, as evidenced by the sharp margin improvement in Q2/08.
AAR has been able to drop more profit to the bottom line with less and less top line (or total sales) growth. This is exactly what you want to see from a company, the aforementioned margin problems notwithstanding.
I feel AAR’s margins will improve and expand going forward even more, and once that happens, if you aren’t already in the stock, it’s too late. The key is to spot trends and performance metrics before they occur on a large scale so that you can benefit by owning the stock.
As long as AAR continues to improve their operations at their flagging acquisitions and cleans things up some more, I believe they will continue to be on a strong upswing as one look at their last 6 quarter margin trend proves.
Valuation:
Below I will outline some brief valuation metrics. To get a complete break-down of my reasoning behind these, please refer to the complete research report on PeakStocks.com under the “Research Reports” section in a few days.
AAR Corp’s stock still looks like a good deal even at today’s prices (about $38 per share) that are about 30% higher than my initial buy recommendation price.
As you’ll see in the Competitors section below, there is no one company that does exactly what AAR Corp. does. There are some companies that do MRO, some that do some parts, some that do some leasing, but none that do ALL the things that AAR does, and therefore, it deserves a premium for being a best-in-breed company for all 4 segments that it competes in.
But for the purposes of putting some type of valuation on the company, I will offer up some comparables for valuation’s sake.
Let’s start with the Discounted Cash Flow Analysis (DCF):
DCF is often called the king of all valuation metrics because it measures a company’s actual ability to generate cash from operations, and in the end, that’s all that really matters.
Other metrics like P/E ratios, and P/S ratios can be manipulated by the company or not lead to a truthful analysis of the business because of accounting shenanigans, but DCF can’t be made up. You are either making and retaining cash, or you aren’t, simple as that.
When assessing a company’s “fair” or intrinsic value using a DCF analysis, many assumptions must be made.
Everything from the potential growth prospects of the company’s earnings, to their tax rate, overall market’s return, risk free rate of return for bonds, their debt ratio, etc.
In other words, using this type of analysis is far from an exact science, like other methods can be, because you need to make assumptions for the next 5-10 years that may or may not EVER come true.
For instance, a Price-to-Sales ratio can be measured in absolute terms: The company’s market cap on that day, divided by their total sales. Easy, simple, clean and exact.
However, with a DCF analysis, there are many variables that need to be accounted for that can change in an instant.
Why do we use this analysis tool then? Because it is one of the most definitive measures of a company’s worth if we look into the future and determine what it can earn for the next 5-10 years.
This analysis gives us a “terminal” value of the shares, and what they are worth right now, based on all our assumptions.
This is also commonly referred to as the intrinsic value of the stock, or it’s absolute highest value based on all our assumptions.
When using this modeling, I typically account for 3 scenarios:
- The best-case scenario: This scenario typically assumes the highest growth rates, margins and cash-flow, and also assumes the lowest volatility, tax rate, debt levels, etc. for the company you are analyzing.
- A middle scenario which is the most likely, with moderate assumptions on growth rates, margins, cash-flow, volatility, tax rates, debt levels, etc.
- The worst-case scenario: This scenario typically assumes the lowest growth rates and margins, and also assumes the highest volatility, tax rate, etc. for the company you are analyzing.
I won’t go into detail on how this is done, but suffice it to say there are calculators on the web that do them, as well as proprietary spreadsheets and systems that all financial firms use.
Using a modified DCF analysis, here’s what I get under these 3 different scenarios:
- Best Case Scenario: AAR’s shares are valued at anywhere from $61.00 - $110 per share
- Middle Scenario: AAR’s shares are valued at anywhere from $49.00 - $78.00 per share.
- Worst-Case Scenario: AAR’s shares are valued at anywhere from $36.00 - $52.00 per share
So using this measure of valuing a company, I get an average share price range from: $44.00 - $85.50, taking the midline of each scenario.
With AAR’s shares trading at about $38.00 as of this writing, even under the worst-case scenario (and with some horrible growth numbers in there that are below what AAR is tracking for even this year!), shares are still undervalued!
More to the point, I believe the midline model is most accurate because it is conservative, while being realistic with growth rates and assumptions made about acquisitions and organic growth. Using this metric, AAR’s value is trading way below its intrinsic value of about $53 per share or so.
Now, of course, DCF can’t be used on it’s own, it needs to be used along with other measures of value, so to that end, I have detailed some more valuation metrics below that are more traditional.
Let’s start with the P/E ratio:
AAR’s trailing P/E ratio is 24.22 using $1.57 in earnings for the last 4 quarters. The industry average is 23.25. This is for the aerospace/defense products and services industry.
I personally feel that AAR isn’t really in this industry at all, but more in their sister industry of “Air Services” of which Limco-Piedmont (Nasdaq: LIMC) is a part of and publicly traded.
If you use this industry, the average trailing P/E ratio is 29.84, which then puts AAR at a discount of about 23%.
But this doesn’t tell the whole story. You see, the aerospace/defense industry is growing at about 13% year over year while the “air services” sector is growing at about 13% per year also, and AIR is growing in the high teens, about 18.5% or so, so by this measure, AAR is trading at about a 40% discount in terms of it’s valuation to growth multiple.
On top of that, the projected growth for a couple of AAR’s competitors that I looked up, Goodrich Corp (NYSE: GR) in the Supply Chain side, and Limco-Peidmont in the MRO side, are at about 15% for GR in 2008 and at about 30% for LIMC.
AAR’s P/E is expected to grow at about 27% for the next 2 years at least.
LIMC is a smaller company that just came public so their growth isn’t the norm. GR on the other hand, is an established company and much slower grower than AAR.
Again, there is no direct comparison because AAR does so many things that no one else does. I think that merits a premium, in addition to the hard evidence that AAR is trading at a significant discount to their peers within industries, sectors and specific companies as well.
I’d estimate that by this measure, AAR is trading at about a 30-40% discount to where it should be.
Now Let’s Look at the Price to Sales (P/S) Ratio:
We can now take this one step further and look at the price to sales ratio, the ratio of a company’s total revenue, to their share price.
If we use the examples above again, we see that in the Aerospace and Defense Industry, the average TRAILING P/S multiple is 1.3, and for the Air Services industry it is 1.89.
Let’s take this down the middle, and be conservative, and make it about 1.5.
AAR’s P/S multiple is 1.1-1.4 (depending on share count used), using $1.19 Billion in sales on a trailing 4 quarter basis.
Again, if we were to take the average P/S of both industries, and then take the lower one for the aerospace and defense industry, we come up with AAR being undervalued by 40% using 1.5 P/S for the average, and undervalued by 20% using the much more conservative pure aerospace and defense industry’s multiple.
Now, taken with the statistic above, that the average revenue growth in these industries is about 13% while AAR’s growth is 18%+, you can see there is a problem with the valuation here.
If anything AAR Corp. deserves a premium over these other companies because it is growing its top and bottom line faster.
I’d estimate by this measure, that AAR is trading at about a 30-40% discount to where it should be.
Finally, let’s look at the Price/Earnings/Growth (PEG) Multiple:
The final valuation multiple that I would like to look at is the PEG ratio, or the P/E ratio divided by Projected growth.
Any multiple that is around 1 or less is considered a bargain for this metric based on the forward growth of a company.
AAR’s earnings are projected to grow at 17.5% for the next 5 years, and specifically, about 25% for the next 2 years (23% this year and 29% next year).
Based on these values, with a forward P/E ratio for 2008 (based on earnings per share of $1.75) is 21.71, and 16.74 for 2009 (based on earnings per share of $2.27).
This gives a forward PEG ratio of: 21.71/17.5 = 1.24 (2008) and 16.74/17.5 = .96 (2009).
Every other quarter for the last trailing 3-year period, but one, AAR has at least met, or beat estimates. I expect that trend to continue and look for margin improvements that will drop straight to the bottom line.
Not only is a PEG ratio of below or around 1 cheap, but AIR is growing earnings over the next 2 years at a much higher rate, at about 25%, which would make their PEG way below one, and if they beat earnings like they always do, it won’t be long before others realize that this stock is also dirt cheap as well.
One more thing: for comparison’s sake, the average PEG ratio in the Aerospace and Defense industry is 1.34, with Goodrich Corp. trading at a 1.21 PEG. Over in the Air Services industry, that average PEG is 1.42.
It doesn’t matter how you slice it, AAR is undervalued by based on this metric as well.
Possible reasons for undervalued shares:
Of course, there are definitely reasons as to why the shares are undervalued. Nothing operates in a vacuum.
Some of these reasons include:
Margin shrinkage: Margins are lower than their industry peers, and have ticked down lately from their expanding ways. (See the Margin Trends for more detailed information on this.)
In the aerospace and defense industry, gross margins are about 25%, AAR’s are 18.5%. The average operating margins are 10.18%, while AAR’s margins are about 8.5%.
It looks like Wall Street is taking a “show me” approach to AAR, and waiting for those margins to improve.
Update: AAR’s margins ticked up to 10.1% in their latest reported earnings announcement, and their longer term projection for operating margins are 12.5% or higher.
Lack of catalysts: AAR hasn’t had any great news come out lately, and with a stock like this that is owned by so many institutions, it takes a good news day to move the stock and keep it there since it requires the retail investor to get excited about this stock, and most retail investors only learn about high-flying stocks that are in the news.
Improved margins, better earnings and some potential acquisitions or other news item could take the shares to their next resting level.
Update: AAR’s just announced earnings caused the shares to significantly pop, see PeakStocks.com for more details.
Slowing growth: It’s undeniable that sales have slowed somewhat. Wall Street and momentum traders always get out of stocks that become “boring” and don’t grow as fast.
This is good for us. It allows the shares to trade sideways for a bit, grow into their valuation, become cheap again (as they are now), and then take off with the next positive news announcement.
High short count: To a lesser extent, a high short count can be a drag on shares. Whenever the shares rise, shorts pile in and this could be putting some additional pressure on the stock.
Never fear, 2 things will happen: improving business trends will force the shorts to lessen their positions (as they are already doing), and if they don’t get out now, something will take place, an earnings announcement or something similar, that will then force the shorts to cover their positions and inevitably, push the stock higher.
Either way, I don’t think this affects us too much, and shouldn’t be that big of a drag on the shares going forward.
Competitors:
There is no one that does everything that AAR corp. does in the way they do it.
Sure there are companies that do MRO, and some that do Supply Chain, and others that lease planes, but there isn’t an apples-to-apples comparison for all the things that AAR corp. does.
Here’s a list of some of their direct competition within each segment:
- Supply Chain:Too many to name. AAR Corp. is the largest after market Supply Chain and parts provider in the industry.
There are many other companies that supply one type of part, or specialize in a couple different types of parts, but there aren’t any direct competitors that do all that AAR Corp. does in terms of supply management, parts repair, and OEM installations. One public competitor though is Goodrich (NYSE: GR).
- MRO:This is also a fragmented segment, with many airlines running their own MRO facilities and more and more of them outsourcing their MRO operations to outfits like AAR.
Some of their competitors in this segment include: Limco-Peidmont (Nasdaq: LIMC), Timco Aviation, and Singapore Tech.
- Structures and Systems:There is not a lot of competition for this segment, but I was told that orders come in all the time, and there is always risk of losing contracts to other bidders. One of their competitors in this sector of note is MC Gill Shelters.
- Sales and Leasing:There are quite a few companies that compete in this space, but AAR has tried to stick with their niche of buying and leasing aircraft that are about 10-20 years old which is considered mid-life aircraft in the business.
Other sales and leasing companies specialize in new aircraft rather than older ones.
In this space there are several publicly traded companies including: Babcock and Brown (NYSE: FLY), Genesis Lease Limited (NYSE: GLS), and Aircastle (NYSE: AYR).
VI. Possible Risks:
As with all businesses, AAR Corp. has its warts, and this wouldn’t be a complete research report if I didn’t tell you about all of the risks that I felt were pertinent to the business going forward.
I will list them in order of potential harm for the company and the stock, from most harmful and most likely to occur, to least harmful and least likely to occur.
Keep in mind this is not an exhaustive list of possible risks. No one could ever know all the possible bad things that might happen to a company, but these are risks that I at least know about, and can fathom, rather than something happening that was totally unforeseen.
The War In Iraq:
Obviously, the very first thing you need to worry about with any company that relies on the government for 30% of their income, is that it will eventually dry up.
This is a very real, and probable possibility with AAR.
Eventually, the US will withdraw from Iraq, and/or Afghanistan.
When that happens, AAR will inevitably lose some of their business and income. Everything from the various Structures and Systems that they produce for the military, to MRO and parts that they provide for the planes.
From what I was told when I asked about this risk, what usually happens in cases like this, is that initially, there is actually a surge in demand for parts and MRO services to repair and service all the returning aircraft and vehicles. This usually lasts about 1-2 years after a major withdrawal.
So, even if the US pulled out of Iraq today, there would still be a steady order flow, and a likely spike, for about 1-2 years as a result of that withdrawal.
Hopefully, within the next few years, as they have been doing, AAR can further diversify away from the government (they used to represent 33% of sales), and lower their risk in this area.
Adverse Affects in the Aviation Industry:
After September 11th, 2001, the aviation industry took a big hit that took years to overcome.
If something like that happens again, less people will travel, there will be more unused planes, and less need for repair of those planes and parts for those planes.
AAR’s sales will be immediately affected in a negative way.
In addition to overall Aviation woes, we can add risks to AAR via specific timing and responsibility for shoddy workmanship on a plane they repaired, or a part they replaced.
If a plane crashes shortly after they did some work on it, and more specifically, it was deemed that that part failed, or the plane crashed as a direct result of AAR Corp’s mishandling of the MRO or parts duties, the stock will surely get hammered and business might suffer if other airlines take their business elsewhere.
Hiring Enough Skilled Workers:
This is a bigger concern than you might think.
Finding skilled, trained and qualified workers in this industry is easier said than done, and competition is fierce.
In a recent article that talks about this problem in their Oklahoma MRO facility, Don Wetekam, their president of Aircraft Services stated:
“”We could hire up to another 100 people based on the workload we have now.”
Wetekam said the company, whose major focus is on maintenance, repair and overhaul, has had to turn down work because there are not enough employees to handle the load.
“We have extra work we can bring here today,” he said.”
This is of course a major concern for us as investors. Turning down business? That’s not a good thing.
AAR is working hard to overcome this problem, but look for it to be a continual drag on the company for a long time to come.
Dependence on Debt to Finance the business:
As I mentioned before in the Financials section, AAR has not had a free cash flow positive year since 2005.
This is a disturbing trend and fact.
This last quarter however, Q1/08, they did become cash flow positive, but not free cash flow positive.
When talking to John Bowman, director of Investor Relations, he commented that they are comfortable with a debt to equity ratio around 40%, and that they are using credit and the money they make in expansion, acquisitions, and to grow the business.
I’m ok with that for the most part. You have to spend money to grow a business, and with a big business like AAR, it can take years to see the fruits of your labor, but this is definitely something to keep an eye on.
The good news in a way, was that they just got approved for a revolving line of credit with favorable terms for up to 340 million if they needed it.
This bodes well for their acquisition strategy and also means that banks felt comfortable enough with them, even in the current loan climate to extend their credit line by about 100 million dollars.
I’ll be keeping an eye on this one, and want to see improvement within 1 year or so.
Deteriorating Margins:
If margins don’t improve, as I believe they will, and as management has said they will, it won’t be long before fundamentals deteriorate and the business suffers.
This can include needing to tap the equity markets for more cash and diluting shareholders further, making less and less cash to finance the business, and finally, a shrinking growth rate as the company will be forced to pay more attention to their cash position, and have less money for acquisitions and business expansion which can all become a vicious cycle that leads the overall business trending downward for years.
Other Risk Factors:
There are so many other possible risk factors, it would take a long time to go over them all, but suffice it to say, they are no different than any other business in terms of their overall risk to the company. Here’s a brief rundown of some of them:
- options scandals
- margin deterioration
- losing business
- losing customers
- losing workers
- shenanigans by the management team or CEO
- decreasing market share
- increased costs
- natural disasters
- overall market volatility
- lawsuits or legal action
- unforeseen costs or expenditures
- bankruptcy
- competition
- etc.
Pretty much anything that can go wrong within a business is a risk factor, but the ones listed previously are the main risks to the business, with these being secondary, and possible primary, risk factors going forward that all businesses need to worry about.
VI. Management
Here’s a brief rundown of AAR Corp.’s management:
From the latest 10-k Filing:Mr. Storchwas elected Chairman of the Board and Chief Executive Officer in October 2005. Previously, he served as President and Chief Executive Officer from 1996 to 2005 and Chief Operating Officer from 1989 to 1996. Prior to that, he served as a Vice President of the Company from 1988 to 1989. Mr. Storch joined the Company in 1979 and also served as president of a major subsidiary from 1984 to 1988. Mr. Storch has been a director of the Company since 1989.
Mr. Romeneskowas appointed President and Chief Operating Officer effective June 1, 2007. Previously, he served as Vice President and Chief Financial Officer since 1994. He also served as Controller of the Company from 1991 to 1995, and in various other positions since joining the Company in 1981. Mr. Romenesko was appointed a director of the Company in July 2007.
Mr. Poultonwas appointed Vice President, Chief Financial Officer and Treasurer effective June 1, 2007. Previously he served as Vice President of Acquisitions and Strategic Investments since joining the Company in September 2006. Prior to joining the Company, he spent ten years in the aviation industry and held senior executive leadership positions with UAL Corporation, including Senior Vice President of Business Development and Senior Vice President and Chief Procurement Officer for United Airlines, Inc.
Mr. Pulsiferhas served as Vice President, General Counsel and Secretary of the Company since 1990. Previously, he served as Vice President (since 1990) and General Counsel (since 1987). Prior to joining AAR, he was with United Airlines, Inc. for 14 years.
Mr. Clarkhas served as Group Vice President, Aviation Supply Chain since 2005. Previously, he served in various Group Vice President roles from 2000 to 2005, and previous to that he served as General Manager of AAR Aircraft Component Services-Amsterdam from 1995 to 2000, and in various other positions since joining the Company in 1982.
Mr. Sharphas served as Vice President, Controller and Chief Accounting Officer since 1999. Previously, he served as Controller of the Company from 1996 to 1999. Prior to joining the Company he was with Kraft Foods from 1994 to 1996, and with KPMG LLP from 1984 to 1994.
Each executive officer is elected annually by the Board of Directors at the first meeting of the Board held after the annual meeting of stockholders. Executive officers continue to hold office until their successors are duly elected or until their death, resignation, termination or reassignment.
As you can see, this is a seasoned management team with the CEO being with the company since 1979.
In addition, management usually tries to not dilute shareholder value by using cash for acquisitions, and always answering for the business and the potential pitfalls, and shortcomings as evidenced by the latest earnings conference all, which I will go over in a later post.
VII. Insider/Institutional Ownership
Insider Ownership:
It’s always a good idea to make sure that the owner’s interests are aligned with yours. So let’s take a look at the insider ownership for AAR Corp.
According to Yahoo finance, insiders own about 4.25% of the company. This is a huge number considering the number of shares outstanding (about 38 million), and the fact that the company has been around for decades as a publicly traded entity.
In fact the CEO owns about 850,000 shares of stock, or about 2% of the company! That’s a high number for one person in a company this size.
Now there has been some selling lately, but very little about 8-10,000 shares by some of the insiders over the last year or so, nothing to worry about, but again, I’ll keep an eye out for this, but as hard workers for the company, they should be able to get some cash out of it from time to time.
Institutional Ownership:
Now let’s take a look at the institutions and mutual funds that are owners in this stock.
According to Etrade, about 95% of the shares are held by these institutions!
Normally, I shy away from companies with this much institutional ownership because it means that the “smart” money is already in the stock and there is less chance of appreciation.
But in this case, I like that, because it keeps the price steady, and as long as AAR executes, whenever the stock does rise, it will hold at sustainable levels because there won’t be any large sellers.
Now the downside to this of course, is that any deterioration in AAR’s fundamentals or business outlook, and you can see a run for the exits, and if all these big boys decide to dump at the same time, look out below.
In fact the Fidelity Management & Research Fund, owns about 12% of the company!
This is a huge amount of ownership, and there are other mutual funds and institutions not far behind in that category.
I’ll be watching this stat closely as well for any sudden changes, selling, or other markers that something might be amiss with the stock.
Short Sellers:
Surprisingly, about 10.10% (3.72 million shares) of AAR Corp. is held short, which means there are a ton of people out there that think this stock is overvalued and expect it to go down.
However, when taken in context, last month there was about 10.7% (3.92 million shares) of the shares held short, so it looks like there has already been a slight change in sentiment, and less of the shares are being held short, which is good new for us, because usually short sellers can portend something wrong in the business, and sniff out companies that they feel have problems on the horizon.
Of course, sometimes, they are bogus and full of it, and are jumping on some bandwagon hoping and betting a stock will go down for no good reason at all other than valuation or some news item, like perhaps the US pulling out of Iraq.
I don’t think there’s anything to worry about here since AAR just reported good earnings and they are undervalued by my calculations in their industry and sector and for their future growth.
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