(MRO) AAR Corp. Still Solid: Reports Record Q1/2009 Sales
On a day that the markets were absolutely crushed, AAR Corp. (NYSE: AIR) survived the maelstrom to finish the day up modestly (+.57 to $16.24) as a result of their continued stellar results even in the face of severe weakness and cutbacks in the airline industry.
As I predicted when reviewing AAR’s quarter and what to expect, the results were absolutely wonderful across the board especially when taking into account all the headwinds that AAR is facing in their various business segments.
Will this continue? Can AAR keep weathering these shifts in the market to keep their dominant position atop the industry?
In this post I’ll be breaking down AAR’s full earnings release, as well as their analyst conference call, and round out my post with what you should do with AAR’s stock.
New to the AAR story?
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.
Want more?
I’ll break down this report into 4 parts:
- Hit Me With The Numbers: Sales, Earnings, Margins: All Up, In-line With Estimates
- Other Business Highlights: Still Expanding the Business, Organic Growth Strong
- Conference Call Highlights: Management Was Confident and Upbeat
- Bottom Line: It’s time to add shares of AAR to your portfolio
Hit Me With Some Numbers
Record Sales, Higher Margins
(Growth from previous year’s 1Q/analysts estimates where applicable):
- Record quarterly sales of $359.9 million (up 18% from prior year (12% organic)/vs. $362.2 million projected by analysts)
- Quarterly income from continuing operations of $18.7 million (up 23% from prior year)
- Quarterly earnings per share of $0.45 (up 23% from prior year/vs. $.45 projected by analysts)
- Q1 Gross margin improves to 18.7% (up from 18.5% in the prior year)
- Q1 Operating margin of 8.8% (even from 8.8% in the prior year)
- Retired $12 million of its 1.75% convertible notes for approximately $10.9 million. As a result of this transaction, the number of shares outstanding used to calculate diluted earnings per share was reduced by 408,000 shares.
- Backlog increased to approximately $500 million at August 31, from $465 million at May 31 and $310 million at August 31, 2007.
- Holding to their growth rate of 15%+ this year.
- Operating cash flow: (-$10 million)
- Sales to Defense customers increased 32%; Defense business now represents 40% of total sales
My Take: A fantastic quarter for AAR and a great way to start their fiscal 2009 year, and what is traditionally known as their slowest quarter.
Analysts were pleasantly surprised, as was I, that margins were so strong, even with AAR’s recently announced potential problems with Mesa Airlines, and other customers as well as slowing demand.
For AAR’s weakest quarter, there was nothing more I could have asked for, except perhaps some cash flow, which went negative this quarter as AAR used more cash to expand their business due to increasing demand, which is great news.
Finally, retiring some of their debt was also a great idea as it led to a lower share count, and improved their balance sheet somewhat.
Other Business Highlights
Organic Growth Strong
As mentioned above, AAR’s organic growth was a stellar 12% this quarter.
AAR saw tremendous growth in all of their segments except their Sales and Leasing segment.
This is absolutely remarkable especially in the face of such turmoil in the airline industry.
AAR was able to weather this downturn in part because of their diversification and sales to the U.S. government via their Structures and Systems segment.
The fact that AAR was able to grow sales in each segment, except Sales and Leasing, speaks to their ability to continuously innovate and take advantage of the downturns and natural cyclicality of their business to trim the fat off of operations and come out on the other side stronger and poised to further increase their businesses and leadership position when the industry recovers.
Here’s a breakdown of AAR’s 4 business segments and notes on each:
Aviation Supply Chain (42.7% of sales) — Sales grew 8% to $153.5 million for the first quarter and gross profit increased 11% to $35.4 million, resulting in a gross profit margin of 23.1% compared to 22.4% last year.
Results in this segment were driven by strong aftermarket parts sales to commercial and defense customers and strength in performance-based logistics programs.
AAR saw some weakness in this division, although sales still grew, as a result of a slowdown in their component repair shops, as well as the overall slowdown affecting the airline industry.
In addition, as a result of the Mesa (NASDAQ: MESA) airlines weakness, the Aviation Supply Chain segment experienced a 200 basis point shortfall in sales growth, and they expect a similar impact going forward.
My Take: Look for sales in this division to pick up slightly higher as AAR begins to service more planes in their MRO division as a result of more airlines outsourcing their MRO and parts needs now that the summer flying season is over.
In addition, it looks like AAR is anticipating where the weaknesses will come from in this division (Mesa, more below), and taking the necessary steps to make sure that things stay on track.
- Maintenance, Repair and Overhaul (MRO) (24% of sales)– Sales grew 38% to $86.3 million for the first quarter and gross profit increased 59% to $12.8 million, resulting in a gross profit margin of 14.8% compared to 12.8% last year.
The sales growth reflects the impact of the acquisition of Avborne Heavy Maintenance Inc. and continued strength at AAR’s landing gear business.
Sales were also higher year-over-year at the company’s Indianapolis and Oklahoma City airframe maintenance centers.
The acquisition of Avborne Heavy Maintenance Inc. a few months back enhances AAR’s ability to service more wide body planes, which typically belong to international carriers.
You’ll recall that last quarter, AAR was dealing with the loss of United Airlines (NASDAQ: UAUA) vacating 3 of their maintenance lines at their Indianapolis facility as a result of United grounding their entire fleet of 737’s.
Shortly thereafter, AAR filled those vacated lines with other customers and only lost a week’s worth of revenue from the lines being vacant.
In addition, AAR commented that their Miami MRO facility was running at half capacity due to a customer utilizing their fleet in the summer months, but that they expect the volume to double as they enter September and this customer looks to service their planes.
Finally, when asked by an analyst about the Southwest Airlines (NYSE: LUV) capacity reductions that were just recently announced and if they would affect AAR, management commented that as of now, this has not yet affected AAR at their Indianapolis MRO facility, and they don’t expect it to.
My Take: Once again AAR is showing that their continued excellence in service that they provide for their customers allows them to continue to grow this segment of their business despite losing customers for brief periods of time, as well as the continued airline reductions that are happening all around them.
I have commented before that as a result of airlines wanting to cut costs and save money, more and more MRO work would begin to be outsourced, and this has thus far proven to be the case.
Why spend money, waste manpower and pay higher wages to your own workforce, when you could easily outsource this work to AAR much cheaper and save your company all the potential headaches and logistical concerns.
- Structures and Systems (32.4% of sales) — Sales grew 53% to $116.8 million for the first quarter and gross profit increased 91% to $17.5 million, resulting in a gross profit margin of 14.9% compared to 11.9% in the prior year.
Sales were positively impacted by organic growth from AAR’s mobility, composite structures and cargo systems businesses and the impact of the acquisition of SUMMA Technology, Inc.
In December 2007, AAR acquired SUMMA Technology, Inc. adding to their precision-machining and fabrication capabilities.
AAR also recorded its first shipments from its recently opened composites center in Sacramento, California.
This segment still shows great promise according to management, as evidenced by AAR’s higher capital expenditures this quarter related to expanding their Structures and Systems business to serve more customers.
Sales growth in this segment reflects AAR’s leading position in specialized mobility products for defense and humanitarian customers, and steady demand for cargo systems and composite structures.
My Take: As AAR continues to diversify their business and begins ramping up production in this segment, we’ll see more sales skewed towards defense customers and less towards commercial customers, in fact this is already taking place.
This segment will see continued growth in the coming year and further diversify AAR’s revenue stream away from the airline industry and allow them to cushion any further blow that lagging sales will have on them.
It’s also obvious that AAR is seeing strong demand in this segment as a result of their further capital expenditures and expansion initiatives that is allowing them to service a wider and more diverse customer base.
- Sales and Leasing Segment (1% of Sales) — During the first quarter of 2009 AAR had no aircraft sales and as a result, sales in the Aircraft Sales and Leasing segment declined $20.8 million and gross profit and earnings from aircraft joint ventures declined $5.5 million from the prior year.
AAR’s aircraft position remained unchanged at 37 aircraft, with 29 aircraft held in joint ventures and eight aircraft held in the company’s wholly-owned portfolio.
5 aircraft in their Sale and Leasing segment are scheduled to come off of leases this year and AAR has agreements in place to sell 2 of these aircraft in Q2.
They are in negotiations with the other 3 to sell or continue to lease them to customers.
AAR achieved a 15.5% return on their investment on their portfolio of aircraft in fiscal 2008, and expect to do the same going forward.
Also within this segment, under an advisory services contract, AAR announced a deal with United Airlines to help United sell or lease their entire fleet of 737’s which amounts to about 100 aircraft.
AAR will get paid a flat per aircraft whether they sell or lease the airplane.
My Take: We’ll see things pick up in this segment next quarter when AAR sells two of their planes, and begins working on selling or leasing the other 3 that are coming off of leases this year.
In addition, AAR’s deal with United Airlines to help them sell or lease their retired fleet of 737’s is not a big deal in terms of a pure dollar value, but rather shows how companies trust AAR and their ability to service their needs even when they are no longer using AAR to maintain and repair their fleet of aircraft.
Conference Call Highlights
Kicking butt despite downturn
- More Color on Deal Flow: The CEO was asked by an analyst about overall business and the deal flow that AAR was seeing.
The CEO then commented on how the deal flow is very strong, and that the Supply Chain and MRO businesses are doing well and that they hope to turn some of their discussions with customers into actual contracts.
He also stated that he was surprised that they haven’t already converted more of these discussions into actual deals.
The deals that are being discussed are with both Defense and Commercial customers for new contracts and orders.
My Take: This comment was typical on the call in which the CEO and CFO were both very upbeat in their comments, and seemed to present a very solid picture for AAR now and as the airline industry starts to recover going forward.
- Mesa Airlines Discussion: Mesa Airlines, one of AAR’s customers, stated in May 2008, that if they could not resolve one of their contract disputes with one of their customers, they may have to file for bankruptcy protection.
During fiscal 2008, sales to Mesa Airlines were approximately $73 million, of which $56 million was in the Aviation Supply Chain segment, and $17 million was in the MRO segment.
As of this conference call, Mesa was still solvent and AAR is currently still supporting Mesa Airlines’ operations, but AAR is anticipating lowered sales volumes for fiscal 2009 and has taken other measures as well to curtail their overall exposure to Mesa.
One of these measures was to restructure some of the terms and conditions with Mesa geared towards reducing balance sheet and cash flow risks.
AAR said on the call that Mesa has been a good customer for them, and thus far as honored all of their commitments to AAR, so they are going to try and continue working with Mesa, albeit with an eye towards the problems that they are facing.
My Take: As we know, Mesa is a small player in the regional airline market, and as a total percentage of AAR’s revenue.
However, because AAR’s margins are already so tight to begin with, and operationally they are trying to improve all of their business segments, even a small player like Mesa could have a disproportionate affect on the company’s margins, and if forced to write down any of the assets associated with their support of Mesa, it would indeed cause problems during the year.
I’ll be keeping an eye on this situation as it unfolds, but lower fuel prices are certainly one ingredient that will keep anything drastic from happening to Mesa in particular, and the overall airline industry as a whole.
- Aircraft Resale Value: An analyst asked the CEO about the current aircraft that AAR has on their balance sheet that they are trying to sell, the two 737’s for next quarter, and then beyond that, the other 3 aircraft that are scheduled to come off of lease agreements this year, and how the pricing of those aircraft is looking considering the current airline market.
The CEO stated that “investors are going to be very happy with the return that we have on the sale of these two aircraft.”
He further stated that the pricing was good and within their expectations and will be yielding them a very healthy return.
My Take: AAR sets out certain parameters and cash generation initiatives that they like to see fulfilled when they enter into a new agreement either for the purchase or lease of used aircraft.
If they cannot get what they need, they will either re-lease the airplane, or not enter into an agreement in the first place.
It’s obvious that after years of doing this AAR has systems in place to ensure they get the return on investment that they need to make these deals feasible, and as such, the aircraft that are coming off of their books shortly will be no exception.
- Commenting on the Commercial Airline Industry: As for the commercial airline industry, the CEO stated that obviously they like the price of oil at $100 much better than at $140, and would like it even better at $60, but that as the price of oil moves downward, of course it is better for AAR’s customers, and therefore, AAR.
He offered no predictions neither positive nor negative, other than to say multiple times that AAR has been through this type of slowdown before, and has always come out ahead.
- Operating Margins: AAR is still focused on a 12.5% operating margin longer term, but may have to wait to achieve that with what’s going on now in the commercial airline market and as AAR tightens their focus, concentrates on taking market share, and looks to increase their liquidity.
Bottom Line
Solid Results Don’t Change My Opinion
It’s obvious to me that AAR is operating on all cylinders in spite of the economic and industry headwinds that are affecting the business.
This leads me to ask one question: If AAR is able to perform so admirably in these types of adverse conditions and in fact thrive in them, then what is AAR’s business going to look like when things do turn around and things improve?
You see where I am coming from here right?
If you look at all traditional valuation metrics for AAR (P/E ratios, P/S ratios, DCF, etc.), you can see that this best-in-breed company is already trading at a large discount to where it should be, as well as to its peer group.
On top of that that, business, although slowing from the previous break-neck speeds of past years because of reduced acquisitions, is still growing at a 12-15% organic clip!
You just don’t get growth like that in a company this size in a market and industry that are clearly stacked against it.
Time after time, quarter after quarter, AAR has proven that it can execute and continue to operate even under the worst conditions and strengthen it’s balance sheet and business fundamentals in the process.
I believe that we are much closer to the bottom of the airline and economic cycle than the top, and therefore, the time to be looking for turnaround plays in cyclical industries is now.
AAR represents a best-of-breed player in the form of a diversified and expansive business that is growing organically in the face of a tumultuous and spiteful marketplace.
If you haven’t already, it’s time to pick up some shares of AAR, and start a heavy position in the company at these levels.
New to the AAR story?
|
*Variables You Should Know About AAR Corp. (NYSE: AIR) |
|
|---|---|
| Current Recommendation: | STRONG 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: |
|
| Market Cap: |
$629.1 |
| Revenue (2008): |
$1,385 |
| Cash/Debt: |
$137.5/ $526.1 |
| Current Price: | $16.50 |
| Risk Rating (?): | 6.5 (Above 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 9-17-08. Except share price, all values in millions.
View original at: PeakStocks.com
Similar Posts: AIR | LUV | MESA | MRO | UAUA | Basic Materials | Oil & Gas Refining & Marketing
RSS feeds:
AIR | LUV | MESA | MRO | UAUA | Basic Materials | Oil & Gas Refining & Marketing |
Other Posts by Shawn | RSS Feed for this author