Air travel is still recovering, but you don’t need to buy airline stocks to take advantage of it. Investors should buy
instead.
AAR (ticker: AIR) isn’t a well-known name, but every airline knows it because it sells used, repaired and reconditioned engine and airframe parts they need to keep their planes flying. The $2 billion company also offers repair and maintenance services at seven facilities throughout North America. Additionally, AAR is a distributor of aerospace parts. More planes flying equals more business for the company.
And there are more planes in the air. April 2023 was the first month in which global domestic air traffic (flights originating and landing in the same country) exceeded pre-pandemic levels. The domestic airline industry finally put Covid in the rearview mirror. International air traffic is also growing, but has not yet eclipsed pre-pandemic levels. In July, according to the latest available global data, international travel was about 11% below July 2019 levels. There is still room for recovery.
But the revival of air travel isn’t the only reason to like AAR stock. Your used parts business will also improve. Original equipment manufacturers such as
(GE) and
(RTX) supplies most new engine parts, but airlines also purchase used parts from authorized suppliers to save money. AAR is a major player in those used parts, which the industry calls “used useful material” or USM.
AAR’s USM business should accelerate as air travel recovers and deliveries of new 737 MAX and A320neo aircraft from
(BA) and
(AIR.France), respectively, accelerate, replacing older aircraft. Many of those older aircraft fly with CFM56 engines built by GE and
(SAF.France). The CFM56 is one of the best-selling engines of all time, with more than 33,000 units delivered. It is a great opportunity for AAR, which should have a large supply of new parts from decommissioned aircraft.
“Part of the reason it’s different is that it works on used aircraft parts, where many others don’t,” explains Melius Research analyst Robert Spingarn. “There comes a point (when) planes (stop flying) and are harvested for parts.”
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The growth is being reflected in results and estimates. In 2019, AAR generated earnings per share of approximately $2.23 on sales of $2.1 billion, before being affected by Covid-19. But profits have recovered and are now expected to reach $3.20 on sales of $2.1 billion in 2023. Sales and profits are projected to grow about 10% to 16% annually on average between 2023 and 2025.
However, the growth has not yet been reflected in the valuation multiple. AAR stock trades at about 16.7 times forward 12-month earnings, below the
S&P 500‘s
19.2 times, even though projected earnings will grow seven percentage points faster than the benchmark index. Growth like that should be worth 20 times earnings, according to Spingarn, who has a price target of $73 in AAR, more than 25% higher than Friday’s close of $57.81.
You are not alone in your positive opinions. All four analysts covering the company rate the stock a Buy. Analysts’ average price target is a little lower at $68 per share, about 18% higher than recent levels.
However, four analysts is not a lot, even for a small-cap company. AAR is trying to change that, making it easier for investors to understand what it does. At its analyst event in July, the company announced three new reporting segments: integrated solutions, parts supply and repair, and engineering. Before the change there were fewer details about key companies.
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There is also a renewed focus on mergers and acquisitions. The company just paid about $120 million in cash, plus an additional $20 million depending on the performance of the acquired business, for aircraft maintenance services provider Trax. It is the first significant acquisition since 2017, the company says. Trax sells software that helps companies manage maintenance on their aircraft and will help AAR sell more used parts.
“We are now more focused than ever,” AAR CEO John Holmes said at the analyst event. “Everything we do, any investment we make for organic growth or inorganic expansion, will be centered around these three focus areas.”
AAR’s balance sheet is well positioned to add business. The company ended May with less than $200 million in net debt on its books. Earnings before interest, taxes, depreciation and amortization, or Ebitda, are expected to be about $214 million in 2023, for a debt-to-Ebitda ratio of less than once. The average S&P 500 company operates about twice as much. AAR is also a steady generator of free cash flow – about $32 million in calendar year 2023.
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The outlook and strategy look promising for AAR, making the stock a good bet. Your earnings can grow and your valuation can expand. That makes the stock a good way to take advantage of the continuing recovery in global air travel, this year and beyond.
Write to To Root in allen.root@dowjones.com