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Story Retrieval Date: 5/20/2013 10:41:15 PM CST
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Gino Vicci/MEDILL
AAR Corp is set to release third-quarter fiscal year earnings March 20, 2012.
Outlook for AAR Corp.'s government business bearish
by Gino Vicci
March 14, 2012
The Illinois-based company, with more than 6,000 employees operating in 17 countries, provides maintenance services for airlines, and it’s been a big beneficiary of carriers’ increased outsourcing of such chores. But it’s expanded beyond that function to include sourcing of new and remanufactured components as well as a number of other services for commercial airlines and, increasingly, for military customers.
In all, AAR Corp. operates in four business segments - aviation supply chain; government and defense services; maintenance, repair and overhaul; and structures and systems.
The company’s supply chain segment purchases and sells new, overhauled and repaired after-market engines and airframe parts and components. It also leases and sells commercial aircraft. Some of its clients include Boeing, Airbus, Continental Airlines and DHL.
In the government sector, AAR Corp. services range from supplying aircraft for humanitarian missions to providing state-of-the-art battle management systems. While the U.S. is AAR Corp’s largest government client, it also does business in Israel, Japan, United Kingdom, Turkey and Singapore.
AAR Corp’s business is nearly divided evenly between the commercial and defense sectors – in fact, the fiscal year ended last August was the first year that government and defense customers provided more than half the company’s sales. Still, some analyst feel it must strengthen its government business to thrive this year.
“The key for the company’s stock price to remain strong in 2012 is government business, but this may be difficult as the tempo changes in Afghanistan,” according to a report released by Ken Herbert, an aerospace analyst from Wedbush Securities.
If defense is the company’s best chance to remain strong – trouble may be ahead.
“We see the potential for much of the defense sector to be dead money in 2012, before underperforming from 2013 as cuts in the defense budget begin to come through,” explained Credit Suisse analyst Julie Yates, in a review of the defense sector’s prospects.
The U.S. defense budget, which accounts for about one-third of discretionary government spending, is thought to be an area where lawmakers could reduce the nation’s rising federal deficit, which may hurt contractors like AAR Corp.
With the previous debt-ceiling debacle still smoldering, and the upcoming presidential election looming, defense cuts are expected to be debated heavily, which further casts a negative outlook on the defense sector in general.
“We view a falling defense budget as bad for defense prime margins as well as revenues, and consequently remain bearish on defense,” Yates added in her review of the industry.
Hebert believes the company’s stock has become a “show me stock” and even though he lowered his target price from $26 to $25 in December, the analyst rates AAR at “outperform.”
Yahoo Finance ranks Hebert an AAR Corp. “Star Analyst” – which means he scored in the top 10 percent of analysts surveyed in terms of his accuracy of earnings estimates about the company.
With a price-earnings ratio of 11.83, its PE ratio is lower than the S&P 500’s current 15.89
“We believe the price is oversold,” Hebert said.
AAR Corp’s second-quarter fiscal year earnings released in December, narrowly beat expectations with net income of $18.9 million, or 44 cents per diluted share, compared with $16.8 million million, or 42 cents per diluted share for the same period last year. Sales for the quarter ended November 30 were $476 million, up modestly from $447 million a year earlier.
Despite a bearish outlook on the defense industry and sluggish sales in the past, AAR Corp. executives remain optimistic.
There was a bit of weakness in the latest quarter’s results, but the shortfall “was entirely attributable to engineering services volumes,” explained CFO and Treasurer, Richard Poulton during a conference call to investors in December.
“Our airframe and landing gear centers produced steady year-over-year sales results,” he added.
“Going forward, we would expect sequential sales growth in our MRO segment as we begin delivering on the engineering services contracts, Poulton said in a reference to the company’s maintenance and repair operations.
The company currently holds $231.8 million of goodwill and other intangibles on its balance sheet - which at first glance can appear to be a red flag.
Goodwill is the difference between the purchase price for a company during an acquisition in relation to the net valuation of the assets of the purchased company.
In this case, experts say, the inflated assets may be a sign of a stronger future.
In October, AAR Corp. announced it would purchase supply-chain providers Telair International and Nordisk Aviation from Teleflex Incorporated for $280 million.
“We agree that the Telair and Nordisk acquisitions can add close to 25 cents in fiscal year 2013, which can provide a nice earnings boost,” Hebert said.
On March 20th AAR Corp. will release financial results for its third quarter of fiscal year 2012
“As we move into the fourth quarter, we see things being even more robust than the third quarter and again you know we will see the benefits from the acquisitions that we've recently made,” AAR Corp. Chairman and CEO David Storch told analysts.
“We feel very confident about the range that we communicated back in October, and that's pretty much how we see things at this point,” he added.
Analysts surveyed by Yahoo Finance expect AAR Corp to post third-quarter fiscal year earnings of 42 cents per share, down from 44 cents per diluted share during the same time last year. For the year ending next May, they are forecasting per-share earnings of $1.90, up from $1.70 in the prior year.
The company’s stock closed Tuesday at $21.89, or about 30 percent lower than its 52 week high of $31.66.
