By Holly LaFon
AAR Corp shares have fallen to their lowest point since August 2013 as investors worry that the aviation company – the largest supplier of airlift services in Afghanistan – may continue to suffer as the government ends its mission there and cuts military funding next year.
But investors’ fears may be overblown. Although the shares have fallen 9 percent so far this year, the company – which began in the 1950s as a radio supplier to the commercial aviation industry – has been attempting to shift more of its business to the commercial sector to compensate for decreased government spending.
In addition, AAR’s shares may be undervalued, with a trailing price-to-earnings ratio of 14.7 compared with 19.2 for the Standard & Poor’s 500 index.
Most investor worry centers on the company’s aviation services segment and continued weakness in defense sales, which fell 26.5 percent in the most recent quarter. AAR Corp.’s airlift business, which supports the U.S. military on special missions and in transporting goods and personnel, has been hurt by the U.S. withdrawal from Afghanistan. In response to the drop in demand, AAR Corp. has cut the number of aircraft it has in service by more than half.
AAR Corp. plans to transition the aircraft used in Afghanistan to places like Africa. This year so far it has secured two contracts in the continent that have start dates in October and December, with values of $34 million and $49 million. The company is also bidding on other airlift contracts from the Department of Defense.
KeyBanc analyst Kevin Ciabattoni, who has a hold rating on the stock, said he believes the current quarter will prove to be a trough for the company and that airlift contracts will increase by the fiscal third quarter ending Feb. 28.
“The airlift team continues to pursue significant opportunities while executing on existing contracts, and management seemed confident that the 11 positions currently operating in Afghanistan would continue for the near future,” Ciabattoni wrote in a research note. “We believe this business is largely de-risked, but still have some difficulty getting comfortable with the fact that nearly half of the business is still coming from Afghanistan.”
The strongest area in the company’s aviation segment is its supply chain division, where sales jumped 20 percent in the quarter with growth in both the commercial and defense sales. Increased sales were driven by the addition in April of new supply chain operations in Brussels that expanded AAR’s international reach to Europe, the Middle East and Africa, and several new commercial and defense contracts.
Even if the company does not attract robust airlift business in defense, plenty of opportunities exist elsewhere in the private sector, according to Ray Peterson, Vice President of research and editorial services at Forecast International.
“There’s always a demand for airlift worldwide,” he said. “I’m sure if the opportunity arises somewhere else [AAR]’s got a shot at it.”
The company has made some progress in increasing its commercial presence. By the third quarter of this year, commercial sales had increased to 65 percent of total sales, up from 58 percent a year ago.
“Commercial trends remain strong, driven by several supply chain contracts and significant anticipated improvement in [maintenance, repair and overhaul] in the back half of fiscal year 2015,” CJS Securities analyst Lawrence Solow, who has a market outperform rating on the stock, said in a research note.
Besides aviation, the company’s main business is technology products. Revenue in that segment fell 12.7 percent in the latest quarter, though several developments suggest the situation may be temporary as well. Some analysts expect the segment will soon benefit from increased commercial cargo sales and deliveries of 174 A400m military jets over the next several years based on a significant $250 million contract with Airbus.
“We do not expect a turnaround in the business any time soon but do believe the rate of decline could begin to slow in the back half fiscal year 2015 with potential stabilization in fiscal year 2016,” Solow wrote.
AAR Corp did not immediately respond to requests for comment on this story. Shares of the company were up 10 cents to $25.53 in Thursday afternoon trading.