AAR Corp.: Ready to Take Flight?

AAR Corp. (AIR) June 4, 2008 price: $18.10

52-week range: $18.01 (Today) - $39.42 (Dec. 26, 2007)

AAR provides new and used aftermarket parts, services and supply chain management to both government and industrial customers. Supply Chain represented 51% of 2007 revenues. Maintenance, repair and Overhaul were 20% of sales, Structures [Cargo Systems] accounted for 25% and leasing of aircraft and engines was the remaining 4%.

The shares hit a new 2 ½ year low this morning despite nothing but good earnings since 2004. Here are the last four years [FY's end in May] of per share data* for AAR:

FY……....Sales……Cash Flow……EPS…….Book Value

2008 ……$34.35 …..$2.85 ……… $1.75 …….$15.40

…….. FY 2008 data is estimated for the 12 mo. ending May 31.

2007 ……$28.08 …...$2.42 …….. $1.42 …….$13.08

2006 ……$24.47 ….. $1.76 …….. $0.94 …….$11.53

2005 ……$22.95 ….. $1.43 …….. $0.49 ……. $9.66

2004 ……$20.22 ….. $0.97…….. $0.14 …….. $9.36

Source: Value Line

As noted above the estimate for the already ended FY 2008 is now $1.75 and the FY 2009 consensus estimate now centers on $2.25 /share. Thus AAR is trading today at just 10.4x trailing and 8.1x forward expectations.

That is the lowest valuation for these shares in more than 16 years. Other metrics look cheap as well. AAR shares are < 1.2x book value and only 6.3x cash flow.

AAR's 10-year median P/E has been 21x and Value line is assuming an 18 multiple for their 3 – 5 year target pricing. Even 15 times the year ahead estimate of $2.25 leads me to a $33.75 goal price about 12 months out.

Is it crazy to think these shares could be $33.75?

Investors paid $39.42 /share as recently as this past December 26^th and $29.80 at the peak in 2006 when EPS were only $0.94 versus today's $1.75 or so.

As of March 31^st insiders held 3% of the shares.

Other major holders were:

Lord Abbett & Co…… 5.41%

Barclays Global ….... . 5.18%

Westport Asset Mgt…. 4.98%

Bank of America ……. 4.81%

This small-cap company seems to offer a good risk/reward at the currently [what I see as unjustly] depressed share price.

For option mavens only:

Here's a relatively low risk combination I did for myself today:

……………………………………cash outlay……….cash inflow

Buy 1000 shares AIR @ $18.10 …..$18,100

Sell 10 Nov. $20 calls @ $1.85 ………………………. $1,850

Sell 10 Nov. $17.50 puts @ $2.10 ……………………. $2,100

Net cash outlay …………………… $14,150

On expiration date if AIR shares are > $20 or + 10.5% from today's price:

The calls will be exercised and your shares sold for $20,000.

Your puts will expire worthless [a good thing for you, the seller].

You will own no shares, no options and have $20,000.

That's a net profit of $5,850 on an outlay of $14,150 or + 41.3% cash-on-cash on just a 10.4% or better move in the stock. Time frame = 5.5 months.

If the shares remain unchanged at expiration date:

Your calls will expire worthless.

Your puts will expire worthless.

Your shares will still be worth $18,100 [today's price x 1000 shares].

Sell the shares for $18,100 and your profit is $3,950 on $14,150 or 27.9% in 5.5 months on shares that went neither up nor down.

Risk?

Break-even is figured as follows:

On the shares you bought it's $18.10 less the $1.85 call premium = $16.25.

On the $17.50 puts it's the strike price less the $2.10 put premium = $15.40.

Worst case is that you'll own 2000 shares of AIR at an average cost of $15.82 /share. That's dollars per share lower than the absolute lows hit in 2006-2007 and year to date in 2008.

Comments

[buyforeclosures]

Do you always buy puts...never just buy calls?