Hook & thesis
AAR Corp. is a classic industrial-growth-turned-value story: a well-established provider of parts, repair & engineering and integrated logistics whose near-term earnings trajectory is finally showing consistent improvement. The market is stubbornly cheap against a forward-looking lens because trailing accounting includes two loss-quarters that depress LTM earnings. I think the market will re-rate AAR as H1 FY2026 performance - and cash-flow conversion - prove sustainable.
Actionable stance: go long AIR with a position-sized entry around the current price ($95.8), a protective stop to limit downside, and two profit-taking targets for both the short and medium term. This is a position trade (months) – not a pure day trade.
What AAR does and why it matters
AAR operates an aviation aftermarket and services business: parts sales & leasing, component and airframe maintenance, landing gear overhaul, fleet management and logistics programs for commercial and government customers. The business benefits when global air-traffic recovers, carriers extend aircraft lives and defense customers increase spending on logistics and expeditionary support.
Why the market should care now:
- Structural MRO growth - industry research highlights a multi-decade tailwind for air-transport MRO spending, which feeds AAR’s parts distribution and repair franchises.
- Recent operational momentum - the first half of FY2026 shows much stronger profitability and an earnings beat (01/06/2026) versus estimates, signaling the company is converting margin expansion into GAAP earnings.
- Balance-sheet scale - AAR’s assets and inventory position enable it to service large commercial and defense programs; that scale is valuable in a market where parts availability and logistics are strategic.
Numbers that matter (from the most recent filings)
- Revenue: $795.3M for the quarter ended 11/30/2025 (Q2 FY2026).
- Gross profit: $156.9M and operating income: $48.1M in the same quarter; net income: $34.6M; diluted EPS: $0.90; diluted average shares: 38.1M.
- Cash flow: Net cash provided by operating activities was $13.6M in Q2 FY2026, a swing from prior quarters (Q1 FY2026 operating cash flow was -$44.9M) showing improving conversion.
- Balance sheet: assets $3.2425B, equity $1.5612B, liabilities $1.6813B; inventory is elevated at $910.8M (Q2 FY2026) after rising from $861.5M in Q1.
- Market snapshot: last trade $95.81 (as of 01/09/2026). Using diluted shares ~38.1M implies an implied market cap of roughly $3.6B (95.81 * 38.1M ≈ $3.65B).
How to reconcile valuation — two lenses
There are two reasonable valuation views depending on whether you look backward (accounting LTM) or forward (recent run-rate):
- Trailing-12-month GAAP net income: If you sum the company-reported quarterly net incomes across the most recently available four quarters the total is depressed (prior loss quarters included) at roughly ~$29.5M LTM. Using that figure and a market cap near $3.65B implies a very high P/E (~124x). That looks bad on paper and explains market skepticism.
- Run-rate / forward view using H1 FY2026 performance: The last two quarters (Q1 and Q2 FY2026) produced net income of about $34.4M and $34.6M respectively (combined ≈ $69M). Annualize that run-rate and you get roughly $138M of net income and an implied P/E closer to ~26x (3.65B / 138M). Using EPS: the two recent quarterly diluted EPS (0.95 and 0.90) annualized gives ~3.7 EPS and a price-to-earnings ratio of ~26x at the $95.8 price.
My view: the market is pricing AAR using a trailing accounting snapshot that understates a genuine improvement in operating profitability and cash-conversion. If management sustains H1 margins and delivers consistent free cash flow, multiple expansion toward the mid-20s P/E is a realistic re-rating.
Catalysts to drive the re-rating
- Continued margin expansion and repeatable quarterly operating income near $45-50M - confirming the H1 FY2026 run-rate.
- Cash flow improvement - conversion of elevated inventory into parts sales and lease turnovers, turning that $910.8M inventory into working capital release.
- Defense and government contracts - any new awards or expansions would add predictable, higher-margin backlog and help smooth seasonality.
- Macro MRO tailwinds - continued air-traffic recovery and replacement/OEM lead-times that keep aftermarket demand healthy.
- Earnings beats and guidance raises - the Q2 FY2026 print on 01/06/2026 showed EPS $1.18 actual vs $1.0487 estimate and revenue $795.3M vs est. $768.7M; further beats would force multiple compression to unwind.
Trade idea (actionable)
Trade direction: Long (position trade, horizon 3-12 months)
Recommended entry (position-sized): $92 - $98. Prefer scaling in: 50% at $96-98, add at $92-95 if price dips.
Initial stop-loss: $84 (about 11-12% below current midpoint). If you want tighter risk, use $88 small-stop for a reduced position.
Targets:
- Target 1 (near-term, 1-3 months): $115 - reflects re-rating toward a ~30x multiple on a cautious forward EPS trajectory and capture of short-term multiple expansion.
- Target 2 (medium-term, 6-12 months): $140 - reflects sustained margin improvement, better cash conversion and a move to ~35-40x on normalized earnings as defense/expeditionary tailwinds add premium valuation in the sector.
Position sizing note: treat this as a medium-risk position. If you are a conservative investor, use a smaller-sized allocation until you see consistent operating-cash conversion (two quarters minimum).
Downside risks & counterarguments
There are real reasons the market remains cautious. Below are the primary risks and at least one clear counterargument to my bullish thesis.
- Working-capital risk: Inventory is high — $910.8M in Q2 FY2026 vs $861.5M in Q1. If parts sell-through is slower than management expects, incremental working capital could depress free cash flow and force financing or margin concessions.
- Cash conversion volatility: Operating cash flow swung from -$44.9M (Q1 FY2026) to +$13.6M (Q2 FY2026). That swing shows the improvement but also highlights volatility. If the company cannot consistently convert GAAP earnings into operating cash, the forward P/E story falls apart.
- Defense/contract timing: AAR’s Integrated Solutions and Expeditionary Services exposure means some revenue is lumpy and tied to government budgets and timing. Delays or reorderings could hurt near-term growth.
- Macro slowdown / airline capex pullback: An airline-capacity retrenchment or collapse in global traffic growth would reduce parts demand and MRO activity, pressuring margins.
- Financing noise: The company recorded substantial net cash flow from financing activities in Q2 FY2026 ($204.3M) and large investing outflows (-$213.3M). Heavy financing could indicate balance-sheet actions (debt or equity moves) that dilute returns or create costs.
Counterargument - The re-rate is premature: If the recent earnings beat is driven by one-time items (timing of parts sales, tax items or transient pricing), and if the company fails to repeat operating cash flows, the apparent ’cheapness’ on a run-rate basis will evaporate. In that case the stock should remain range-bound or move lower as the market re-prices AAR using the conservative trailing numbers.
What would change my mind
- I would become more bullish if AAR demonstrates two consecutive quarters of meaningful operating-cash flow conversion (operating cash > $50M per quarter) while sustaining Q1/Q2 FY2026 margin levels and reducing inventory intensity.
- I would get cautious if inventory continued to climb without commensurate sales, or if operating cash flow flips negative again and financing activity is required to plug holes.
- A material cut to defense spending or visible airline demand shock would also invalidate the thesis.
Final take
AAR is a quality aerospace services franchise trading at a distorted multiple if you look only at trailing GAAP. The stock already reflects the risk that earlier loss quarters dragged reported LTM earnings down. But the business has scale, recent operational momentum (Q1 and Q2 FY2026 operating income around $48M, EPS beats on 01/06/2026) and a balance sheet that supports market share in an attractive MRO market. For disciplined investors willing to tolerate working-capital noise, this is a buy-on-dip opportunity with clear entry, stop and target levels.
Trade summary: Long AIR in the $92-$98 zone, stop around $84, targets $115 and $140, horizon 3-12 months, risk medium. Monitor quarterly operating cash conversion and inventory trends closely - those data points will determine whether the market gives AAR the multiple it deserves.
Note: All figures and dates referenced are taken from company filings and the market snapshot as of 01/09/2026.