Is AAR Corporation (AIR) Undervalued Amid Strengthening Margins and Earnings Momentum?

The aerospace sector, long a barometer of global economic resilience, has seen renewed investor interest as supply chains stabilize and defense spending accelerates. AAR Corporation (AIR), a diversified aerospace and defense services provider, has emerged as a compelling case study in value investing. With a recent surge in earnings, margin expansion, and a valuation that appears to lag behind its fundamentals, the question arises: Is AAR undervalued, and does its trajectory justify a high-conviction bet?

Earnings Momentum and Margin Resilience

AAR's Q1 2026 results underscore its operational strength. The company reported net income of $34.4 million and revenue of $739.6 million, with a 12% year-over-year sales increase driven by its Parts Supply segment, which grew 27% to $318 million. Adjusted EBITDA rose 18% to $86.7 million, with margins expanding to 11.7% from 11.3% in the prior year. This margin improvement reflects strategic initiatives, including the acquisition of Aerostrat to enhance its Trax software capabilities and new contracts like the exclusive distribution agreement with AmSafe Bridport.

The Repair & Engineering segment, despite a 1% sales decline to $215 million, demonstrated organic growth of 8% when excluding the impact of the landing gear divestiture. Meanwhile, the Integrated Solutions segment grew 10% to $185 million, fueled by robust government demand. These trends suggest AAR is not only navigating sectoral headwinds but also leveraging its diversified business model to drive profitability.

Valuation: A Discount to Peers

AAR's valuation metrics further strengthen its case. As of Q2 2026, the company trades at a P/E ratio of 37.9x, below the industry average of 40.4x and significantly lower than its peer average of 57.9x. This discount is particularly striking given AAR's projected earnings growth of 34.7% annually. Analysts argue that the company's operational efficiencies-such as a shift toward higher-margin work and cost discipline- position it to outperform in a sector where margins often compress during downturns.

However, skepticism persists. AAR's trailing twelve-month (TTM) net income margin of 3.2% lags behind its forward-looking projections of 9.2%. This discrepancy is partly attributable to a one-off $70.5 million loss in the TTM period, which skewed metrics. Yet, the 2025 annual report reveals a critical turning point: AAR's Q2 2025 results included a $30.6 million net loss due to FCPA-related charges, a one-time event that has since been resolved. The contrast with Q2 2026's $34.6 million net income ($0.90 per share) highlights the sustainability of current margins.

Strategic Catalysts and Analyst Optimism

AAR's long-term value proposition hinges on its ability to execute strategic acquisitions and capitalize on sectoral tailwinds. The acquisition of ADI and HAECO Americas has already bolstered its Repair & Engineering segment, while the Trax software expansion targets digital transformation-a key differentiator in aerospace. Additionally, the company's focus on government contracts, which offer stable cash flows and higher margins, aligns with broader trends in defense spending.

Analysts project a dramatic turnaround in free cash flow, from a negative $27.3 million to $589 million by 2035. While such projections carry inherent risk, they are underpinned by AAR's disciplined capital allocation and its ability to scale high-margin services. The recent $70.5 million one-off loss, though painful, appears to be an anomaly rather than a recurring drag.

Addressing the Risks

Critics may argue that AAR's valuation still reflects lingering doubts about margin sustainability. The TTM net income margin of 3.2%-despite excluding the 2025 FCPA loss-remains below industry benchmarks. However, this metric is distorted by the one-off charge, which is unlikely to recur. AAR's adjusted EBITDA margin of 12.1% in Q2 2026, up from 11.4% in the prior year, suggests that operational improvements are taking hold.

Moreover, the company's balance sheet remains robust, with $1.2 billion in liquidity and a debt-to-EBITDA ratio of 2.1x, well within conservative thresholds for the sector. This financial flexibility allows AAR to pursue strategic opportunities without overleveraging, a critical advantage in a cyclical industry.

Conclusion: A High-Conviction Buy

AAR Corporation presents a rare intersection of value and growth. Its earnings momentum, margin expansion, and strategic positioning in aerospace and defense justify a premium valuation. While the TTM metrics are clouded by a one-off loss, the company's forward-looking fundamentals-coupled with a P/E ratio that lags its peers-suggest the market is underappreciating its potential. For value investors seeking a high-conviction play, AAR offers an attractive opportunity to "buy the dip" in a business that is not only stabilizing but accelerating.