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We have upgraded our recommendation on AAR Corp. (AIR - Analyst Report) from Underperform to Neutral based on the company’s strong sales growth attributable to operational efficiency witnessed over the last few quarters. Moreover, the company’s favorable mix of inventories, strategic tax planning strategies resulted in a stronger balance sheet.

AAR Corp. is well positioned to benefit from the Defense and Airlift contracts, providing value-added solutions for the U.S. Army, Navy and other foreign governments.  The improved commercial air transport market worldwide looks favorable due to increase in demand for the company’s products, especially maintenance and spare parts.

The company has maintained a satisfactory competitive position through its market expertise and technical/financial capabilities across segments. In addition, a strong aviation market in 2012 is expected to reinvigorate the commercial air transport sector, raising the company’s sales volume for equipments and methods of repair and overhaul services.

The company remains committed to shareholders through its timely disbursement of dividends.

However, risk remains as the company operates in an adverse commercial aerospace market of overcapacity. Further, the cyclical demand situation among military flight operations may disrupt smooth revenue flow in the long run.

The capital intensive industry, in which the company operates, calls for continuous availability of debt and equity capital for executing the company’s business strategies. Thus, inability to obtain financing on favorable terms would be harmful.

Mention may be made of continued margin pressures on account of delayed aircraft availability, unscheduled maintenance inspections, higher-than-expected start-up costs and cost overruns. These factors along with huge oil price assumption continue to threaten stock performance.

Moreover, the company is exposed to currency fluctuation due to a widespread client base and operations beyond the U.S.

The company provides strong competition to its peers, such as Goodrich Corp (GR), Boeing Co (BA - Analyst Report) and Lockheed Martin Corporation (LMT - Analyst Report).

AIR carries a Zacks # 4 Rank, which translates into a short-term (1-3 months) ‘Sell’ rating. The Zacks Consensus Estimate of earnings per share for AAR Corp, for the fourth quarter of 2012, is pegged at 48 cents.

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