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We recently upgraded our recommendation on AAR Corp. (AIR - Analyst Report) from Neutral to Outperform.

Things went in favor of AAR Corp. as after four straight quarters of negative earnings surprises, the company reported a decent 7.1% positive surprise in the first fiscal quarter of 2013 (ended August 2012).

Earnings per share in the first quarter came in at 45 cents, up 10% from the year-ago earnings and in line with the high-end of management’s guidance range of 42-45 cents. Revenue jumped 13% on the back of strong commercial aviation services business.

Based on strong sales growth, operational efficiency and enhanced product availability, management raised its fiscal 2013 earnings guidance to the $1.60-$1.70 range compared with the $1.55-$1.65 range expected earlier.

Apart from its results, we find AAR Corp. well positioned to benefit from the Defense and Airlift contracts, providing value-added solutions for the U.S. Army, Navy and other foreign governments. Moreover, 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 also maintained a satisfactory competitive position through its market expertise and technical/financial capabilities across segments. In addition, the company’s commitment to returning value to shareholders through its timely disbursement of dividends bode well for the stock.

Moreover, the company’s competitive advantage over its peers based on its market expertise and technical/financial capabilities and strategic contract wins hold out promises for the future. These positives more than offset concerns arising from stiff competition and overcapacity in the aerospace market, margin pressures on account of delayed aircraft availability, unscheduled maintenance inspections and high fuel prices, and inadequate debt financing, unfavorable aircraft lease agreement and currency fluctuations.

The company currently carries a Zacks #1 Rank, implying a short-term Strong Buy rating. Its prime competitor Boeing Co. (BA - Analyst Report) has a Zacks # 3 Rank (Hold) while Lockheed Martin Corporation (LMT - Analyst Report) holds a Zacks #1 Rank (Strong Buy).

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