We maintain our Neutral recommendation on Embraer S.A (ERJ).
Improved worldwide commercial and defense aviation demand reflect a positive outlook for the future. In such a scenario, we believe Embraer will be able to sustain its strong position in the security solution business across Brazilian and other governments with a series of applications.
Embraer’s worldwide customer orders servicing and on-time deliveries of corporate, defense jets and executive jet-support structures are worth mentioning. Such efforts are expected to foster stronger global footprints while generating healthy revenue in the near future. We are confident of the company’s diversification into broader defense and corporate jets, which are anticipated to lend more stability to the company’s earnings stream and foster cash flow growth, going forward.
Conversely, concern remains as the competitive commercial aircraft manufacturing industry stay dominated by companies with longer operating histories and established reputations. We suspect that Embraer’s ability to retain market share and remain competitive in the commercial aircraft manufacturing market, in such a scenario, will call for continued technological and performance enhancement, involving a recurring cost to the company.
Rising cost is also matter of anxiety for Embraer. Cost of sales and services as well as administrative, selling and research expenses has exerted pressure on operating margins, hindering growth. Moreover, the recent rise in fuel prices and the appreciation of the Real against the U.S. dollar have also been affecting the company’s profitability.
These headwinds weaken our view on the stock. Adding to the woes, the scenario of rising wages in Brazil has also been compressing margin, since long.
The company’ earnings growth has, over time, been severely impaired by order cancellations due to a high concentration of customer preference on a few models. Besides, a drop in demand for business jets as well as reduction in government spending on defense and security poses uncertainty. Overt dependence on a few customers, accounting for a major portion of the company’s firm backlog, is also anticipated to severely impact the company’s earnings growth, going forward.
Although the scenario looks bleak, this Brazilian aircraft manufacturer and seller, still kindles the flame of hope for the investors. Of late, Embraer received orders for 13 ERJ Jets from China and established a joint venture, “Harpia,” with AEL Sistemas, the Brazilian subsidiary of an Israeli defense firm Elbit Systems.
The company’s technology deal with Alcoa deserves special mention. Such strategic deals are anticipated to lend more stability to the company’s investment stream ensuring future growth. We believe, the company’s efforts to improve productivity and efficiency alongside a firm order backlog, may combat the potential risks for the stock.
Embraer S.A designs, manufactures and sells aircraft and aviation-related structural parts to the world’s commercial aviation, executive aviation and defense markets. The company’s product portfolio supporting strong customer orders and diversified global footprint, gives a tough competition to its peers, such as Boeing Co. (BA), Lockheed Martin Corporation (LMT), Northrop Grumman Corporation (NOC), etc.
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