Is Embraer An Emerging Defense Industry Leader?

| About: Embraer S.A. (ERJ)

By Mike Kapsch

It’s already the fourth-largest aircraft manufacturer in the world.

Brazil’s Embraer S.A. (NYSE: ERJ) has produced more than 5,000 aircraft that operate in 92 countries on five continents. Annual revenue from commercial and private jet sales alone total nearly $4 billion.

But the company isn’t satisfied. It’s expanding its defense and security operations, as well. And it may have struck gold in its home country.

According to SunTrust Robinson Humphrey Senior Analyst Peter Skibitski, three pending defense deals with Brazil’s government could add “several billions of dollars” to Embraer’s coffers “over the next four or five years.”

Considering Embraer’s current annual revenue is $5.28 billion, an additional $1 billion a year is an enormous opportunity. The only question is, is Embraer ready for the challenge?

Three Reasons Embraer’s Shares Could Fly

Although it has spent the majority of its time producing aircraft for commercial and private use over the last 40 years, Embraer has also spent plenty of time building a solid framework for its defense and security business.

Only problem is… defense and security make up just 10 percent of Embraer’s total revenue. But that’s set to change:

  • Embraer is preparing to build Brazil’s first geostationary satellite: The construction of this satellite alone is a $400-million opportunity. And Brazil can use it to help improve its communication, remote imaging and weather prediction services.
  • Embraer is in the final stages of capturing a border security program in Brazil: Drugs and arms smuggling across borders with Bolivia and Paraguay has plagued Brazil for decades. But using drones made by Embraer should help prevent a good amount of drugs and guns from entering Brazil. For Embraer, this is a $4-billion opportunity.
  • Embraer singed a deal with Brazil’s Air Force to build a new aerial refueling tanker: The contract has Embraer set to provide 23 refueling tankers, its KC-390, for $1.3 billion. Service is expected to begin in 2015.

There’s still more, too. Embraer boasts a $16-billion order backlog. It recently put in a $950-million bid for a contract with the U.S. Department of Defense. And its Super Tacano fighter jet just received FAA approval in the United States.

Take into account the stock is trading at 33 percent of its 52-week high and it seems Embraer has nowhere to go but up. But a concern still remains.

Embraer is being probed for a potential corruption charge by the U.S. Justice Department. The company hasn’t been charged with anything. And its CEO said the investigation won’t hinder business.

But if the Justice Department does find something, Embraer could be barred from doing business with the U.S. government in the future as a worst-case scenario. Right now, it looks premature to think that the situation will reach this point, though.

Final Departure

In all, Embraer looks set for a great run… These three defense deals with Brazil’s government could essentially double the company's revenue over the next few years. Therefore investors will certainly want to keep an eye on the stock and its legal situation in 2012.

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