Investors May Be Valuing The New Embraer At Less Than $0

Nov. 20, 2019 11:27 AM ETEmbraer S.A. (ERJ)BA14 Comments

Summary

  • Embraer reported weak results for the third quarter, particularly in its commercial aviation segment.
  • Yet a planned commercial aviation joint venture with Boeing will take most of the risk out of this business from the perspective of Embraer shareholders.
  • Embraer's executive jets business (its largest remaining unit) is finally on the mend, after years of subpar performance.
  • Despite some short-term headwinds, Embraer's defense segment also provides substantial long-term revenue and profit growth potential.

Embraer (NYSE:ERJ) has suffered plenty of setbacks in recent years. The company's updated E2 line of commercial jets hasn't sold well in the face of blistering competition from Boeing (BA) and Airbus (OTCPK:EADSF). Embraer's efforts to convince airlines of the merits of smaller aircraft have mostly fallen on deaf ears. Meanwhile, a long-running glut of used business jets undermined pricing for the company's executive aviation segment. Finally, completing the trifecta, government funding shortfalls in Brazil led to delays and cost increases for the KC-390/C-390 multi-mission military jet.

Due to all of these headwinds, Embraer stock has lost more than half of its value over the past five years. The latest blow came after the company's third-quarter earnings report last week. Embraer shares fell because the company reduced some aspects of its guidance for 2019 and said that it might issue a smaller special dividend following the sale of an 80% stake in its commercial jet business to Boeing (expected in early 2020).

ChartData by YCharts

However, the proposed payout still represents a substantial proportion of Embraer's current market cap. Moreover, an accelerating recovery in its executive jets business and the long-term potential of its defense segment point to meaningful upside for investors over the next few years.

Commercial aviation continues to disappoint

Embraer's commercial jets business -- up until now, its most important unit by far -- posted another subpar performance last quarter. Embraer delivered 17 commercial jets in the period: up from 15 a year earlier. However, the company reported a -11% operating margin for the segment.

To be fair, the commercial aviation segment absorbed the bulk of the $35 million of separation costs that Embraer incurred last quarter in connection with its planned Boeing joint venture. That likely reduced the segment's operating margin by about 8 percentage points. Seasonally low delivery volume

This article was written by

Adam Levine-Weinberg is a value investor who has been researching and writing about stocks for Seeking Alpha and The Motley Fool since 2011. He graduated from Swarthmore College in 2007, received an M.A. in Political Science from the University of Chicago in 2009, and received his CFA charter in 2017. He is always on the hunt for irrationally beaten-down stocks, particularly in the aerospace, retail, real estate, and auto sectors.

Disclosure: I am/we are long ERJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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