Will Embraer Fly?

Summer is a time for travel -- and airshows. At this year's Farnborough International Airshow in the United Kingdom, Boeing (NYSE: BA  ) and Airbus have dominated the news as expected. Airbus is earning headlines with its new A350 jet, which could rival Boeing's 787 "Dreamliner" in range and fuel-efficiency. That may help the ailing Franco-German jet maker revive its recently flagging fortunes, or so the reports say.

But that's hardly enough to get an investor like me excited. I'm a Rule Breaker; I'm looking for game-changing news. The tit-for-tat spat between Boeing and Airbus doesn't qualify, even if it is interesting. That's why I've cast my eyes southward, toward Brazilian jet maker Embraer (NYSE: ERJ  ) . I think you should do the same.

Embraer? Really?
Yes, really. For those unfamiliar, Embraer gets 70% of its revenue by producing a fleet of regional jets that seat between 50 and 110 passengers. It also makes some military craft and executive jets for rich globetrotters.

Unfortunately, business hasn't been great lately. Return on capital is declining, margins are eroding, and earnings were down significantly from 2004 to 2005. What's more, its first-quarter financial performance was anything but stellar. Margin pressure continued, since the Brazilian unit of currency, the real, has appreciated 17.7% versus the dollar over the past 12 months. Meanwhile, start-up costs for the new E190 regional jet, with which JetBlue (Nasdaq: JBLU  ) reported some initial problems, have proved to be substantial. No wonder the stock has taken a beating over the past six months.

Nevertheless, global trends favor Embraer. Commercial airlines need its regional jets badly. For example, UAL's (Nasdaq: UAUA  ) United Express airline has created a service called "Explus" that equips Embraer jets with first-class cabins, which United says is more profitable than what it replaced. I'm guessing that's why U.S. Airways (NYSE: LCC  ) decided to upgrade its existing order for E170 jets to the newer E190, which took the stage briefly this week at Farnborough. U.S. Airways has said it plans a first-class cabin on the E190s.

Ready to do business
I'm even more impressed by Embraer's push into the business-jet market. Just yesterday, CEO Mauricio Botelho told reporters at Farnborough that its firm order backlog for executive aircraft stands at $1.25 billion, 12% of the $10.2 billion total order backlog reported at the end of June. That's important, because it shows Embraer is successfully diversifying away from its exposure to the global commercial airline market, which hasn't exactly proved to be stable in recent years.

And very light jets, or VLJs, are a growth business. Last year, researcher Forecast International pegged the 10-year market value of VLJs at $141 billion. This year, its analysts raised their estimate by 12%, to $158 billion. Embraer expects to capture a sizeable portion of the market, with CEO Botelho telling the Aero Club of Washington in June that his company plans to deliver 1,000 of its Phenom-class jets.

Cleared for take-off
Forecast International, for its part, considers Botelho's estimate aggressive, but not by too much. It has Embraer delivering 674 of the Phenom 100 and 179 of the Phenom 300 over the next decade, which would earn the jet maker more than $3 billion at list prices. What's more, Forecast expects the Phenom 100 to be one of only four VLJs approved by the FAA, with the other three coming from privately held Adam and Eclipse, and Textron (NYSE: TXT  ) subsidiary Cessna.

Momentum is also on Embraer's side. So far this year, nine of its Legacy 600 executive jets have been delivered, up from five last June. Embraer says it will end the year with between 25 and 30 business jets delivered, up from 20 in 2005. All told, the jet maker says it has increased its share of the super-midsize business jet market from 12% in 2004 to 13.5% currently.

Back-up systems? Check!
I like Boeing. I like Airbus. They both make great aircraft. But neither company interests me as an investor. Embraer does, because the short term looks bleak. Ramp-up costs for the E190 and E195 will continue to plague margins, and possibly earnings as well.

Those problems have made the stock much cheaper today than it was six months ago. Yet Embraer has a major growth catalyst in business jets, holds more than $300 million in net cash, and pays a 2.49% dividend yield. Color me crazy, but I believe that getting paid to wait while a proven firm manages a transition it has faced before (with the E145 regional jet) is exceedingly Foolish and should lead patient investors to soaring returns.

Embraerand JetBlue are Motley Fool Stock Advisor selections. Ask for us anall-access pass, and you'll get a backstage look at all of the stocks that are helping David and Tom Gardner beat the S&P 500 by more than 34% as of this writing. It'sfree for 30 days.

Fool contributorTim Beyerswants to attend both the Farnborough and Paris airshows someday. Tim didn't own shares of any of the companies mentioned in this story at the time of publication. You can find out which stocks he owns by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.


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