2006 in Review: Embraer

It's been a mediocre year for Brazilian jet maker Embraer (NYSE: ERJ  ) . And it shows in the stock price: This Motley Fool Stock Advisor pick's shares have returned roughly 13% this year, just shy of the S&P 500 as I write.

A low-altitude stock ...
That's also well short of the sky-high returns produced by some of Embraer's customers, including United Airlines parent UAL (Nasdaq: UAUA  ) , which is up 31%, and US Airways (NYSE: LCC  ) , up 51%.

Blame the E190. Embraer's newest regional jet is now a staple of JetBlue's (Nasdaq: JBLU  ) fleet, but JetBlue CEO David Neeleman told analysts in January that there were operational issues with the aircraft. (They now appear to be resolved.)

Nevertheless, in April, Embraer reported a strong fourth quarter. Sales were up 25% and net income rose by 88%. To be fair, much of that bottom-line growth was aided by lower interest payments and a big tax benefit. And orders were modestly lower than in the year-ago period. Still, a good quarter is a good quarter, and the stock held firm at $36.

Investors harbored high hopes going into the first quarter, but Embraer instead encountered turbulence. Currency effects, production inefficiencies, and higher marketing expenses led to huge drops in operating and net income. The stock promptly dropped to $31.

By July, squabbles between Airbus and Boeing (NYSE: BA  ) over who would dominate the market for fuel-efficient long-haul passenger aircraft had reached a fever pitch. Meanwhile, Embraer reported that its backlog had dropped to $10.2 billion in the midst of a brutal summer downturn. I began to wonder whether Embraer would ever take off for investors.

August brought the needed lift: The company delivered 26% sales growth and 68% net income growth in Q2. Meanwhile, Brazilian carriers Varig and TAM (NYSE: TAM  ) reversed a decades-long practice of buying foreign equipment to seek financing for Embraer aircraft.

And there was more good news to come. Over the Labor Day holiday, the company received a 100-jet order from China's HNA Group worth $2.7 billion. Days later, at a showing of its new Phenom 100 and 300 executive aircraft in New York, air taxi service Magnum Jet said it had ordered 50 of the Phenom 100s and retained the option to order as many as 50 more. Bank at least another $137.5 million.

By the time the Q3 report appeared in November, the stock had soared to $41. Expectations climbed toward the heavens, but financial results wouldn't follow. Neither sales nor earnings met expectations. Operating margin declined by nearly 11 percentage points.

Investors ignored the bad news. How Foolish: Embraer had produced $464 million in free cash flow and boosted its backlog by roughly 30% to $13.3 billion. Then, a week later, the jet maker released delivery projections that call for at least 14% annual growth over the next several years.

... But ready to soar
Embraer's Q4 report is likely to be months away. Nevertheless, the vast majority of investors participating in Motley Fool CAPS see higher altitudes ahead:

CAPS rating

4 Stars (out of 5)

Total ratings

110

Bullish ratings

106

Bearish ratings

4

Bull ratio

96.4%

Bear ratio

3.6%

Bullish pitches

26

Bearish pitches

1

Source: Motley Fool CAPS

Talk about a running of the bulls. CAPS all-star metoo105 explains the thesis:

"Embraer, which I spotted thanks to [The Motley Fool], is in a real sweet spot. First, they are based in Brazil, which helps to keep their labor costs low. Second, they now have a plant a China, which does the same. Third, they make a product, the 100-passenger jet, which is central to the future profitability of the airlines. Discount airliners are frustrating because they simply employ the most basic ideas. Simple operations research could allow most airlines to be much more profitable if they had more flexibility with their fleets ... Embraer jets clearly fill a role in a space without much competition."

Ready for takeoff
While costs could remain high over the short-term, as the E195 and Phenom jets move towards mass adoption, Embraer has been down this path before with earlier models. Higher profits have always followed, which, in turn, have led to big returns for investors. That's why I've twice argued that it deserves consideration as the best international stock -- first in February and again last month. I still believe I'm right.

But when will the higher profits land in Embraer's bank account? 2007? That's a question for another day, but be sure to tune in for our 2007 preview. And, in the meantime, if you're looking for superior stocks ideas, consider Stock Advisor. Thanks to a portfolio that combines steady performers like Embraer with massive winners like Marvel, David and brother Tom are walloping the market by nearly 40%. Clicking here will get you 30 days of free access to the service right now. Enjoy, and happy holidays.

Check out the other companies featured in"The Motley Fool's 2006 in Review and 2007 Preview"special.

Fool contributorTim Beyers, ranked 1,013 out of 17,523 inMotley Fool CAPS, has yet to fly in an E190 jet, but he's sure he would enjoy the experience. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. Get the skinny on all of Tim's stock holdings by checking his Foolprofile. JetBlue and Marvel are also Stock Advisor recommendations. The Motley Fool'sdisclosure policyadvises you to invest regularly. That's the only sure way to get rich.


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