Can Embraer SA (ADR) Seize This Enormous Opportunity?

The scope in 70-130-seater aircraft segment could turnaround Embraer’s future altogether. Let’s take a sneak peak at the opportunity…

May 5, 2014 at 11:13AM

Brazilian plane maker Embraer (NYSE:ERJ) is a leader in the less-than-130-seater commercial airplane market. This has been a small segment so far, but with demand increasing for small planes from regional airlines, mainly in emerging markets, the story is changing fast.

Aircraft majors Boeing (NYSE:BA) and Airbus (NASDAQOTH:EADSY) are good at making planes with 175 seats and above, but not so much with smaller planes. While they are concentrating more on bigger planes, it virtually leaves the 70-130-seater market entirely open for smaller plane makers. Embraer has the biggest market share in this category, and thus stands to gain the most with its E-Jet family of aircraft. Let's take a look at the opportunity, and how Embraer plans to seize it.

The new E2 jets
Embraer has already done the groundwork by cementing its lead in the global 70-130-seater market. It commands more than 51% market share. Between 1999 and 2013, the company has received 1427 firm orders and delivered 998 E-Jets as its customer base grew from two to 67.

After carving a niche, Embraer is now preparing for a bigger game. It's bringing to the market more advanced, fuel efficient, and economical jets. Instead of crafting a new plane altogether that involves higher costs and complications, the company's taken the safer route of reengineering the E-Jet family of aircraft, dubbed as the E2 E-Jet.

The E2 E-Jet family of planes is slated to enter service between 2018 and 2020. "The reengined aircraft from Embraer will still be more cost-competitive than the (Airbus 320) Neo and the (Boeing 737) Max," William Blair analyst Nick Heymann said.

The E2 E-Jet. Source: Embraer

Airlines are looking to expand their fleet by adding regional service jets for some routes during non-rush hours. The Brazilian jet maker's E2 E-Jet could just be the thing for them, giving optimum capacity to minimize seat-kilometer costs. The E2 E-Jet serves as a good replacement for the single isle Airbus and Boeing.

Embraer Asia Pacific vice president Mark Dunnachie said, "The E195-E2 jets will be at least 20% cheaper in terms of trip costs as compared to the Boeing 737 or the Airbus A320." In addition, the E195-E2 is listed at $60.4 million, while Airbus A320Neo and Boeing 737 Max 7 will cost $102.8 billion and $85.1 billion, respectively, to the airlines. 

Embraer's on the right track as the market for regional service jets is expanding, and this could secure the company's future.

The next big thing
Demand for aircraft with lesser capacity is the next big thing in the aviation industry. The market's huge for these jets that claim cost advantage per passenger, and is expected to get even bigger as demand from the Asia Pacific region is on the rise.

Aviation specialist Saugata Mukherjee says that in terms of volume, Asia Pacific has surpassed the European aircraft market and is close behind North America. As the aviation market's booming in the region, low-cost Asian carriers such as Air Asia, Air Costa, and Lion Air would place huge orders for smaller jets. This is creating the right set of circumstances for Embraer. The plane manufacturer predicts that 6,400 aircraft in the 70-130-seater range would be delivered globally over a period of two decades. 

It's already started showing in Embraer's backlog, which increased 5.5% sequentially in the first quarter of 2014 as the company recorded total firm orders for 456 jets worth $19.2 billion. The rise in backlog is attributable to the new low-cost Indian carrier Air Costa's deal for 50 E2 E-Jets that Embraer bagged at the Singapore Airshow. With the increase in customer base (presently 67), orders would keep flowing in and boosting the backlog.

Backlog, in $billion. Source: Embraer

As the commercial backlog piles up, it's imperative for the plane maker to increase its production rate. Embraer deliveries improved 17% during the first quarter over the past year, but this was mainly due to higher deliveries of business jets. Commercial deliveries fell to 14 aircraft, down 17.7% over last year's comparable quarter. This could be an effect of the company's lowered production capacity; this lowered capacity comes from a measure it took last year when its 2012 backlog was reduced to less than two years of production, valued at $12.5 billion.

As the backlog is now seeing steady growth, Embraer should increase its capacity that would in turn boost commercial deliveries.

Journey of hope
Embraer's future looks quite stable provided it right sizes its production capacity, carries out the E2 E-Jet program as per plan and further strengthens its position in the 70-130-seater aircraft space. Obviously, exposure to the emerging market has its own set of risks, but it's the same for any aircraft manufacturer. The plane maker has huge room to grow in the absence of the larger jet makers. Embraer's journey ahead looks quite exciting.

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4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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