Brazilian aircraft manufacturer Embraer (ERJ 7.33%) has had a bumpy ride recently. While larger jet makers Boeing (BA +4.08%) and Airbus have soared on rapidly rising order backlogs, investors have wondered whether Embraer would be able to find enough customers to keep its factories running.
On Thursday, Embraer took a big step in rebuilding its order backlog. It reached an agreement to sell 60 of its E-175 regional jets to American Airlines (AAL 5.17%), with deliveries beginning in early 2015. This single order represents more than half a year's production for Embraer!
Embraer just won another big order for its E-175 regional jet (Photo: Embraer)
Embraer's success in winning the lion's share of this year's regional jet orders from the U.S. airlines should give investors confidence in its ability to keep production lines running until its next-generation jet is ready in 2018. This is great news for the company and its investors.
Embraer's problem
Embraer piled up orders for its E-Jets in their first few years on the market. The E-190, which seats about 100 passengers (depending on the configuration used) was particularly popular with airlines looking to "right-size" capacity in midsize markets and as a replacement for old DC-9s. However, the rapid rise of oil prices in the last 10 years and the airline industry downturn in 2008 combined to sabotage demand for the E-190.
The problem is that the E-190 is not as fuel efficient as the larger narrowbodies sold by Boeing and Airbus. When jet fuel cost less than $2 per gallon, that wasn't a big problem, but when it surged past $3 per gallon, the E-190 did not fare so well.
Demand for the E-190 has fallen off a cliff, and many companies are looking to unload relatively new E-190s that no longer fit in their fleet plans. Earlier this fall, JetBlue Airways (JBLU 1.65%) deferred 24 E-190 orders until the end of the decade and beyond while ordering more large narrowbodies from Airbus.
Meanwhile, Republic Airways (NASDAQ: RJET) is trying to sell at least five of its 10 E-190s, as the new owner of Frontier Airlines was not interested in keeping these higher-cost aircraft around. Just this week, Air Canada announced that Boeing would be taking 20 E-190s off its hands as part of a deal to buy up to 109 737 MAX aircraft. Air Canada is also "reviewing various options" for the remaining 25 E-190s in its fleet.
E-175 to the rescue
With demand for the E-190 falling and plenty of (lightly) used E-190s coming to the resale market, Embraer needed to look elsewhere to meet its production targets. Fortunately, all of the U.S. legacy carriers have recently become desperate to replace their fuel-guzzling 50-seat regional jets with more cost-effective (and more comfortable) 76-seat jets, like Embraer's E-175.
Last December, Delta Air Lines (DAL 3.42%) kicked off the most recent round of regional jet orders. However, Bombardier won the Delta order, which covered 40 CRJ900 aircraft and another 30 options.
Since then, Embraer has been on a roll. In January, it won an order for 47 E-175s (plus another 47 options) to be operated for American Airlines by Republic Airways. Then, in April, United Continental (UAL 3.52%) ordered 30 E-175s for its regional fleet. The next month, regional operator SkyWest (SKYW 3.52%) ordered 40 E-175 aircraft, also for use with United Express.
This spring, United announced plans to replace 70 50-seat regional jets with Embraer E-175s
Including this week's announcement, Embraer has secured firm orders for 177 E-175s from the top three U.S. carriers and their regional airline partners in 2013. At the company's recent production rate of 90-95 commercial aircraft per year, this represents nearly two years of production!
Opportunity remains
Embraer has done well this year, but it still has an opportunity to sell more E-175s in the U.S., particularly to American Airlines. Before this week's orders, American's pilot contract allowed it to increase its large regional jet fleet by more than 200 planes. Thus, while American placed 90 firm orders for regional jets this week (60 from Embraer and 30 from Bombardier), it could grow its fleet of large regional jets significantly beyond that in the next few years.
As part of Thursday's order, American received 90 options for E-175s to be delivered later in the decade. If the expansion of American's large regional jet fleet is as successful as expected, there is a good chance that it will exercise some of these options, further boosting Embraer's order backlog.
Foolish conclusion
At the beginning of 2013, Embraer faced a potentially serious problem. With a shrinking order backlog in its commercial aircraft division, the company was in danger of needing to slash E-Jet production from its already slow rate of 90-95 aircraft per year.
Having secured 177 new firm orders for E-175s from the U.S. legacy carriers and their partners this year -- as well as a smaller number of orders from other airlines -- Embraer has a much more secure future now. These orders should tide it over until the second-generation E-Jets (which will boast big fuel efficiency gains) go into production later in the decade.
Surprisingly, despite this brightening picture, Embraer shares are up only 10% year to date, well below the market's performance. With the company trading for just 13 times the average analyst estimate for 2014 EPS, Embraer appears to have significant upside.
