The aerospace industry has been red-hot lately, with the success of commercial airlines spurring a huge increase in demand for new aircraft that are more fuel-efficient and have other technological advances. Even as many investors focus solely on the two largest players in the aerospace industry, Embraer (NYSE:ERJ) has built a strong reputation as the third-biggest manufacturer of commercial airplanes. Coming into Thursday morning's first-quarter earnings report, investors had some concerns about the Brazilian company's exposure to weak economic conditions in Latin America, and Embraer's results indeed reflected the impact of some of the economic challenges that Brazil and its neighboring countries are facing. Let's take a closer look at Embraer and what it has had to deal with lately in making the most of the huge worldwide aerospace opportunity it has right now.
Embraer loses out
Embraer's results reflect some of the difficulties the aircraft manufacturer has faced lately. Revenue fell 15% from the year-ago quarter to $1.06 billion, which was considerably less than the $1.22 billion that most investors had expected Embraer to bring in during the quarter. Shareholders had already expected last year's profit to get cut in half, but Embraer couldn't even do that well, instead posting a loss of $61.7 million or $0.34 per share. Even on an adjusted basis that takes out the impact of required social contributions and deferred income tax, adjusted net income of $48.3 million was down by almost a quarter versus early 2014.
Embraer didn't provide a lot of additional information in its financial report, but the aerospace company did show some signs of strength. The company delivered 20 commercial jets during the first quarter, as well as 12 executive aircraft composed of 10 light jets and two large jets. With revenue from its defense operations falling by nearly half and a drop of 37% in business jet sales, Embraer has had to rely on big deliveries to commercial airline customers to help pick up the slack in its overall sales. Operating margins improved from year-ago figures, with EBITDA margins jumping almost 2 full percentage points to 14.1%. Embraer's firm order backlog posted a substantial rise over the past 12 months, climbing 6% to $20.4 billion. With $2.39 billion in debt and $1.81 billion in cash, Embraer's balance sheet looks relatively healthy.
The reason for the loss was the strong dollar, but not in the way that most U.S. investors would expect. For the Brazilian company, a strong dollar can actually be helpful, as much of its revenue comes in specifically in dollars while many of its expense items involve paying in Brazilian currency. The problem, though, is that Embraer also faces tax liability on its dollar-denominated assets, and so when the value of those assets rises in local-currency terms, it can create additional future tax obligations that it has to recognize in its financials.
Can Embraer pick up altitude?
One of the biggest challenges Embraer faces is that some of its most important customers have been slow in paying for orders. Specifically, the Brazilian Air Force has taken responsibility for funding Embraer's development of the KC-390 military cargo aircraft, but the government is about $300 million behind in payments to Embraer and other defense contractors. With Brazil seeking to impose austerity measures on government spending in order to try to support its weakening economy, Embraer said that it might have to slow down its development efforts on the aircraft if its customers don't get their payments caught up soon.
In the long run, though, Embraer should continue to prosper from demand for its regional jets. Even though U.S. carriers initially drove interest in that niche, Embraer has seen increasing order activity from emerging-market carriers throughout Latin America, India, China, and even Africa. Moreover, with the development of its second-generation E2 jets, Embraer hopes to keep building up its order backlog in anticipation of starting to deliver the new aircraft in 2018.
Investors have been nervous about Brazilian stocks generally, but Embraer's announcement helped send shares up 2% even as most Latin American stocks fell. Given its worldwide potential, Embraer isn't as dependent on Brazil as some of its compatriots, and smart investors have seen recent weakness in the stock as an opportunity to make long-term investments more cheaply. If aerospace keeps soaring, Embraer should be able to claim its share of the spoils.