Demand for new aircraft has been extremely high in recent years, and Embraer (NYSE:ERJ) has done its best to take full advantage of airlines seeking to upgrade their fleets with the company's regional jets while also serving the needs of various military organizations. Coming into Thursday morning's second-quarter earnings report, however, terrible conditions in the company's home country of Brazil have held the stock back, and some investors worried about the ability of customers in Latin America to sustain their share of Embraer's business. Embraer's results reflected the deterioration in the value of the Brazilian real compared to the U.S. dollar, but the company also sees operational challenges ahead. Let's look more closely at Embraer's most recent quarter and what it says about the future.
Why Embraer fell from the sky
Embraer's second-quarter results continued some of the troubling trends we saw earlier in 2015. Revenue dropped 14% to $1.51 billion, with the decline being far worse than the roughly 8% drop that most investors were expecting to see. Net income declines of 10% to $129.3 million weren't nearly as bad as some had feared, but even though earnings of $0.71 per share were a third better than the consensus estimate, Embraer nevertheless wasn't able to find growth even in a reasonably favorable global aerospace environment.
One surprising aspect of the report was that Embraer actually had considerable success in delivering planes and collecting new orders. Embraer delivered 27 commercial jets as well as 33 executive aircraft during the quarter, which was a nice pickup from the slower pace in the first quarter of 2015. The company also managed to bring in more than 100 firm orders for its E-Jets commercial-jet line, more than quintupling Embraer's order count at the midpoint of the year. Due to this increase in orders, Embraer's backlog reached a record $22.9 billion. That figure was up $2.5 billion just since last quarter.
Embraer did see some glimmers of hope. The company experienced a slight improvement in its balance-sheet position, as while net debt of $511 million was up considerably from the year-ago period, it was down about $70 million over the past three months.
Yet looking at Embraer's segment results shows more of the trouble the aircraft manufacturer is going through right now. Commercial aviation revenue fell 9% year over year, and given that the segment brings in more than half of all sales, that drop had a big impact on Embraer's overall revenue. Yet the defense and security segment suffered an even more dramatic drop of almost 40%, and only the executive jet division's 4% sales gains were able to help offset poor results throughout the rest of the company.
Why Embraer expects stormy skies ahead
Even worse, Embraer made downward revisions in its guidance for the full 2015 year, cutting its provisions for revenue. Further weakness in the defense and security segment prompted Embraer to cut its guidance for the division's revenue by $300 million to a range of $800 million-$950 million. That in turn reduced companywide sales guidance to between $5.8 billion-$6.3 billion. Embraer blamed the downward revision on two things: the continued weakness in the real versus the dollar, and sluggishness in moving forward on development with contracts in the defense and security area.
Interestingly, though, Embraer doesn't expect the sales decline to have an impact on its operating earnings. As a result, the company actually boosted its operating margin figures by about half a percentage point, both in terms of pre-tax operating earnings as well as earnings before interest, tax, depreciation, and amortization.
Nevertheless, investors were far from pleased with the company's results, sending Embraer stock down 7% for the day following the morning announcement. In the long run, Embraer will have to demonstrate its ability to become less reliant on its home country of Brazil if it wants to become less dependent on the state of the local economy. With such favorable conditions that other aircraft manufacturers have turned into growing sales and profits, Embraer can't afford to post such disappointing results during what should be the best of times for the company.