For more than a year, Embraer (ERJ) was preparing to participate in the upcoming civil aviation joint venture project along with Boeing (BA). However, after Boeing decided to terminate the project, Embraer once again needs to learn how to thrive on its own. The termination of the deal came at the worst time possible, as the Brazilian aircraft manufacturer has been severely hit by the pandemic and its share price crumbled. The recent earnings report showed that Embraer doesn’t operate at its full capacity, as the number of its plane deliveries declined in comparison to last year. Nevertheless, the airline has enough liquidity to survive this crisis, but its recovery to its pre-COVID-19 profitability levels will take years. With negative margins and an uncertain future ahead, the company decided to suspend its guidance, while the stock has a high chance of continuing to trade at distressed levels for a while.
As we mentioned in our latest article on the company, Embraer spent a lot of time preparing for the implementation of the Master Transaction Agreement (MTA), which eventually should’ve led to the creation of a joint venture project with Boeing, which was valued at $5.26 billion. Embraer itself was expecting to receive around $3 billion in net proceeds that it could’ve used for dividends and buybacks. At the same time, it could’ve leveraged Boeing’s global reach to quickly expand and enter new markets. Since the deal is terminated now, Embraer has no other choice but to learn how to thrive on its own once again. In early June, the company said that it views Indian and Chinese companies as possible new partners for upcoming civil aviation projects. However, after that statement was made, no new news about the possible partnership has surfaced to this day.
Currently, Embraer works on a plan, which should help it to offset its losses and return to profitability. However, it will take a long time until the company could once again reward its shareholders. The second quarter of FY21 was undoubtedly one of the worst in Embraer’s history, as its revenues decreased by 61.1% Y/Y to $537.2 million, way below the Street consensus by $103 million. At the same time, its net loss for the period was -$198.8 million, and currently, Seeking Alpha’s quant rating has a very bearish stance on the company.
Source: Seeking Alpha
The good news is that while Embraer has $2 billion in liquidity and $3.36 billion in debt, the majority of that debt is not going to mature in the next couple of years, so the company has enough time to try to improve its financial situation. It also expects to receive an additional $700 million in financing from private institutions in Q3, and there’s a strong indication that the Brazilian government will not let Embraer go under, since the aircraft manufacturer already received $600 million in loans from the Brazilian development bank and Brazilian private banks.
In addition, despite suffering immense losses in Q2, Embraer didn’t have any cancelations since the beginning of the year. However, numerous orders were deferred to later dates, and the company currently doesn’t operate at its full capacity. Since the beginning of the pandemic, the number of Embraer deliveries dramatically declined. In Q2 2020, it delivered only 4 commercial and 13 corporate jets to its customers. In comparison, a year ago, it delivered 26 commercial and 25 corporate jets during the same period. The reality is that until the virus is contained, weak demand for new planes and constant supply chain issues will prevent the airline from reaching its 2019 delivery levels anytime soon.
One of the few things that Embraer has going for it is a strong backlog of orders. Over the next few years, the company is expected to deliver 314 new planes and the total value of its backlog is $15.4 billion. However, since Embraer is unable to efficiently deliver those aircraft at the same rate as a year ago, it will take longer for the company to unlock value. In addition, as the executive jet market is expected to grow at a CAGR of only 1%, the company’s upside there is limited. At the same time, IATA forecasts the air travel market to recover to its 2019 levels only in 2024. Considering this, it’s unlikely that Embraer will receive a substantial amount of new orders in the upcoming years, as there’s a weak demand for new planes right now, and the only thing that the company has going for it is its backlog of already existing orders.
Since Embraer is not expected to be profitable in the next couple of years and the company will continue to operate in an uncertain environment, we continue to believe that it’s better to avoid the stock. By having one of the worst net income margins among its peers, it will take longer for the company to reach a breakeven point, and the opportunity cost of holding the stock at this stage is too high.
Source: Capital IQ
New Marketplace Service
On September 1, Bears of Wall Street will launch a new Marketplace service: Best Short Ideas.
The goal of the service is to provide you with actionable short ideas from which you can profit by betting against the companies that trade at irrational exuberance levels and have limited upside. While the Fed continues to pump the stock market, there is still an array of businesses that cannot justify their premium valuations, and our goal is to find those businesses. If you have a high-risk tolerance and are interested in shorting stocks, then this service is for you.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.