5 January 2016
In June 2014 Paris Saint-Germain (PSG), the soccer club based in Paris, splurged GBP50 million (USD74 million) on a Brazilian player named David Luiz. It was a world record transfer for a defender who had previously moved to Chelsea barely three years earlier for half that price.
To put things into perspective, that sort of money is more than enough to pay for many schools in Brazil’s favelas, with sufficient change for teachers’ salaries for many years. Or, if you’re into a tipple or two, Luiz’s transfer fee could theoretically ensure the country’s population of 203 million gets a free glass of caipirinha each night, again, for many years.
But since we’re in the business of helping our friends make more money, the better way to spend USD74 million (if you have that kind of moolah), in our sober mind, is to place an order for Embraer aircraft. It is likely to give investors much, much better value for money, a better return on investment.
Who is Embraer?
In Southeast Asia, where over 600 million people call home, the main brand names you’d come across while waiting for flights at airports are Airbus and Boeing. Occasionally you’d see propeller-driven aircraft, mostly made by ATR, the European manufacturer. Mention Embraer and you’d likely to get blank stares.
Embraer is an acronym; it stands for Empresa Brasileira de Aeronáutica (Embraer history). Located in São José dos Campos, in São Paulo state, the company makes among others, commercial, executive and military aircraft. It was formed on 19 August 1969, well over a year before Airbus was born. The first aircraft Embraer made was a turboprop Bandeirante or “pioneer” in Portuguese.
In the 1970s Embraer made aircraft mostly for the Brazilian Air Force. It also made a high performance glider called the Urupema and a small crop duster known as the Ipanema (from a sugarcane town, not the beach in Rio de Janeiro). The Ipanema was popular but did not generate enough money to sustain Embraer, and thus the decision to ramp up its presence in the civilian marketplace, according to Jeffrey L. Rodengen, the author of “The History of Embraer”.
We first came across Embraer in the late 1990s, during an aviation conference and received a small gift (see pic of EMB145 below). In 2000, Embraer opened an office in Singapore, about a year after it launched the E-jet family of aircraft at the Paris Air Show. The aircraft entered production in 2002 and made an appearance at the Singapore Air Show in 2006 when the E170 (see E170 pic below) ferried guests for a short ride around the island state.
In mid-November 2015 we had the privilege of visiting Embraer’s HQ at São José dos Campos and to check out the progress of the company’s latest programme – the Next Generation E2 jets. But first, a quick snapshot of what we saw during the tour of Embraer’s facilities…
The first impression when we arrived after meandering along the verdant valley was not just the laidback location, rather the lack of “grandeur”, with average-looking buildings and not many indications that the place produces planes. Nothing fancy, unlike the mammoth structures at Boeing’s plant in Everett, Seattle or the smart buildings at Airbus’s factories in Toulouse and Hamburg.
But looks are deceiving. Step inside Embraer and one is struck by the professionalism shown by its people, from the office workers to the engineers and technicians on the factory floors. Even the guys who served food at the delivery centre appeared genuinely happy. And this is pretty much a reflection of the way senior management runs the company.
Paulo Cesar Silva, the president and CEO of Embraer Commercial Aviation, is an amiable and an unassuming leader with a background in finance and banking. He is pretty much the driving force not just behind the E2 project but also the overall direction of Embraer in the civilian aerospace arena.
Supporting the CEO is his energetic and enthusiastic chief commercial officer, John Slattery (not to be confused with his namesake in the hit series Mad Men). Slattery joined Embraer in 2011 after a successful stint with RBS Aviation Capital (now known as SMBC Aviation Capital).
Why invest in Embraer aircraft?
Mid- to long-term the company:
- Has a well-positioned product portfolio, accompanied with a firm backlog;
- Has solid liquidity; and
- Is a leader in the regional jet market
Embraer delivered 68 commercial aircraft in the first nine months of 2015 compared to 62 in the same period in 2014. It posted a 3Q15 net loss of USD110 million – not nice indeed – but look closely and part of it was due to the dramatic decline (almost 30%) of the Brazilian real (BRL) against the USD. Revenue was up 3.6% to USD1.3 billion.
The company’s liquidity is strong, judging from its cash balances and credit facilities (Embraer 3Q15). Cash and marketable securities look comfortable, compared with short-term debt. The next maturities on bond issues are due in 2017 and 2020. Moodys rate Embraer at Baa3 while Standard & Poor’s has assigned the company BBB.
Another good reason to invest in Embraer is the E2…
These are the 2nd generation of Embraer’s E-jet family, with three new variants namely E190-E2, E195-E2 and E175-E2. They are anticipated to enter into service in 2018, 2019 and 2020, respectively. Embraer said the programme cost the company some USD1.7 billion.
According to Embraer officials, the catalogue price of the E2 jets range from USD45 million to USD60 million. Airlines are known to secure substantial discounts from aircraft manufacturers when they place bulk orders, up to 30%.
On the technical side of it, the new aircraft will be fitted with Pratt & Whitney two geared turbofan engines while key components are being supplied by Liebherr (flaps, slats), Moog (fly-by-wire systems) and Rockwell Collins (horizontal stabiliser systems). What we find most impressive though, is the cabin layout (no middle seats), which is chic and offers very generous and neat luggage storage. The design contract of the aircraft cabin was awarded to UK firm Priestmangoode (see pic below).
All things being equal, we think the E2 will be well ahead, in terms of efficiency and passenger comfort, of its competitors from Canada and Japan. We anticipate the aircraft will also have lower maintenance costs. Most importantly, the E2 programme is on schedule, so if an airline orders it today, it is likely to get the plane on time, unlike the delays faced by Bombardier and Mitsubishi.
US-based carriers have led the way in capitalising the ability of regional jets to help it make more money on many sectors. American Eagle, Compass, Jetblue and Republic Airways are among current operators of Embraer E-jet aircraft. In Europe KLM is operating a fleet of 30 E190s and has ordered 15 E175s and two E190s – one of which joined the airline in December 2015 (KLM E190 takeoff).
Asia Pacific remains one region that has yet to catch up with North America and Europe. There are several airlines in Southeast and East Asia whose yields would, in our view, see significant improvements were they to run a fleet of regional jets compared to the narrowbody aircraft they currently fly. A combination of both single aisle and regional jets might also be beneficial.
The Embraer brand name does not quite have the same allure as Airbus or a Boeing. Moreover, there are reservations about the secondary market value and if the E2 jets would cannibalise the first generation planes. Additionally, very few leasing companies have the gumption and the appetite to order the aircraft.
Value for money
In our opinion, the E2 has unrivalled economics in its class and is value for money. It is an excellent Embraer product produced by a bunch of dedicated and talented Brazilians. Sure, they can’t play-act like many of their compatriots on the football or political fields (the politics are just too ugly to elaborate). What Embraer does is something Brazil’s footballers and politicians ought to emulate – give their investors better return on investments.