Bloomberg News

Embraer Shares Beat Bombardier on Regional-Jet Strategy

January 14, 2013

Embraer Stock Tops Bombardier on Jet Strategy

Shares of Embraer outperformed both Bombardier and the nation’s benchmark Bovespa index in the year through Jan. 11. Photographer: Chris Ratcliffe/Bloomberg

Embraer SA (EMBR3), Brazil’s biggest planemaker, is betting the E-jet will win a greater share of the shrinking regional market because airlines prefer revamped versions of current aircraft to risking delays and malfunctions in new models such as Bombardier Inc.’s (BBD/B) CSeries.

The choice of Pratt & Whitney engines last week for the next line of aircraft marked a milestone in Embraer’s strategy. When Embraer’s E-jets debut in 2018, Bombardier will have been flying its CSeries with those engines for four years -- and grappling with any flaws in the new technology.

Jet buyers are getting fresh reminders of the difficulty in starting a model from scratch. Boeing Co. (BA:US)’s 787 Dreamliner, which entered service in 2011, came under a special U.S. regulatory review last week following a fire, two months after Bombardier said it was pushing back the CSeries’ first flight to resolve unspecified “issues” with suppliers.

“The riskier path is obviously being taken by Bombardier, because they’re doing a new plane and spending more money,” Turan Quettawala, a Toronto-based analyst at Scotiabank, said in a telephone interview. “Time will tell if it will be higher reward. On a risk-adjusted basis, Embraer probably does a little bit better.”

Shares of the Sao Jose dos Campos, Brazil-based planemaker outperformed both Bombardier and the nation’s benchmark Bovespa index in the year through Jan. 11. Embraer climbed 2.7 percent to 14.27 reais at the close today in Sao Paulo, outpacing a gain of less than 1 percent for the benchmark Bovespa index.

Bombardier’s stock traded at an 86 percent discount to Embraer’s on a price-to-earnings basis at the end of last week.

Less Expensive

The E-jet redesign will be about $1 billion cheaper than the $3 billion or more needed for a brand-new plane, Paulo Cesar Silva, the company’s commercial-jet chief, said when the decision was announced in 2011. An Embraer spokesman, Marcio Meo, declined to comment on the company’s strategy.

Embraer and Bombardier share a duopoly in a segment of the airline market that’s under pressure as carriers increasingly favor larger planes. Regional-jet orders for the two companies slid to 181 planes in 2011, less than half the 2007 total. Single-aisle jet orders were 2,107, according to data compiled by Bloomberg.

“I don’t know if there’s room for two players,” said Jacques Kavafian, vice president of brokerage Toll Cross Investment.

Kavafian said some airlines are keen on new models, partly because of the discounts they receive as initial buyers. Others tend to shy away from new technology, he said.

Dreamliner Delay

Manufacturers of a new plane, meanwhile, grapple with risks from high costs for research and development, the prospect of significant delays in which capital costs mount and erosion of early profit margins from the discounts.

Boeing stock still trades 26 percent (BA:US) below its price on Oct. 9, 2007, the day before announcing the first of a series of delays on the Dreamliner because of parts shortages, vendors missing deadlines and tests that showed unplanned stresses on the plane’s structure.

In November, Bombardier’s credit rating was lowered one level to BB, two steps below investment grade, by Standard & Poor’s, amid heavy expenditures for its new aircraft. The manufacturer subsequently postponed a bond issue for almost two months.

Fuel Efficiency

Embraer’s upgrade has proceeded more smoothly so far, with investors boosting the stock 19 percent from mid-November 2011, when it announced its plans, through the selection of its engine supplier last week.

More than 900 E-jets are in use now, with the smallest variant carrying 70 passengers and the larger version capable of flying 120. Embraer has said the upgrade will improve fuel efficiency with new wings and the geared-turbofan engines from Pratt & Whitney, currently in use by Bombardier, will decrease maintenance costs.

The CSeries carries catalog prices of $58 million to $67 million, while Embraer’s E-Jets list from $38 million to $48 million. Airlines typically negotiate discounts of up to 45 percent, said George Ferguson, an analyst at Bloomberg Industries.

“There is a lot less risk with what Embraer is doing,” he said by telephone from Skillman, New Jersey. “Look at the problems with the Boeing 787. It’s a viable airplane, but this was an all-new system, and all-new systems can have that many more problems because it has that many more things that can go wrong.”

Moving Goalposts

The new Canadian jets are designed to carry 100 to 145 passengers, competing with the largest E-Jets as well as the smallest commercial single-aisle planes from Boeing and Airbus SAS.

Fierce competition from both Boeing and Airbus in the narrow-body segment played into Embraer’s strategy, Silva said. The company said today it delivered 106 E-Jets last year, a period in which orders for the CSeries slipped to 15, leaving the backlog at 138.

Bombardier shipped 14 of its CRJ regional jets, which seat 60 to 99 passengers, in the same period and posted orders for 73. Those included an agreement by Delta Air Lines Inc. to buy 40, a purchase for which the Canadian company competed with Embraer.

Embraer’s strategy is risky because it means the company isn’t innovating as the market changes, said Kavafian of Toll Cross, which holds no shares of either planemaker.

“The new engine is what they think they can do to at least narrow the gap of cost” with Bombardier jets, which are now cheaper than Embraer’s planes, he said in a telephone interview from Toronto. “Bombardier is applying the right strategy, whereas Embraer is being more lazy.”

New Engine

The Canadian company’s jets will continue to be more efficient than those of its Brazilian competitor, said Benjamin Boehm, vice president for business development and strategy at Bombardier.

“Re-enginings don’t move goalposts,” Boehm said in a telephone interview. “They are taking an existing design and putting a new engine on it. Our current data would indicate we will retain a competitive advantage.”

The Brazilian planemaker posted a book-to-bill ratio of 0.3 percent in the third quarter. The gauge, which shows demand by comparing orders to deliveries, was the lowest of the four largest planemakers, according to data compiled by Bloomberg. Bombardier is tied for first place with Airbus at 1.6 percent.

“If this CSeries gets delayed, you could find out that Embraer is in very good shape,” Ferguson said. “If Embraer is doing a refresh, they can be first to market. The game is now in Bombardier’s camp. They’ve got to get that CSeries through flight testing and into service, and they really need to build out their customer base.”

To contact the reporter on this story: Christiana Sciaudone in Sao Paulo at csciaudone@bloomberg.net

To contact the editors responsible for this story: Jessica Brice at jbrice1@bloomberg.net; Ed Dufner at edufner@bloomberg.net


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