ERJ - Embraer Stock Buy Rating Delivers

2023-03-13 13:15:21 ET

Summary

• Embraer stock has outperformed since the last time I covered the subject.
• Embraer has shown strong deleveraging in 2022.
• 2022 results show strong cost control with further upside to revenues and efficiency.

I have been following Embraer ( ERJ ) for a while and what I noticed is that while the company’s gross margins were good, its operational costs were such that it would often be pushed into an operational loss position. In my report from September 2022, I noted that gross margins as well as its operational costs were improving warranting a Buy recommendation for Embraer stock. In this report, I analyze the 2022 results and outlook showing that the investment thesis remains intact.

Embraer Stock: A Market Outperformer

When selecting buy opportunities or even Holds, what I am generally looking for is names that can outperform the market and Embraer did just that with a 36.3% stock price increase compared to a 5.1% loss for the broader markets since my last coverage . Moreover, since I marked shares a hold rather than a buy due to the lack of visibility in step-down in costs, the stock has returned 53% outperforming the market even stronger as the cost step-down became visible.

Embraer: A Higher Revenue, Higher Margin Opportunity

Embraer derives most of its revenues from commercial aviation deliveries and execution aviation deliveries. Having higher deliveries also provides support to services and support revenues which more and more are becoming an integral part of the business of original equipment manufacturers. For the Commercial Aviation deliveries, we see that despite a big bump in Q4 Embraer missed its target. Given the current supply chain challenges in the industry, I would say they did quite well with a 19% increase in deliveries and Executive Aviation deliveries came in at the low end of the range providing a 10% year-over-year increase. The delivery profiles were heavily backloaded due to supply chain constraints.

For the year, Commercial Aviation revenues increased by 17% on 19% higher volume. So we see revenue growth more or less in line with volume growth, with some mix pressure as deliveries were heavier on the Embraer E175 in 2022. Executive Aviation revenues jumped 10% on 10% higher volume showing, stable delivery and pricing mix. Defense & Security revenues were down 25% due to lower Super Tucanos deliveries while Services revenues grew by 12%. Total revenues improved by 8% which is strong given the supply chain constraints, the one month company shut down in January 2022 to re-integrate the Commercial Aviation business as well as the decline in the Defense segment. Defense remains a watch item, but it should also be noted that the revenues were up year-over-year for the quarter.

Looking at the full year results, you might be given the impression that the operational performance deteriorated but this is actually not really the case. Some costs are higher due to higher sales activity and campaigns. The big item that pushed Embraer into a loss position for the year are the Other Expenses which are 9x times the 2021 figure. The reason is that some warrants had to be restated due to a review at Eve Holding ( EVEX ) which brought a $142 million pressure to the costs. Furthermore, there was $136 million non-cash expense due to a revised combination with Zanite and $15 million in transaction costs. None of these costs were related to Embraer but did increase the other expenses by $293 million. Excluding these costs, the other expenses would be $151.5 million. Furthermore, there were integration costs of $60.5 million for the Commercial Aviation unit. Excluding this as well would bring the cost figure down to $91 million.

So, looking at adjusted numbers is more helpful. Adjusted EBIT margin for Q4 2022 increased from 4.3% in Q4 2021 and 5.4% in Q3 2022 to 8.3% while Adjusted EBITDA margin declined from 8.2% in Q4 2021 and 10% in Q3 2022 to 11.5%. For the full year, adjusted EBIT margin improved from 4% to 6% and EBITDA margin expansion improved from 8.6% to 10.1%. These numbers better reflect the operational performance improvement at Embraer.

Embraer Liquidity Improves

What we also see is that liquidity is improving. Gross debt was reduced by $824 million and net debt dropped by $457 million on adjusted free cash flow $540.1 million excluding EVE compared to $292.4 million last year. So, that shows a significant improvement in free cash flow that allowed Embraer to bring its leverage down from 3.9x to 2.1x.

Bullish Guidance Supports Embraer Stock

For the full year, Embraer is expecting 65-70 Commercial Aviation deliveries which is at the higher side of the range provided last year for 2022 and 120-130 Executive Aviation deliveries compared to 102 deliveries in 2022, which should aid the company in achieving $5.2 billion to $5.7 billion in revenues providing 20% growth in revenues. Adjusted EBIT margin is expected to be 0.9 percentage higher measured from the midpoint and Adjusted EBITDA margins are expected to be up 0.4 percentage points. While the improvements in adjusted margins are not as spectacular as seen in previous years, there still is significant room for improvement all the way up to the high end of the guided ranges which coupled with strong volume growth should translate in more profits for the business. On defense, Super Tucano sales were down, but Embraer has been seeing some interest in that product. Free cash flow is a bit low at $150 million, but that is driven by working capital pressures which I believe partially are the result of the big push of deliveries in Q4 2022.

Which Airlines Use Embraer Aircraft?

The Embraer aircraft are used by airlines to support their regional operations. The E175 is a popular aircraft for US regional airlines supporting the legacy carriers and within Europe, the aircraft family is being used in the Lufthansa Group ( DLAKF ) as well as Air France-KLM amongst.

Conclusion: Embraer Stock Remains A Buy

I believe Embraer stock is a strong buy, the business has been able to cut costs significantly. The Embraer E2 family is not the best seller and the Embraer E175 might be facing some pressures due to pilot shortages, but overall, the margin transformation is visible with further improvement expected this year coupled with volume growth allowing the company to deleverage.

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