ERJ - Embraer Stock Remains A Strong Buy After Q2 Earnings

2023-08-16 10:36:49 ET

Summary

• Embraer S.A.'s second quarter results showed improvement in commercial and executive aviation deliveries, but disappointing performance in defense and slower growth in services.
• The company's cash flow was negative in preparation for higher deliveries in the second half of the year, but its liquidity remains strong.
• Despite the stock's decline, analysts believe there is significant upside potential for Embraer, with a price target of $19.56 representing a 34% increase.

Embraer S.A. (ERJ) posted its second quarter results on the 14 ^th of August. Even though the results beat expectations on top and bottom line, the stock has lost some of its value post-earnings. In this report, I will be analyzing the second quarter results for Embraer and revisit my price target for the stock.

Embraer Aviation Results Improve

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. Commercial deliveries were up 6 units to 17 while Executive Aviation deliveries increased from 21 to 30. What we are seeing is that after little to no growth in the first quarter deliveries, the second quarter was significantly better with 55% growth in commercial deliveries and 43% higher and 47% higher combined deliveries.

During the second quarter , Commercial Aviation revenues grew 57% driven, which was in line with the increase in deliveries while margins stayed more or less stable. Normally, with higher deliveries one would expect some margin improvement due to better cost amortization. However, that was not the case in the second quarter due to positive non-recurring items in the same quarter last year. Executive Aviation revenues increased by 42% to $378 million, in line with the growth in deliveries as well, while also this segment saw some margin pressure due to favorable items in the comparable quarter last year.

Defense revenues decreased by 28% to $82.4 million and the segment saw significant margin erosions from 28% to negative 1.5%, driven by other expenses and mix. Furthermore, the company experienced delays in contract awards, which subsequently have delayed revenue recognition. The services business saw growth slowing to 6%, with margins of 24.4% down from 31.8% in the prior year due to positive non-recurring items.

Total revenue of $1.292 billion provided an increase of 26.8% year-over-year improvement, which is a nice double-digit growth rate aided by better commercial and executive aviation delivery volumes, offset by disappointing performance in defense and lower growth in the services segment.

Overall, the key indicators did not contain big surprises. Cost of sales and services increased by 5 percentage points to 82.7% but I would say the cost of goods and services was just strong last year and in the same quarter this year, they were still strong when measured against the other years. Adjusted EBITDA margin declined from 12.2% to 11.5% which is not a huge decline and I would say the lacking performance in Defense is the main reason for this as well as the less favorable mix in aftermarket sales.

Embraer Cash Burns On Preparation For Higher Deliveries

The positive story for Embraer is that, with the cash on hand, it should be able to easily cover its debt through 2027, but perhaps that is all the positives that we can tell on liquidity. During the quarter, free cash flow was negative, but that is in preparation for significantly higher deliveries in the second half of the year, while net debt remained stable and net debt to EBITDA reduced by 1.7x year-over-year and reduced by 0.1x sequentially.

What Is Embraer Stock Worth?

Embraer has guided for revenues between $5.2 billion and $5.7 billion with adjusted EBITDA margins between 10% and 11%. Based on estimates for 2023, we see significant upside for Embraer stock. Our price target is $19.56 representing 34% upside. This price target is lower than the $20.18 target set by Wall Street analysts, but still one that provides an attractive risk-reward profile.

Conclusion: Embraer Stock Remains A Buy

The Embraer S.A. second quarter results were disappointing when looking at the weak performance in Defense and the slowing growth in aftermarket sales, but commercial and executive volumes were promising and the higher cash burn is in anticipation of increased delivery volumes in the second half of the year.

However, I do believe that analysts had factored in revenues that did not fetch with the reality of supply chain challenges and backloaded delivery profiles. The other reason why results were underwhelming is because the margins in commercial and executive aviation were weak. I knew that there would be some pressure, especially for commercial, but when the company booked strong margins last year in these segments it failed to mention that these were driven by one-offs. So, in some way, I do believe that management's communication on this has created the plunging stock price, but it should also be noted that with the current turmoil in the stock markets and Embraer's run up since I tipped it for investment, fear driven downside exists and that is what we saw today.

If we consider that Embraer S.A. indicated it is still on track to deliver on its 2023 targets, then we cannot conclude anything else than that this should trade at $20, and even then the company is cheap compared to its peers. I am upgrading from Buy to Strong Buy, as today's selloff was short-term focused, ignoring the value that already should materialize this year.

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