Thesis:

 An investment in Embraer represents an opportunity to buy a top aerospace company with 200%+ upside potential. ERJ stock is trading near historic lows on most metrics, while the company’s fundamentals seem poised to improve significantly due to a recovery in its core markets, combined with market share growth. ERJ is also the best way in my opinion to invest in the electric vertical takeoff and landing (eVTOL) market, because it owns 90% of a leading publicly traded (eVTOL) company, EVE (Ticker: EVEX), which Embraer recently spun out. Our research indicates that EVE has among the highest probability of successfully launching a profitable global eVTOL vehicle/vehicles that will capture a meaningful portion of the market. The current market capitalization of EVEX is $2.43 billion, which equals $11.90 per ERJ share, SHOKINGLY 20% more than ERJ’s current stock price. It seems like the stock market is making a huge valuation error by factoring $0 EVE value into ERJ’s valuation. When the market wakes up to the valuation disconnect, and as Embraer’s core business recovers to mid-cycle levels, I expect ERJ to increase to my estimate of its fair value range of between $20-$30+ per share.

Why Does This Opportunity Exist:

The dramatic under-valuation for ERJ exists for several reasons:

1. The EVEX spin was completed recently in May, during a tumultuous time for the market, seemingly causing a delay in recognition of its value within ERJ stock.
2. Recession and supply chain fears could cause a delay in Embraer’s recovery, but I believe these factors are more than reflected in the stock.
3. Management is not promotional.
4. ERJ has sold off in sympathy with the market and other plane manufacturers, although they have much brighter prospects than the overall industry.
5. ERJ is a Brazilian-based company, and foreign stocks often exhibit a much higher market beta during market sell-offs.

In summary, ERJ’s tremendous decline seems to be simply a case of the baby getting thrown out with the bath water.  

Valuation:

ERJ seems vastly undervalued on every valuation metric. Notably, the company appears to be valued at a significant discount to liquidation value (even excluding the value of EVEX), at a current P/TBV (Price-to-Tangible Book Value) of 0.66x, vs. a historic average of 1.1x. Using a historic P/TBV of 1.1x, Embraer would be worth approximately $16.50. If we were then to add the additional EVEX value of $9.50 per ERJ share (at a conglomerate and liquidity discount of 20%), this will result in a total value of roughly $26 per ERJ share. Looking at valuation from an EBITDA perspective, ERJ is currently valued at an EV/EBITDA of 5.7x our FY23 estimate, versus its historic average of around 9x, and the peer group at around 11x. We derive a fair value for ERJ of $21 using this methodology by assuming ERJ is fairly valued at an FY23 EV/EBIDTA of 9x. Adding the same $9.50 in value for EVE results in a current fair value of $30.5.

One could justify even more upside for ERJ if we look at EVE on a long-term fundamental basis. If EVE wins even a tiny portion of the eVTOL market, we project the stock would likely go up many times over a 5-10 year period. During EVE’s investor presentation, they estimated approximately $4.5 mil in FY30 revenues. Assuming a 20% EBIDTA margin and a 15x EBITDA multiple, EVE stock could be worth about $13.5 billion by FY30 or $72 per share. You can discount that back at any rate you feel appropriate to arrive at a present value. For example, if we discount these projected numbers by 10% over eight years, we derive a current value of $31.

Company Overview:

Embraer is a Brazilian aerospace company formed in 1969 by the Brazilian government and privatized in 1994. Embraer primarily develops, manufactures, and services commercial, executive, and military aircraft. Embraer has four primary divisions: Commercial Aviation, Defense and Security, Executive Aviation, and Services and Support. In 2021 these divisions comprised approximately 31%, 14%, 27%, and 27% of revenues. Embraer is a world leader in developing and manufacturing aircraft. It began production with its ERJ family of jets, a regional twin jet, and then produced the successful EMBRAER 170/190 commercial jet family. They have produced more than 1,600 aircraft, with around 150 orders in backlog. Embraer recently released the second generation of its E-Jet family, which modernizes many of the already successful aircraft designs in its 170/190 family. Embraer has also penetrated the executive aviation industry with their Phenom and Praetor executive jets. In 2017 Embraer created a subsidiary called EVE for developing electric vertical takeoff and landing (eVTOL) vehicles for urban air mobility (UAM). EVE merged with Zanite Acquisition Corp in 2021 and was listed on the NYSE.

Embraer faces competition from Bombardier’s A220 jets., Bombardier’s CRJ series regional jets and other mid-size regional jets. Embraer is the leading manufacturer of jets with up to 150 seats, accounting for 29% of the global market (in terms of accumulated deliveries since 2004). Embraer has also competed historically in the turboprop market with Bombardier. Embraer has not produced a turboprop aircraft for 20 years. However, Embraer recently announced plans to develop a new family of turboprop regional airliners, featuring aft-mounted engines for noise reduction and greater efficiency compared to competitors such as the Dash 8 and ATR turboprops while using 20-40% less fuel and emitting up to 40% less carbon. If Embraer decides to proceed with the development of the next-generation turboprop, it is expected to enter service by 2028. Embraer’s product development experience, relatively low prices, and established global customer base could give it an edge against its competitors in the recovering airline industry.

Embraer’s strategy is to continue to gain share within the regional jet market for planes with up to 150 seats. It hopes to expand in developing markets such as India, Brazil, and Turkey, where demand for regional jets is increasing. Embraer also has a new passenger-to-freight conversion program to convert passenger jets from their E-jet family into freighter jets. The converted jets feature 50% more capacity and three times the range of large cargo turboprops while having 30% lower operating costs versus narrowbody freighters. In June 2022, Embraer signed its first deal for the passenger-to-freight conversion of 10 E-Jets for one of its customers. Deliveries of the converted jets are expected in 2024.

Embraer’s 90% ownership of EVE makes it a major player in the UAM market, which is anticipated to scale to tens of billions of dollars in the future. EVE seeks to produce eVTOLs that are quiet, environmentally friendly, and safe. Eve expects its eVTOLs to decrease carbon emissions by 850 million tons within ten years. Eve is also currently developing an Urban Air Traffic Management (UATM) software system to prepare for the implementation of UAMs. EVE faces competition from other UAM companies such as Joby, Lilium, and Volocopter.

We believe EVE’s strategic partnership with Embraer, and its lower capital business plan, make it the most likely eVTOL company to launch a successful and profitable aircraft that will gain significant market share. Many global airline customers seem to agree. As of January 2022, EVE had a backlog of 1825 orders of eVTOLS from 19 companies, valued at around $5 billion, which is the largest order book of any eVTOL company by far. These orders are likely due to Embraer’s reputations as a very credible aircraft developer and manufacturer, with a strong track record of success in developing and certifying many aircraft on time and within a given budget. I think EVE’s partnership and backing by Embraer’s is the most significant advantage over many of the competitors that have little or no mass development and certification experience. EVE is encouraged to use all Embraer’s resources, including global service, maintenance, sales, manufacturing, certification, development, marketing, and engineering teams. Embraer has given EVE priority use to all its resources, including approximately 5000 employees and 3500 engineers. I suggest you view EVE’s investor day on YouTube at Eve Investor Day 2022 - YouTube 

EVE is targeting the eVTOL market through developing the most efficient aircraft using existing technologies, with a target of achieving the lowest cost per mile. This is the same game plan Embraer has successfully implemented in many of its other past development projects which have been on time and on budget. EVE also plans to launch a global eVTOL maintenance and servicing operation in partnership with Embraer, which will service any eVTOL, even those not manufactured by their company. EVE’s business plan is only to sell their eVTOL and not to compete with their airline customers by developing the entire infra-structure themselves. This strategy increases EVE’s probability of success because it dramatically lowers its capital needs and brings in many partners worldwide, multiplying the company’s effort.

Eve is currently working with regulators in Asia, Australia, Europe, and the Americas to gain certification so it may begin production. EVE’s first flight is being targeted by 2025, and the company expects deliveries to start in 2026. Although EVE has made proof of concept flights, the company has yet to publicly demonstrate a fully operational and equipped eVTOL, so there is still a long way for the company to go on many fronts. EVE currently has about $360 mil  of cash and receives additional financial, and other assistance from EVE.

Financials: 

Embraer’s financial performance significantly deteriorated during 2020 and 2021 primarily due to the decline in air travel caused by Covid shutdowns and fear. We estimate Embraer is just entering a multi-year growth cycle driven by a post-covid recovery in regional air travel, replacement of an aging fleet, and market share gains for Embraer. We estimate that Embraer’s mid-cycle adjusted EBITDA has been in the $700 mil range historically, with a 10 year range of $941-$243. We expect Embraer to achieve mid-cycle EBITDA within the next 12-24 months, depending on the outcome of several variables. We also expect Embraer’s to have several years of significant growth, with the potential peak EBITDA to be significantly higher than the last cycle. ERJ’s recovery is foreshadowed by its backlog numbers, which including recent orders, are in the $19 bil range, up almost 20% year-over-year (YOY), and at the highest level since 2015.

Risks:

1. A significant slowdown in the economy or supply chain issues could hurt Embraer’s financial performance, but I think this risk is more than reflected in the current stock price, and the backlog numbers speak for themselves.

2. EVE may not be successful within the eVTOL market.

3. A new strain of Covid or some other new pandemic could negatively impact regional air travel.