Description

Brazil's Embraer is extraordinarily cheap. They and Bombardier are the only two suppliers of regional jets in the world (Dornier/Fairchild has a lame thing going right now, but they've lost out on the installed base game). The ADS hit a high around $40 this year and the company now sells for $12.50 on the NYSE. It was heading for EPS of ~$3.60 this year, so on earnings power, the company is dirt cheap. It'll probabaly do $1.80 to $2.30 EPS this year, so it's still beaten to hell. On an EBITDA basis, it's trading around 4.0x EBITDA and on sales, about 0.75x. Embraer did a well-time stock offering this summer in the upper $30s, so it has cash of $1.7 billion with debt of $567 million. Being that it's not a vertically integrated manufacturer, either, they get to shop around the world for companies that can offer the best mix of design/cost for important subsystems. Those firms also put up a big chunk of the development money for new models. Embraer makes its money as the designer, marketer, and assembler of the aircraft and also makes money on services and spares. The company's return on invested capital for this year is 57+ with a 50% ROE. That with negative net debt/invested capital.

90% of their revenues are in dollars and 70% of costs are in dollars, so the company actually makes money on the dollar/real conversion so long as the real depreciates at a faster pace than cost inflation in Brazil. With the real off the dollar peg and real interest rates staunching capital outflows, the currency is not a big deal here.

Based on pre-Sep 11 estimates and the current price of $12.50, this is what it looks like:

Revenues
2001: $3.5 billion
2002: $4.04 billion
EPS
2001: $2.82
2002: $3.52
EBITDA
2001: $624 million
2002: $662 million
Operating income
2001: $587 million
2002: $622 million
Dividend
2001: $0.76
2002: $0.88

159 million shares
Market cap at $12.50: $1.99 billion
Cash and debt mentioned above
Equity: $921 million

This stock price is idiotic, in my opinion. And no, there’s no catalyst. Valuation is its own catalyst. At 3.6x earnings power and 2.6x pre-Sep. 11 EBITDA with the ability to beat its cost of capital in down years, you can wait a while until it returns to earnings power and still do very well.

As for current market conditions, regional jets make sense on a number of routes if the airline business is permanently impaired. With a seating capacity of 50 passengers on the company’s bread-and-butter ERJ 145, you need to fill only 33 seats to break even versus having to fill 88 seats on 737. If you need to capture only 38% of the potential passengers on which a larger jet breaks even, then your total market penetration can be much lower to make a route profitable.

The company’s main competitors, Bombardier, is still selling at 19x 2001E EPS, 1.22x 2001E revenues, and 11.9x 2001E EBITDA with a 6.6% ROIC and 29.7% ROE. That’s with cash of $421 million and debt of $8.2 billion. While Bombardier is more diversified, the valuation difference is stark.

Embraer’s backlog going into Sep 11 was $11 billion+ with Continental Express and American Eagle the two bigger customers. The company is going to get hurt with revenues and receivables, but they can push that back on payables. The company is also nearing completion of a capacity expansion, so they can increase deliveries for those airlines that want to move up in line. Also, the company will introduce two new 70-110 seat jets in the next few years, which have 35-55% high sticker prices than the smaller regional jets. $1 billion of the firm backlog for these aircraft is held by General Electric, a triple-A credit. Embraer has also started delivering its ECJ 135 business jet, which has basically the same dimensions as a Gulfstream GV. Its takeoff length is shorter than the GV but its range is ~1,800 nautical miles while the GV’s is 6,000+. They’re different aircraft, but the sticker price on the ECJ 135 is $15 million while the GV sells for $40 million+. Given capacity constraints in business jets and the growth in that industry, Embraer’s ECJ program should ramp quickly and generate economically-positive results.

In short, Bombardier was a 10-bagger within the space of a decade largely as the result of its regional jet and business jet business, not the Ski-Doo business or manufactured homes. As the other member of what is essentially a global duopoly in the most attractive segment of civil aviation, Embraer as a high-return company with net cash selling at 3.6x EPS power is a no-brainer, in my opinion.

Oh, yes, Porsche is also extraordinarily cheap.

Catalyst

There is no catalyst. The catalysts are negative right now, in fact. But value is its own catalyst.