Embraer Regains Altitude With Boeing Alliance
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The sigh of relief from Embraer SA ADR (NYSE: ERJ) management was audible all the way from Brazil. Finally, the company had some good news coming from the United States instead of the recent strings of disappointments. In a major announcement, Embraer said that it has entered a cooperation agreement with Boeing (NYSE: BA) in developing a new midsize military transport and refueling aircraft, the KC-390.
This deal is all part of a strategic shift by Embraer to move towards military aircraft and to become less reliant on the civil aviation industry which is in the midst of a slowdown brought about by the global economic slump.
In March, Embraer stated that sales in the military sector in 2012 would be $950 million, exceeding last year's $868 million. Its defense backlog has risen from $600 million in 2006 to $3.5 billion this year. In addition to the KC-390, Embraer is also developing other new products for the military including unmanned aerial and surveillance aircraft.
The new transport aircraft developed by both companies will offer an alternative to the current leader in this space, the Hercules C-130 from defense giant Lockheed Martin (NYSE: LMT). The C-130 is the global benchmark for airlift aircraft. Earlier this year, the C-130 program reached another milestone with the delivery of its 2,400th aircraft. The C-130 is used not only by the US Air Force, but also by the air forces of other countries including many European countries along with Canada and Australia.
Embraer's new KC-390 will not really challenge the C-130 in developed markets. But the emerging world is a different story. Initially, the main customer for the aircraft will be the Brazilian Air Force. But Embraer is expected to take advantage of Boeing's extensive relationships with customers in the Middle East and elsewhere to sell the KC-390 in many developing nations around the world. The company sees a market for at least 700 of its lift aircraft, worth more than $50 billion by 2025 as emerging countries replace their aging C-130s.
This alliance truly comes at an opportune time for Embraer after the US Air Force earlier this year abruptly canceled a contract for the company, with its US partner Sierra Nevada, to supply a light attack aircraft for use in Afghanistan. The other bidder on the contract is US firm Hawker Beechcraft, which is currently in Chapter 11 bankruptcy, so politics may have come into play on the decision.
It is also an opportune time because of the struggles of the civilian aircraft industry. Embraer itself was forced to report a loss in the fourth quarter of 2011 because of a $366 million writedown due to the bankruptcy filing in November by AMR Corporation (NASDAQOTH: AAMRQ.PK). AMR had leases on 216 Embraer aircraft.
The company has said though it is optimistic that changes in AMR pilots' contracts in the bankruptcy proceedings may actually give its regional jet business a boost. The change involves the current limit on “feeds” to major routes, currently limited to 50-seat jets, being changed to an 88-seat jet limit. That would be perfect for Embraer's range of 70+ seat jets.
Things are finally looking up for Embraer and its investors, especially after the disastrous cancellation of the Air Force contract. The newly formed alliance with Boeing holds the promise of a tightening relationship between the two which should benefit Embraer.
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