July 31 (Bloomberg) -- Embraer SA, Brazil’s best-performing stock this year, is sacrificing margins as it fights to overtake Bombardier Inc. in U.S. jet sales.
The trade-off is part of reaping big orders from U.S. carriers such as United Airlines, Chief Executive Officer Frederico Curado said. Demand for smaller, cheaper models and discounts to attract customers “put pressure on pricing,” Curado told analysts on a July 26 conference call.
While Embraer’s firm order backlog of 366 regional jets now leads Bombardier’s 279 for the CRJ and CSeries aircraft, the push to win new business is shrinking earnings margins before interest and taxes. EBIT margin fell to 6.8 percent through the first half from 10 percent for all of 2012, according to the Sao Jose dos Campos, Brazil-based company.
“Their strategy has been exceptionally impressive as it relates to showing up and getting orders,” Nick Heymann, a William Blair & Co. analyst in New York, said in a telephone interview. Price cuts to win business were an admission that “their product isn’t as competitive, particularly in the U.S.”
Embraer’s swelling order book is positioning it to claim the top spot among regional-jet brands in service in U.S. airline fleets. The planemaker’s total is 835, compared with 1,051 for Montreal-based Bombardier, according to data compiled by Bloomberg.
The company also is better situated to withstand U.S. airlines’ planned retirements of less-efficient regional jets with 50 or fewer seats, said George Ferguson, a senior air transport analyst with Bloomberg Industries in Skillman, New Jersey.
“Embraer’s active fleet is younger, of higher quality and has more years to run,” Ferguson said in a telephone interview. CRJs “are very likely candidates for getting parked in the next five years.”
A 37 percent surge this year through yesterday made Embraer the best performer in Brazil’s benchmark Ibovespa index, which fell 20 percent, and beat the 36 percent gain for Bombardier’s widely traded Class B shares. For Bombardier, that produced a price of 12.8 times estimated 2013 earnings, compared with a ratio of 15.2 for the Brazilian company. Embraer fell 2.1 percent to 19.36 reais at 1:23 p.m. in Sao Paulo.
“They’ve done the right things to maintain leadership,” said Cai Von Rumohr, a Cowen Securities LLC analyst in Boston who, like Heymann, rates Embraer’s American depositary receipts as market perform. “They’ve developed a broader customer base. Having a ubiquitous product is important.”
Embraer’s wins in the U.S. this year include 30 regional jets for United, the world’s largest airline, and 50 of its new E2 family for American International Group Inc.’s International Lease Finance Corp., the second-biggest lessor. Delta Air Lines Inc. agreed to buy 40 Bombardier aircraft in 2012, leaving American Airlines as the last major carrier yet to order in this round of regional-jet upgrades.
“These buyers have the power to pressure the price down,” Eric Hugel, a New York-based analyst with S&P Capital IQ Inc., said in a telephone interview.
Embraer’s Curado is forecasting sales this year of as much as $6.4 billion, while Bombardier’s total may be $18.2 billion, based on analysts’ estimates compiled by Bloomberg. The Canadian company got 51 percent of 2012 revenue from its aerospace unit.
Discounting by Embraer comes as no surprise, said Philippe Poutissou, the Toronto-based vice president of marketing at Bombardier’s commercial aircraft unit. Because the CSeries is a new plane that has yet to enter service, almost any orders for that model would come at the expense of rivals, he said. Its largest version lists for $71 million, compared with $60.4 million for the biggest of the second-generation E-Jets.
“Our competitors are going to fight, and one of the tools that an established player has is to fight with price discounts,” Poutissou said in an interview. “It’s not unexpected that we face pressure as we try to establish ourselves in the market.”
Bombardier is “very comfortable” with its decision to focus on developing the CSeries and forgo upgrades to its current CRJ lineup, a contrast with Embraer’s strategy to overhaul its regional jets and skip an all-new plane.
Embraer’s margins are under pressure from two directions, according to analysts such as Hugel. The E-175 jets seat as many as 88 people and list for $41.7 million. They provide less profit than the larger E-190 and E-195, which have a catalog price of as much as $48.9 million and can carry 124 people.
This year’s order announcements also include some of the E2 variants, the shorthand for so-called second-generation planes in the E-Jet lineup. They won’t be available until 2018.
Embraer is “working very hard” to stabilize margins, CEO Curado said. “But on the pricing side, for sure it’s going to be a challenge because of the nature of the mix of the aircraft.”
To contact the reporter on this story: Christiana Sciaudone in Sao Paulo at email@example.com