Embraer’s Delta Order Loss Signals New Margins Pressure

Embraer SA’s surprise loss of a $1.85 billion regional-jet order from Delta Air Lines Inc. signals the planemaker needs to sweeten incentives such as buyback guarantees and maintenance deals to fend off Bombardier Inc.

AMR Corp.’s American Airlines and United Continental Holdings Inc. revived the prospect of U.S. sales for Embraer by winning new labor contracts last month that would allow their commuter carriers to fly larger planes, according to Philadelphia-based Drexel & Hamilton LLC.

Landing those sales would be a boost for Embraer after Bombardier’s Dec. 6 deal with Delta, the only big U.S. carrier ordering regional planes last year. Sao Jose dos Campos, Brazil-based Embraer fell 5.7 percent, third-most in the benchmark Bovespa index, in the seven trading days after Delta opted for Bombardier models over Embraer’s E-jets line.

“Each manufacturer will become more creative in ways to attract business,” said Brian Foley, a former marketing director at Dassault SA’s Falcon business-jet unit who is now an aviation consultant. “I’m sure whatever happened between Embraer and Delta was a learning experience.”

North America -- where United, Delta and American are the three biggest airlines -- will be the top regional-jet market in the 20 years ending in 2031, according to an Embraer forecast. The company projects global demand for 6,795 planes, with 32 percent in North America, at a list value of $315 billion.

Market Duopoly

Embraer and Montreal-based Bombardier’s regional-jet dominance is so pronounced that winning new business can pivot on planemaker tactics such as offering long-term maintenance or pledging to repurchase used planes, Foley said.

“The cost equation is much more complicated than just the purchase price,” said Foley, who runs Brian Foley Associates in Sparta, New Jersey. “With that kind of duopoly, it’s just a matter of time for one to take some sales from the other.”

Embraer’s regional jets carry catalog prices from $37.8 million to $47.8 million with a standard setup, and airlines typically negotiate discounts.

The Brazilian planemaker’s press office declined to comment about its order prospects for this year. Chief Executive Officer Frederico Pinheiro Fleury Curado said on an Oct. 24 conference call he expected to “achieve sales in the next few months.”

The shares have rebounded since their post-Delta slide. They closed yesterday at 14.73 reais, the highest since May 23, before a 1.2 percent drop today to 14.56 reais. That price was 5.7 times estimated 2013 earnings, compared with a multiple of 8.1 for Bombardier, based on data compiled by Bloomberg.

Ebitda Margin

Embraer reported a third-quarter margin for earnings before interest, taxes, depreciation and amortization of 11.8 percent. Ebitda will be 11.5 percent for all of 2012, before “gradually increasing to 12.5 percent by 2014,” Marcus Fernandes, a Standard & Poor’s credit analyst in Sao Paulo, said in a Dec. 26 report.

Demand could be in the “hundreds” of planes in future orders tied to United and AMR, said Raymond Neidl, an independent aviation analyst based in Connecticut.

Interest in regional jets is increasing because new, larger versions can handle longer routes more efficiently, Neidl said in a phone interview. U.S. carriers are shifting to planes with 76 seats or more from Embraer and Bombardier models with as few as 37 seats.

“The Embraer products seem to meet their needs,” Neidl said. “Long-term, I think they’ve got the right product, right time, right place, right cost.”

Order Prospects

United and AMR, which is restructuring in bankruptcy, aren’t discussing specifics of their fleet plans, spokesmen said yesterday. Pilots at both companies ratified contracts last month giving the airlines the right to fly larger regional planes at their commuter partners, where labor costs are lower.

Embraer planes accounted for 198 of the 245 regional jets in AMR’s American Eagle fleet as of Sept. 30, according to the airline’s latest filing. Embraer had 307 jets in service at regional partners for United through July, compared with 190 for Bombardier, a filing from the carrier showed.

CEO Curado told analysts in October that there was “growing activity” building toward possible sales to U.S. airlines.

“Probably 2013 there will be a much more intense activity and maybe -- I’ll say probably -- some decisions happening in that regard,” Curado said on the call. He said at the Farnborough air show in England in July that Embraer was counting on U.S. orders to make up for a demand slump in Europe.

Buy Rating

Peter Skibitski, a Drexel Hamilton analyst, said in a Dec. 27 report that he is keeping his buy rating on Embraer, citing reasons that included anticipated United and American orders and expectations for growth in the business-jet and defense segments. Embraer had firm orders of $12.4 billion through the third quarter, while Bombardier’s backlog was $26.1 billion.

The Brazilian company is spending about $2 billion to reconfigure its E-170 and E-190 jets with a new engine and new wings by 2018.

Embraer also is awaiting a decision that may come early this year on a U.S. military contract for light-attack aircraft, after losing an initial order following an appeal from a U.S. rival, and has invested in business jets at a time when competitors have pulled back.

Regional jets are still “a big part of the business and they have to continually improve the business because airlines demand it and competitors are doing so,” said Foley, the consultant. “It’s a pretty small universe. While it wasn’t their turn this time, next time it probably will be.”