Time to Buy Embraer?
May 28th 2013 10:30AM
Updated May 28th 2013 11:00AM
What a difference a mega-order makes! Recently, I discussed Embraer's disappointing first quarter in light of its long-term prospects. At the time, I put forward that if Embraer could add another $1 billion-$2 billion in orders to its backlog, a missing puzzle piece would fall into place, making this company a persuasive investment candidate. Last week's announcement of a significant order from regional airline SkyWest, , provides a $4.1 billion jigsaw cutout to complete Embraer's picture.
Details of the deal
SkyWest has given Embraer a firm commitment for 40 E-175 "E-Jets". These planes will be added to Embraer's second-quarter 2013 backlog. At the end of the first quarter, the backlog stood at $13.3 billion. The next 60 planes to be produced (which will bring the order total to $4.1 billion) are contingent upon SkyWest completing Capacity Purchase Agreements, or CPAs, with various airlines. SkyWest is a regional carrier for airlines such as Delta, United, American Airlines, and US Airways. It operates under many of these airlines' familiar express brands, including Delta Connection, United Express, American Eagle, and US Airways Express. SkyWest also has the option to purchase 100 additional E-175s. If exercised completely, the options would increase the current deal total to $8.2 billion.
Relevant big picture items
The 40 planes which constitute the first portion of this order will all be dedicated to United Continental's United Express. This is on the heels of a United order for 30 E-175s a few weeks ago, which will also fly under the United Express livery. The two orders together represent a significant investment by United in the fuel-efficient E-175 platform, but it's spreading the financial risk by owning 30 planes outright on its books, and purchasing capacity from SkyWest, which will have title to 40 planes.
Another interesting point, noted last week by The Wall Street Journal, is that you can read Embraer's influx of new orders, along with other anecdotal information in manufacturing, as a portent of global economic recovery. This is because regional travel of the kind that Embraer's smaller E-175 jets enable is associated with both increased corporate trade and tourism.
Bulking up the pipeline
Embraer's big SkyWest order will increase its order backlog significantly. Latin American investment banking firm BTG Pactual estimates that the first 100 planes, if fulfilled, will increase Embraer's total backlog by 20%. An increase of 20% would bring Embraer's backlog to roughly $16 billion. If you doubt the power of a robust order backlog, look no further than Boeing . At $392 billion, Boeing's total order backlog is roughly equal to the GDP of South Africa. The long cue of orders served as a primary support for Boeing's stock price when the new Dreamliner 787 was grounded for 123 days earlier this year. In fact, Boeing's stock is up roughly 27% year to date. A substantial dollar amount of orders in a company's pipeline can help insulate it from near-term problems in the eyes of investors. Now, Boeing has one of the largest sales backlogs of any company in any industry. How does Embraer's backlog compare to Boeing's? We can level the comparison if we consider each company's backlog in relation to current annual revenue:
As you can see, Boeing's backlog is roughly equal to five times its annual revenue.* Accounting for the new SkyWest order (and assuming that the first 100 planes are fulfilled), Embraer's backlog stands at 2.6 times annual revenue. Posting a metric that is more than 50% of Boeing's in this category is no small feat. Maintaining this metric at the current level for the next several quarters will be a sign of sustained financial strength for Embraer.
A decent entry point
Despite Embraer's poor first quarter of 2013, in which net income declined 70% from the prior year's comparative quarter, the company now has some momentum behind it which should help it outperform. While its trailing-12-month P/E ratio seems high at 24.3, I believe this is largely a function of the stock price holding up even in the light of disappointing earnings. As Embraer's earnings improve over the next year, this ratio will likely normalize, and it may even increase slightly. For those who were inclined to buy Embraer but were waiting for a rebound, this is not a bad time to start constructing a position.
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* Incidentally, this calculation is similar to, but not the same as the "Sales/Backlog Ratio," which is a predictor of future sales and uses quarterly revenue in its numerator.
The article Time to Buy Embraer? originally appeared on Fool.com.Fool contributor Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends Embraer-Empresa Brasileira. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.