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Morningstar | Embraer 3Q Revenues and Margins Fall due to Weakness from Regional Jet Business

Embraer continues to work through its transition to the new E2 models and the third quarter featured pressure on revenues and profitability due to poor performance out of commercial aviation. Boeing’s acquisition of 80% of Embraer’s commercial jet business looks increasingly likely due to the election of Jair Bolsonaro as Brazil’s next president and after incorporating the transaction we arrive at a new fair value of $23 compared to $25 previously. We’ve maintained our narrow moat rating for Embraer, but we plan to revisit this nearer to deal closure, which we anticipate occurring in late 2019.

Revenues this quarter fell 11.5% year over year, as lower deliveries led to a decline in commercial aviation revenues for the fifth quarter in a row and pushed operating margins down to just 1.1%. Consolidated adjusted operating margins contracted 60 basis points to 3.9% and management reiterated 5%-6% margins for 2018.

Despite higher priced E2 jets entering the mix, we continue to anticipate basically flat full-year commercial revenue for 2019 on the back of slightly lower deliveries (we're at 82 deliveries in 2019 versus 88 in 2018). Defense & security and executive jets enjoyed solid top-line expansion with both notching growth of 43% and 48%, respectively. We’d note that executive jets’ revenue growth was partially underpinned by an easy comparable and that management is now guiding toward the bottom end of its 2018 delivery range (around 105 aircraft). We’ve moved down our forecast in response.

Although backlog collapsed because of the removal of the SkyWest order, the defense business was a bright spot. Management highlighted the already announced downselection it received from the Brazilian navy for the corvette class program, while also touting the light attack program in the U.S. as an opportunity. The services and support unit grew 2.6% year over year and continues to post some of the best profitability across Embraer with 10.7% operating margins this quarter.