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Morningstar | Embraer Puts a Tough 2018 to Bed, Looks Ahead to Forming Two Joint Ventures With Boeing in 2019

Narrow-moat Embraer reported weak 2018 results that featured a full-year revenue decline of 13% and adjusted EBIT margins of 4.4%. Embraer also took an impairment on assets related to the Lineage business jet program due to weak demand and faced additional KC-390 charges this quarter. Guidance for 2019 mirrored the initial outlook given at the January investor day: $5.5 billion of revenue at the midpoint coupled with break-even EBIT. We’re maintaining our fair value estimate of $23 per ADR. The stock looks a bit undervalued at price/fair value of 0.85 and we'd note that the anticipated $3 billion of net proceeds from the sale of commercial aviation to Boeing represents about $16 per ADR.

For 2019, management still envisions $5.3 billion-$5.7 billion in revenue on the back of 90 E jet deliveries (flat year over year) and 100 business jet deliveries. EBIT for 2019 is pegged at breakeven, including separation costs to form a commercial aviation JV with Boeing. Although management declined to give details on these separation costs, they have previously stated that excluding these costs results in margins roughly similar to 2018. Based on this, we calculate one-time separation costs in the range of $250 million-$300 million.

Management anticipates the planned sale of its commercial aviation business to Boeing, which will control 80% of the commercial aviation joint venture post close, will be consummated by year-end 2019. We're already modeling in this divestment, which results in a drop in revenues and profits as Embraer’s largest unit is deconsolidated. Concomitant with the deal close, Boeing will form a JV with Embraer to market the KC-390 transport.

Management confirmed its 2020 targets on the call. The 2020 outlook still stands at $2.5 billion-$2.8 billion of revenue, 2%-5% EBIT margins, and break-even cash flow. These figures do not include any potential synergies from leveraging the commercial aviation JV's anticipated buying power thanks to Boeing.

We are bit disappointed with the 2%-5% margins even when excluding synergies because this indicates little to no improvement over today's profitability. Management reiterated that its 2020 view is conservative, and we think it’s possible that there is a contingency for the KC-390 in the numbers, which will still be ramping up after the delivery of two aircraft to the Brazilian air force later this year. We’re at 4.1% operating margins in 2020 (4.1% in defense, 3.2% in executive aviation, and 6.5% in services) on consolidated revenue of $2.7 billion.