Has Embraer turned the corner? – Part 1

Embraer, in the last few years, has been hit by several events outside of its control, including the deal breakup with Boeing, the global pandemic, and continued pilot union intransigence regarding the scope clause, impacting the regional jet segment in its largest global market. The impacts of these actions sent revenues plummeting from $5.4 billion in 2019 to $3.7 billion in 2020, which recovered to $4.5 billion in 2022. The company is projecting revenues between $5.2 and $5.7 billion in 2023, which would be close to 2019 results before the multiple crises.

Their CEO, Francisco Gomes Neto, has set a target of $8 billion in revenue in 2027, an ambitious growth plan. Has Embraer turned the corner since the Boeing breakup and global pandemic in 2020? We’ll examine that question market segment by market segment.

Embraer has four major business segments: commercial aircraft, business aircraft, military aircraft, and services and support. The company also holds the majority of equity in Eve, the leader in urban mobility that it spun off as an IPO to fund development. In this series of articles, we will examine each of the sectors and comment on the near and longer-term outlooks for each business unit.

Commercial Aviation

The largest business segment at Embraer, the company currently manufacturers the E2 series of small mainline passenger jets under 150 seats and the first generation E175 regional jet aimed at the US market. The pilot union scope clause in labor contracts with the major airlines in the US limits the number of regional jets, passenger seats, and gross weight of the aircraft and varies slightly by contract.

Embraer had planned an E2 version of the E175, but postponed it due to the higher weight of the new technology engines, which pushed the aircraft over the current contractual weight limit. The airlines and Embraer were unable to convince the unions to relax the weight restriction of the scope clause. As a result, Embraer must offer an older technology alternative to the US market, something that makes no sense from an environmental or logical standpoint, since seating capacity, number of aircraft, and number of pilot jobs would remain the same.

The planned merger with Boeing would have enabled Embraer aircraft to seamlessly be sold in “package deals” to airlines that might have included the E190-E2 or E195-E2 bundled with larger Boeing MAX and wide-body aircraft with airline customers. Airbus, which acquired the competing CSeries from Bombardier and renamed it A220, can bundle its small mainline jets with the A320 family and offer discounting based on higher volumes. In the post-Boeing world, Embraer has been forced to change its marketing approach and become more aggressive in cost-cutting to match more aggressive competitive pricing.

The good news is that Embraer has been able to reduce costs and focus on improving its market penetration. The company has seen orders increase in the post-pandemic environment, signing Royal Jordanian, Scoot, and SKS Airways in Malaysia to E190-E2 or E195-E2 deals. Canada’s Porter Airlines, who signed for 50 aircraft, will be a showcase for the aircraft in North America, and Embraer is hoping for a mainline aircraft breakthrough in the US market.

Historically, Embraer’s sales levels for the E-Jets were robust, but the Boeing breakup and global pandemic crashed sales in 2020. The following chart shows historic deliveries by aircraft type from 2017-2022.

Embraer has re-established a target to produce 100 commercial aircraft per year, a level it has not come close to over the last couple of years. That will require additional penetration of the US market, which without the E175-E2, has not provided much incentive for change. While there are older E175s that will approach 20 years in service soon, the bulk of a potential replacement wave will occur in the 2024-2030 time frame.

As the chart shows, the sales drop-off was rapid, but the recovery is proceeding much slower. Getting back to 100 aircraft per year before 2026-2027 will be a challenge for Embraer. One element of the challenge is that the latest version of the E175 is only about 7 percent better than the first models delivered, versus about a 20-25 percent improvement if the E2 version became available in the US.

Only one manufacturer left

The good news for Embraer is that Bombardier is no longer in the regional market and Mitsubishi cancelled its competing program, leaving it the only manufacturer, despite being forced to offer old technology in the US market. There simply isn’t another choice available to airlines who need regional jet lift. Older airplanes will eventually wear out and need replacement, and Embraer currently has no competition in the 76 seat range.

The E2 models, in the 100-150 seat market, have also been impacted by teething pains with the Pratt & Whitney GTF engine family. While the impact of reliability has not been as severe at Embraer as it has been on the Airbus A220 and A320 family, the impacts are being managed by Embraer as best as possible.

Fortunately, the Embraer engine was introduced later than the Airbus model, and several improvements were incorporated early on in the program. Nonetheless, the issue of combustor reliability remains not fully solved for all GTF models. The impact of supply chain issues remains at P&W, but are impacting Embraer less than Airbus, as the E2 jets are the lightest aircraft using the GTF the engines, therefore don’t work quite as hard, and combustor liner wear is less severe. But it is an issue.

Embraer is already thinking about potential trade-ins of older aircraft, and has begun a passenger to freighter cargo conversion for E1 jets. This aircraft would fill a niche for smaller freighters and could be a good fit within some cargo networks, and we would expect some success given the unique size of the aircraft in the cargo market. Nonetheless, with many 737NG and A320ceo family aircraft also being converted to freighters, that market niche may not be very large.

The Turboprop is off the drawing board 

Looking to the future, activity on the next-generation turboprop program has been stopped due to the lack of substantial improvements in engine technology. While the turboprop engine OEMs have offered updated engines, they do not as yet provide the economics for the compelling business case that Embraer is looking for to invest in this market.

As a result, we are likely five years or more away from a brand new innovative turboprop design getting a go-ahead, and entry into service has slipped into the early 2030s. “If it happens at all”, added Arjan Meijer, President and CEO of Commercial Aviation. That leaves ATR with a virtual monopoly in the large turboprop niche given De Havilland Canada’s production cessation.

The bottom line for Commercial

Embraer is recovering in the commercial market, and now has more than 70 E2 aircraft in service after the first delivery in 2018. The E2 finally appears to be gaining some traction in the marketplace, but only after a slower than anticipated and difficult start competing against bundled deals from Airbus and the A220.

The E175 will still be needed for regional flying in the US, and is the only alternative remaining for regional jets. We do not expect competition any time soon, providing Embraer a market advantage in the large US regional market.

For the E2 jets, the largest model, the E195-E2 is the best selling variant, with better seat mile economics than its smaller counterpart. This aircraft is an ideal replacement for older 737-700 and Airbus A319 models currently in service that Airbus is targeting with the A220-300. This is a close and tough battle for Embraer, which lacks the leverage of bundling multiple aircraft types together in a package deal for airlines. Embraer fits only the 100-150 seats segment with its E2 jets, versus a wide range of products from Airbus.

Nonetheless, the recovery for Embraer in commercial aircraft appears to be well underway, but will be a slower climb back to the 100 aircraft per year goal than the rapid downturn during the pandemic and Boeing breakup. The future for the E2 Jets is improving, particularly the E195-E2, even with strong competition from the Airbus A220-300, and the E175 remains the only choice for new regional jet aircraft in the 76 seat category. Is the goal of 100 aircraft by 2027 feasible? Yes, but this may be the most challenging segment within Embraer’s portfolio in the near term. But as the company’s largest revenue segment, success with the E2 jets and the E175 will be critical in the next four years.

Our view is that the outlooking is indeed improving, and beginning to move in the right direction, albeit potentially a bit slower than Embraer would like.

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