Should Embraer build larger commercial aircraft?

There was a flutter of news recently after the WSJ reported Embraer would build larger aircraft to compete with Airbus and Boeing. Just how realistic is this? In this story, we make the case for and the case against Embraer joining the fight with the duopoly in the narrow-body market. The case for building a larger commercial aircraft: There has never been a better time for such a move. The duopoly has a backlog that is between seven and ten years out. The supply chain is stressed, supporting the duopoly. COMAC and UAC cannot move into the market demand and supply gap. Only Embraer has the experience, IP, and ability to enter the gap. The best example of its ability to "go bigger" is the C-390, which competes with the C-130. Embraer has a superb record of on-budget and on-time program development. Embraer is less dependent on the industry supply chain as it builds more of its parts internally. Without a track record in that market, Embraer may need to "buy" into the business with lower initial ROI The competing designs began operating in 1967 and 1989, with older DNA than a fresh clean-sheet design. The case against building a larger commercial aircraft: Embraer would need access to about $30Bn to develop such an aircraft. TAC reports that the OEM is chasing this. In addition, Embraer would need to upsize its workforce significantly. Time is the next big hurdle. Can Embraer go from computer screen to test aircraft within five years? And if it could, what market segment would it aim for? The single-aisle sweet spot has moved from 150 seats to 180+—essentially a 757-sized model—and turning that into a family of at least two models (perhaps 180 & 210 seats). These aircraft require first-class support. Embraer has some exposure to big airlines, as opposed to regionals. But selling a plane to a top-tier carrier is risky for both. Yet Embraer got a shout-out from American's CEO, and they already sell to KLM, Singapore Airlines, and other top-tier airlines. Embraer may need lower prices than Airbus or Boeing, as the existing duopoly can squeeze it with combined deals. Embraer's entry into the market could spur one or both duopoly players to invest in a new narrow-body program to improve their competitiveness. Duopoly and Risk The big issue here is risk management. Boeing's next aircraft program is valued at $30Bn on the low side and $50Bn on the high end. We think Embraer's cost structure could allow it to accomplish a program at a lower number. Airlines and lessors would love to see a new entrant into the duopoly. The truth is, so should the two duopoly members. Airbus would face a far more stable market environment if Boeing were not so unstable. The supply chain would equally be happier to have more market stability. The more competitive the market, the sharper all the players must be. That, ultimately, works in everyone's favor. After all, who loses? Even though Boeing is distressed, it remains a formidable player. It has tremendous resources and can develop and deliver a market winner. Boeing's challenge is not technology, IP, or talent. The problem is management and the culture it created. Those problems are fixable. It would be far worse if Boeing lacked IP, technology, and talent - as was the case at McDonnell Douglas. Embraer weathered a terrific shock from the Boeing merger rejection. That experience hardened its culture. The challenge for Embraer is "what's next"? eVTOL is one direction. Regional flying remains its core domain, and it has a plan for it via the Energia project. The gap is the E2 program, which is seeing much slower adoption than expected. Airbus has the means to struggle through the A220 hiccups and create cocktail deals combining other models with the A220. Embraer can't do this, and neither can Boeing. They needed each other for that. But we don't see Embraer going down that road again anytime soon. Embraer faces risks when moving beyond regional flying, and it must do this. The big money is with bigger airplanes. The market would be jolted if Embraer presented a 180-200 seater idea. Recall that Airbus saw the threat of the Bombardier CSeries, not Boeing. Embraer saw it, too, and took its time to develop the E2, which shows Embraer has the strategic ability to pivot and defend its turf. However, it does not have the critical mass to take on Airbus or Boeing. Yet it must, as regional flying is essentially a North American market, and it's shrinking. If Embraeris remains in commercial aviation, it must move into the duopoly turf. This is a nasty, no-holds-barred market - the MMA of aerospace. Airbus and Boeing can be expected to be brutal. However, given the duopoly's current state, perhaps the two giants are distracted enough by their backlogs and other challenges. After all, they account for ~95% of deliveries. Moreover, they are watching China and COMAC warily. That is where they think the threat is coming from, not south of the equator. If Embraer can assemble a phalanx of capital from patient investors, as suggested by TAC (sovereign funds), it may move forward with much lower risk. Moreover, these sovereign funds are natural customers. Several lessors have these funds as investors, so they understand the business. Moreover, the Global South is growing. Saudi Arabia has a very deep pocket and wants to prepare for a less oil-dependent future. Aerospace is not only a viable path but also a great creator of IP. One can readily imagine aerospace IP created by Brazil, Saudi Arabia, and other partners. These partners could all have roles in designing, building, and supplying parts for a future, let's call it the E-x program. In summary, despite the risk of duopoly reaction and the market risks, there has never been a better time than now for Embraer to break out from its current market position as a top-tier regional aircraft maker. The C-390 proves it can go bigger. The company must move forward while the future is somewhat muddled for the duopoly. The time to act is now.

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