Embraer: Not A Buy For Now, But Worth Monitoring

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Embraer SA's ADR has more than doubled YTD, outperforming global airline and international stocks significantly.We touch upon a few reasons why Embraer is worth keeping on your watchlist.Forward ...

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On a YTD basis the share price has more than doubled, and in the process, has ended up delivering a return profile that is 4x higher than other stocks from the global airline industry, and 18x higher than other international stocks!","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"BK4187":"航天航空与国防","LU0823046494.USD":"AMUNDI FUNDS LATIN AMERICA EQUITY \"A2\" (USD) ACC","LU0823046577.USD":"AMUNDI FUNDS LATIN AMERICA EQUITY \"A2\" (USD) INC","ERJ":"巴西航空工业"},"translate_title":"巴西航空工业公司：目前不值得买入，但值得监控","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"ERJ":0.9},"content_text":"Embraer SA's ADR has more than doubled YTD, outperforming global airline and international stocks significantly.We touch upon a few reasons why Embraer is worth keeping on your watchlist.Forward valuations are not cheap, but the sturdy EBITDA outlook through FY26 may help mitigate that.ERJ is seeing strong momentum, but the risk-reward does not look appealing, and it remains one of the more overbought stocks in the aviation industry.   primeimages/E+ via Getty Images Introduction The ADR of the Brazilian-based – Embraer SA (NYSE:ERJ), a manufacturer of jets, with a tilt towards the sub-150 seat category in the commercial sector, has experienced an exemplary 2024 so far. On a YTD basis the share price has more than doubled, and in the process, has ended up delivering a return profile that is 4x higher than other stocks from the global airline industry, and 18x higher than other international stocks!   YChartsSo, should you be pursuing this highflyer? Why Embraer Should Be On Your Watchlist One of the more appealing aspects of the Embraer story is that you get a healthy chunk of diversification, within the broader aerospace & defense spectrum.   Investor Day Presentation 2024The current backlog (at 9-year highs of $22.7bn) tilts more towards the commercial aerospace segment (49%), but this is mainly because deliveries in the segment are getting hamstrung on account of supply chain delays. Nonetheless, even as the commercial segment hasn’t been at full tilt, the executive segment, which contributed 27% of last year’s revenue has been on fire, growing by a whopping 65% in Q3 (the executive segment aircraft deliveries have largely always taken place in Q4, but ERJ management has been implementing a production leveling plan designed to stimulate production in other quarters, and the fact that Q3 saw a sturdy 46% spike in deliveries alone, suggest that the leveling initiatives have been paying off). Abetting the executive aircraft segment, you also have the Defense & Security segment which also saw a 65% growth in revenue and a 70% q-o-q and y-o-y spike in its backlog. Amidst all this ERJ also runs a very profitable (9m-24 EBIT margins of 16.4% vs 10.3% for the whole company) after-market segment (Services & Support) that supplements the operations of the other three divisions. Coming back to the commercial aviation segment, prospects here still look very bright once the supply chain issues dissipate. We are particularly enthused by the Embrauer’s single-aisle small narrow body (NB) aircraft- The Embraer E-Jets E2 (it accounted for 75% of total deliveries from this segment), which is likely to benefit from additional appetite from mainliners and low-cost carriers that are looking for economical options even as they deal with significant aging of the fleet in the sub-150 seat category. These E2s offer great value proposition for low-density operations, as they offer a similar cost per seat as a larger NB, but with higher profitability.   Investor Day Presentation 2024Operationally as well, Embraer as a whole is expected to be more resolute as they are currently implementing a slew of measures across the enterprise, which encompass improvements on the supply chain front, cost of goods, inventory management, digital initiatives, better forecasting, production linearity, etc.   Investor Day Presentation 2024It's worth noting because of these initiatives, and better deliveries from the Commercial segment going forward, ERJ’s adjusted EBIT margins (not including the impact of the Boeing agreement) which are currently around the 6-7% levels, are expected to hit high single digits or even double-digits over the next few years. Management also deserves great credit (no pun intended) for reducing the level of financing gearing over time. Three years back, they had an inordinate level of debt, relative to their EBITDA at almost 4x; now the leverage ratio stands at a very comfortable level of just 1.3x, prompting two of the three prominent rating agencies to once again assign an investment grade status (Fitch revised its rating a couple of months back, following S&P’s stance in February, and one would think Moody’s will follow suit, soon enough). Also, what’s comforting to note is that ERJ does not have any major debt obligations due through FY26.   Investor Day Presentation 2024Supplementing this position, you also have consistently healthy cash generation dynamics. Note that since FY21 ERJ has consistently generated over $300m of adjusted free cash flow per annum; initially it looked like they would fall short of that landmark this year with an expected figure only within the ballpark of $220m, but during the Q3 event management chose to lift their FCF forecasts to over $300m. Note that the current Q4 is typically the strongest quarter of cash flows for ERJ, given that the bulk of aircraft deliveries take place then, and this is further supplemented by a larger chunk of down payments from their defense programs.   Investor Day Presentation 2024Even otherwise, it’s worth noting that ERJ management continues to drive significant efficiencies on the working capital front which help abet the cash flow position. On average, over the past five years, the working capital turnover ratio has come in at 1.7x, but currently it is substantially higher at 2.8x.   YChartsForward Valuations Are Not Cheap, But Sturdy Operating Outlook Helps Mitigate That After a strong run in the share price this year, ERJ's stock is not a particularly cheap stock to own, even if one considers the degree of upward EBITDA revisions that have taken place recently. Following a solid Q3 earnings event on November 8 (the share price expanded by 9% on the day of results), we’ve seen the sell-side lift its EBITDA estimates by quite a significant margin, and effectively, over the last six months, the EBITDA for the year has been boosted by 14%.   YChartsYet, during the same period, ERJ’s market-cap has expanded by over twice that pace at 34%, so much so, that the forward EV/EBITDA multiple has hit double-digit levels at over 11.1x. This essentially translates to an approximate 30% premium over the stock’s long-term average, which is certainly not cheap.   YChartsWe’ve already touched upon the operating improvements that management has been driving, and this is something that is expected to reflect very favorably on ERJ’s outlook through the next three years. This may help explain why the stock is seeing a strong cadence of re-rating.   YChartsThe image above provides revenue and EBITDA estimates of ERJ over the next three years, and the broad takeaway here is that you’re likely to see a tremendous deal of operating leverage through FY26. To elaborate, if we may take last year’s revenue of $5268m and adjusted EBITDA of $563.6m as a base, and run a CAGR through the next three years (based on the numbers above), we’re looking at a business that is poised to generate topline growth of 14%, but EBITDA growth that is 1.47x higher at 21%. Paying 11x EBITDA for a business poised to generate 21% EBITDA growth over three years doesn’t necessarily feel like the worst deal around. Closing Thoughts – Is ERJ Stock A Good Buy Now? Despite all these favorable narratives floating around Embraer, it is questionable if ERJ stock will serve as a good buy at current levels, given what the charts are currently suggesting. Don’t get us wrong, we’re not suggesting that momentum players ought to be perturbed, as the daily chart suggests that the stock continues to trade at a healthy premium over each of its three key moving averages- the 50DMA (10% premium), the 100DMA (17% premium), and the 200DMA (33% premium). Buoyancy here could be explained by the fact that Embraer is currently in its seasonally strongest quarter. However, if one pays attention to the developments on the longer time frame charts, we feel it may be wise not to get carried away at current levels.   InvestingLet’s start with the weekly chart (the image above), which captures the movements since ERJ started trending higher (at the turn of H2-23). From then until now, it’s evident that the price has trended up within the boundaries of an ascending channel. Buying closer to the lower boundary of the channel, and trimming one’s position at the upper boundary would’ve worked well so far. As things stand, the risk-reward on offer is not ideal as the price is rather close to the upper boundary, and a long way off the lower boundary.   InvestingThen if one wants to get a bird’s eye view of things, we may also look at the monthly chart. What this tells us is that historically at around the $39-$41 levels, there's usually been an additional supply of shares which prompts the upward price momentum to peter out and drop lower or flatten out. There have been four separate instances of this (highlighted in yellow); in 2001, 2006, 2013, and 2014. Once again, the stock has now reached the $39-$41 levels, after a rather strong uptrend. We could be wrong, but we suspect the stock will look to take a pause or drift lower, more so as the RSI indicator below is signaling heavily overbought conditions. Either way, our point is that it's probably too late to participate in the current bout of momentum, and investors would be better served waiting on the sidelines until a better entry zone emerges in the future.  Finally, the long case is also dampened by how overbought ERJ looks relative to other airline manufacturers and operators. As things stand, ERJ's relative strength ratio versus its peers is more than double its long-term average of 0.77x and could remain susceptible to some normalization in the future.   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