Nov. 22, 2016: UBS resumed coverage on Embraer (NYSE: ERJ) today, rating the stock a Sell. It is the only Sell rating among seven analysts previously covering the company; six are Buys and one is Hold. UBS rated ERJ Neutral prior to suspending coverage.
“We are skeptical of its ability to monetize its nearly $2bn investment in its next generation “E2” commercial aircraft while its midsize bizjet ramp-up is largely behind and competitive growth from Cessna is accelerating. ERJ trades at a ~10% discount to aerospace peers, about in line with its historical discount, but we think a bigger discount is warranted given its slowing growth outlook and still breakeven to negative FCF,” UBS wrote today.
UBS zeroed in on the E175-E2, slated for introduction in 2020, as the prime reason for its Sell rating.
The airplane is over the maximum weight allowed in US pilot labor contracts, the so-called Scope Clause, that permits the major airlines to contract out small airplane services to regional carriers.
The Scope Clauses limit the weight of the airplane, the number of passengers and the number of airplanes permitted to be operated by the regional airlines on behalf of the majors.
“We had been assuming that the pilots would eventually sign off on a weight limit increase, allowing for outsourced “E2” operations,” UBS wrote. “However, our recent meetings with the leadership of AAL’s pilots’ union, indicated that they have no intention of doing so, and our follow-up conversation with John Slattery, the head of ERJ’s Commercial Aerospace business, confirmed this roadblock, not just at AAL, but at DAL/UAL too. We don’t think AAL/DAL/UAL would procure “E2” without the ability to outsource its operation as flying it at the mainline is prohibitively expensive. This puts the viability of the E175-E2 at risk since most of the demand for it originates at those three airlines.”
Embraer recognizes the problem and plans to continue production of an improved E175-E1 if no relief comes on the Scope Clauses.
Embraer stock was of 5% in early trading today.