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Time to Buy Embraer SA (ADR) (ERJ)?

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A Deeper Look At Brazil’s Commodity IndustryWhat a difference a mega-order makes! Recently, I discussed Embraer SA (ADR) (NYSE:ERJ)‘s disappointing first quarter in light of its long-term prospects. At the time, I put forward that if Embraer could add another $1 billion-$2 billion in orders to its backlog, a missing puzzle piece would fall into place, making this company a persuasive investment candidate. Last week’s announcement of a significant order from regional airline SkyWest, Inc. (NASDAQ:SKYW), provides a $4.1 billion jigsaw cutout to complete Embraer SA (ADR) (NYSE:ERJ)’s picture.

Details of the deal
SkyWest, Inc. (NASDAQ:SKYW) has given Embraer SA (ADR) (NYSE:ERJ) a firm commitment for 40 E-175 “E-Jets”. These planes will be added to Embraer’s second-quarter 2013 backlog. At the end of the first quarter, the backlog stood at $13.3 billion. The next 60 planes to be produced (which will bring the order total to $4.1 billion) are contingent upon SkyWest, Inc. (NASDAQ:SKYW) completing Capacity Purchase Agreements, or CPAs, with various airlines. SkyWest is a regional carrier for airlines such as Delta, United, American Airlines, and US Airways. It operates under many of these airlines’ familiar express brands, including Delta Connection, United Express, American Eagle, and US Airways Express. SkyWest also has the option to purchase 100 additional E-175s. If exercised completely, the options would increase the current deal total to $8.2 billion.

Relevant big picture items
The 40 planes which constitute the first portion of this order will all be dedicated to United Continental Holdings Inc (NYSE:UAL)‘s United Express. This is on the heels of a United order for 30 E-175s a few weeks ago, which will also fly under the United Express livery. The two orders together represent a significant investment by United Continental Holdings Inc (NYSE:UAL) in the fuel-efficient E-175 platform, but it’s spreading the financial risk by owning 30 planes outright on its books, and purchasing capacity from SkyWest, which will have title to 40 planes.

Another interesting point, noted last week by The Wall Street Journal, is that you can read Embraer SA (ADR) (NYSE:ERJ)’s influx of new orders, along with other anecdotal information in manufacturing, as a portent of global economic recovery. This is because regional travel of the kind that Embraer SA (ADR) (NYSE:ERJ)’s smaller E-175 jets enable is associated with both increased corporate trade and tourism.

Bulking up the pipeline
Embraer’s big SkyWest order will increase its order backlog significantly. Latin American investment banking firm BTG Pactual estimates that the first 100 planes, if fulfilled, will increase Embraer’s total backlog by 20%. An increase of 20% would bring Embraer’s backlog to roughly $16 billion. If you doubt the power of a robust order backlog, look no further than The Boeing Company (NYSE:BA). At $392 billion, The Boeing Company (NYSE:BA)‘s total order backlog is roughly equal to the GDP of South Africa. The long cue of orders served as a primary support for The Boeing Company (NYSE:BA)‘s stock price when the new Dreamliner 787 was grounded for 123 days earlier this year. In fact, Boeing’s stock is up roughly 27% year to date. A substantial dollar amount of orders in a company’s pipeline can help insulate it from near-term problems in the eyes of investors. Now, Boeing has one of the largest sales backlogs of any company in any industry. How does Embraer SA (ADR) (NYSE:ERJ)‘s backlog compare to Boeing’s? We can level the comparison if we consider each company’s backlog in relation to current annual revenue:

Company Backlog Annual Revenue Backlog/Revenue
Boeing $392.00 $81.20 4.8
Embraer $15.97 $6.11 2.6

Source: SEC Filings, company press releases, and author calculations. All dollar figures in billions.

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