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Do You Know What Steven Cohen Is Doing in Aerospace?

November 07, 2013 | About:
The aerospace industry has seen several up and downs due to rising gas prices, technical failures, and a global economic crisis. Now, amid a more optimistic economic environment and current commercial planes being replaced, hopes for the industry appear to light up again. However, no future is secured unless an economic moat is dug. That is exactly the characteristic shared by Empresa Brasileira de Aeronáutica (ERJ) and The Boeing Company (BA).

Sequestering Growth Elsewhere

The Boeing Company has been touched by the sequester as its activities are concerned with defense equipment, in addition to commercial airplanes and finances. Hence, competitors are not limited to Airbus, and include defense contractors Lockheed Martin, Northrop Grumman, and General Dynamics. Consequently, the company´s most important segment is the defense segment. And according to the firm’s chairman "Consistently strong operating performance is driving higher earnings, revenue and cash flow as we deliver on our record backlog and return increased value to shareholders."

Commercial airlines have identified a positive trend on commercial travel frequency. This has worked as an additional enticement for companies to renew their fleet, and address the fuel efficiency issue at the same time. This is the context in which positive prospects for The Boeing Company continue to grow. According to management, production of the 737 model is expected to increase to 10 units each month by year-end 2013 and the production of the 787 model to 42 per month by mid-2014.

The greatest threat to The Boeing Company is the sequester, because the defense segment contributes with 40% of total revenues. The problem arises because its products are not a top priority for the Department of Defense. So far, its financial strength and diverse portfolio provided the firm with the strength to face current difficulties. Surprisingly, overall performance improved during the last quarter due to higher deliveries and a steady flow of orders. Another upside has been a higher international demand for fighter jets, the rotorcraft line-up, and 737-based military derivatives.

The balance sheet for The Boeing Company is strong. Trading at 23.6 times its trailing earnings, the stock carries a 17% premium to the industry average. Andreas Halversen and Primecap Management have reduced their stake in the company during the first half of the year. Steven Cohen the fourth largest guru with a position, made a great bid on the company and I share his optimism.

The Southern Giant

Empresa Brasileira de Aeronáutica’s strongest segment is Regional jets, and shares the global duopoly for small commercial aircraft manufacturing with Bombardier of Canada. Activities have also spread to the defense sector in relation to the development of the successful Tucano and Super Tucano models. As of today, the most ambitious plan is the production of a medium-size, twin-engine jet-powered military transport aircraft baptized KC-390. Although the project is led by the Brazilian manufacturer, several regional counterparts are expected to take part on the production phase.

Looking forward, Empresa Brasileira de Aeronáutica has several growth catalysts. To start with, the KC-390 is destined to replace all Lockheed Martin HC-130´s in the region. Also, the introduction of medium-size business jets Legacy 450 and 500 has widened product offering. More, the company has launched the advanced E-2 commercial aircraft, and the E175-E2 variant already counts with 100 orders and another 100 purchase rights. The commercial jets segment has allowed the Brazilian manufacturer to continue expanding internationally, especially in the European continent.

Empresa Brasileira de Aeronáutica´s future plans continue to be driven by capital spending for research and product development. This is not surprising since Brazil´s National Defense Strategy has included the company as one of the pillars for the national development. Hence, just like many North American contractors, Empresa Brasileira de Aeronáutica counts with the backing of the Brazilian government. Among other things, reductions on import/export fees, as well as enticement packages are expected to be provided by authorities. This explains in great part the emphasis placed by the firm on research and development.

Financially, Empresa Brasileira de Aeronáutica is strong and operates greater margins than The Boeing Company. Currently trading at 26.9 its trailing earnings, the stock packs a 35% premium to the industry average. While the largest guru holding a stake in the firm, Charles Brandes continues to reduce his stake and enjoy the benefits of early investment, Steven Cohen followed suit. I share their pessimism given the sudden drop on stock face value.

Military and Government Backing

At this point I continue to prefer Empresa Brasileira de Aeronáutica over The Boeing Company. I believe the Brazilian manufacturer possesses a great deal of growth catalysts. Additionally, the firm counts with the backing of the military and government authorities. However, I recommend waiting until stock price touches bottom in order to offset the current premium.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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