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Private jets are seen at the Embraer headquarters in Sao Jose dos Campos, 100 km (62 miles) from Sao Paulo May 14, 2013.NACHO DOCE/Reuters

With the investment deal between Quebec and Bombardier Inc. finalized, eyes turn to whether the federal government will make a similar $1-billion investment in the company's C Series program. That works out to about $28 for every one of the roughly 35 million men, women and children in Canada.

As it happens, the American depositary receipts of Embraer SA, one of Bombardier's chief competitors, trade for the equivalent of about $28 (Canadian) on the New York Stock Exchange. This is near its 52-week low, as concerns about the Brazilian economy and a surprise CEO transition have combined with general investor worries to beat down the shares.

Embraer, however, offers an on-schedule program for the introduction of its next aircraft, as well as some of the best margins in the industry – available via a stock trading at the lowest earnings multiples of its peers. If you'll pardon the lack of patriotism, they represent an interesting hedge for Canadians who may end up investing, involuntarily, in Bombardier.

The business of jet making has a size-based hierarchy. Boeing Co. and Airbus Group SE, which are easily the industry's two most valuable companies, also happen to make the biggest airplanes, the multiaisle behemoths suited for carrying hundreds of passengers for overseas travel. They also dominate the market for narrow-body or "single-aisle" aircraft, which range from 100 to 300 passengers and have a shorter flying range.

Bombardier and Embraer have historically operated a tick below, in what are called "regional" jets, which also – confusingly – have a single aisle but have an even shorter flying range and carry fewer passengers, say 50 to 100, than the narrow-body planes.

Bombardier's C Series, rather famously, is an attempt to move up this food chain with 100- to 160-seat planes. This plan attracted the attention of, and competition from, Boeing and Airbus. The C Series delays have made it deeply uncertain just how much business Bombardier can capture from the two giants.

What has been more clear, however, is that Embraer has been winning business in the regional-jet market with its own series of planes that top out at 130 seats, says analyst Chris Higgins of Morningstar. "Thanks to this first-mover advantage and superior products, Embraer steadily took market share from the then-leader Bombardier, eventually surpassing the Canadian firm," he wrote in a recent report. "Embraer is now the market leader, in our opinion."

Embraer still must play catch-up in the even-smaller business-jet market, in which Gulfstream Aerospace Corp. and Bombardier lead with 30 per cent share apiece, compared with Embraer's 7 per cent. Its Phenom 3000 aircraft has registered "impressive growth," Mr. Higgins says, and he estimates the company can hit $1.9-billion (U.S.) in business jet sales this year, compared with just $278-million 10 years ago.

The Embraer story is not all planes, though. Citigroup Global Markets Inc. analyst Stephen Trent says investors are overlooking Embraer's emerging defence-business segment. Brazil has adopted the company's Sisfron border protection product – a system of sensors, computer networks and communications equipment. It's perhaps no surprise, given Embraer's favoured status in its home country – but Mr. Trent says the company has generated interest from Arab countries in replicating the system.

It all sounds positive, so why the recent lows? Investors have been rightly concerned for some time with Brazil's financial and political instability, with the attendant currency risk with the country's real. While Mr. Higgins of Morningstar considers that the primary problem with investing in Embraer, Citigroup's Mr. Trent notes 45 per cent of the company's currency exposure is hedged, and it has a Florida facility to produce Phenom jets. About half of Embraer's sales come from North America.

The company's recent earnings report saw a small dip in profit margins – but, according to S&P Global Market Intelligence, Embraer still has the best gross margins (revenue minus costs of goods sold) and EBITDA (earnings before interest taxes depreciation and amortization) among Airbus, Boeing and Bombardier.

In addition, the market was caught off guard when Embraer said June 10 that chief executive officer Fred Curado, just 54, would step down in July as part of a "planned transition" of which outsiders seemed unaware. The company's president and CEO of commercial aviation, 54-year-old Paulo Cesar de Souza e Silva, will replace him.

Of the 20 analysts following the company, according to Bloomberg, 12 have holds and one has a sell, reflecting the near-term uncertainty and analysts' typical 12-month focus when forecasting returns. However, the shares have dipped enough since the company's most recent earnings report that the average target price of $28.51 represents roughly 33 per cent upside from Friday's close of $21.34.

The buys, of course, see bigger gains, particularly since the current share price levels are at a deep discount to Embraer's norms. Mr. Higgins of Morningstar estimates a $34 "fair value" based on future cash flows, and the shares get four stars in the Morningstar system. (They briefly touched five stars as the stock fell on Mr. Curado's resignation.)

The $33 price target from Deutsche Bank's Myles Walton is, he says, implies a 20-per-cent discount to his targets for the commercial aerospace industry as a whole – "warranted, given macro and currency volatility," he writes.

And S&P Global Market Intelligence equity analyst Jim Corridore writes the recent share declines "overstated issues related to Brazilian defence spending and the Brazilian economy." Mr. Corridore's target price of $32 is 14 times his 2016 earnings estimate, which is "toward the middle" of the stock's historical P/E range. He's impressed with the company's growing backlog of orders, which should improve with the launch of its next-generation EJet E2 plane, with models ranging from 80 to about 130 seats, in 2018.

The larger of the E2s will compete with Bombardier's CS100, say Citigroup's Mr. Trent and his colleague Jason Gursky, who note that "unlike many commercial aircraft development programs of the past 15 years, Embraer's EJet E2 is on time." They say Embraer's potential return on investment "looks much stronger than its closest rivals," and the company's customers are offering positive views about Embraer's after-market support for its planes. As a result, they see "potential upside" on the long-term EJet E2 production numbers.

It sounds like a great opportunity for Canadians.

Jet makers

The business of jet making has a size-based hierarchy. Boeing Co. and Airbus Group SE, which are easily the industry’s two most valuable companies, also happen to make the biggest airplanes. Embraer and Bombardier produce the smallest planes, but the business can also be lucrative, as Embraer has shown. 

CompanyTickerMarket CapNet Debt Enterprise ValueRevenue EBITDA Net Income EV/EBITDAP/EDividend Yield
Boeing Co.BA-N85,0731,65086,78696,5978,7785,0598.214.9 3.3%
Airbus Group SEAIR-ENXTPA45,0662,71147,75971,7805,4362,5616.614.9 2.3%
Embraer S.A.EMBR3-Bovespa4,0331,4305,5646,5826602436.511.1 0.9%
Bombardier Inc.BBD.B-T3,4515,25810,34817,689485-5,60614.6NM-

Source: S&P Global Market Intelligence

In millions of USD; Net debt is debt minus cash; Enterprise value is market capitalization plus net debt; Revenue, EBITDA and net income are for the past 12 months; EBITDA is earnings before interest, taxes, depreciation and amortization; EV/EBITDA and P/E are based on analysts' estimates of future earnings.

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