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On Jan 15, we downgraded aircraft manufacturing company, Embraer S.A. (ERJ - Analyst Report), to Underperform based on the company’s loss of a major contract from Delta Airlines in mid November 2012.

Why the Downgrade?

Estimates for Embraer, which focuses on the aerospace and defense markets, have been declining since it lost an important contract from Delta Airlines in mid November last year, which went to its arch rival Bombardier Inc., based in Canada. The order consisted of 40 regional jets with a capacity of 50 passengers. The contract value was vital for Embraer in terms of revenue generation, due to which the estimates have been revised downwards.

In the latest reported quarter, ending September 2012, the company reported earnings per share of 36 cents, higher than the earnings of 1 cent per share reported in the year-ago quarter. However, earnings fell short of the Zacks Consensus Estimate of 54 cents. In the last 60 days, the Zacks Consensus Estimate for 2012 as well as 2013 went down by 2.0% and 5.4%, respectively. The company now has a Zacks Rank #5 (Strong Sell).

Cause for Concern

Embraer has a lot of possible contracts in the pipeline, including Light Attack Aircraft, which is to be decided upon in February. Among them are American and Continental regional jet orders. Although Embraer has more probabilities of winning the contracts than rival Bombardier, due to the presence of Embraer jets in the existing fleet of the companies, there always remains an overhang until they are actually won by the company.

On top of this, the increasing cost of raw materials for the company also adds to our concern. Margins for the company are also under pressure, due to the rise in fuel costs along with rise in the selling and general expenses.

The Zacks Consensus Estimate for the second quarter of fiscal 2013 has dropped by two cents to 83 cents, in the last 60 days, on the back of uncertainties of further contract wins. 

Aerospace Stocks That Warrant a Look

We prefer other aerospace and defense stocks like Erickson Air Crane (EAC - Snapshot Report) and BAE Systems Plc (BAESY) to Embraer. These companies hold a Zacks Rank #1 (Strong Buy) and a Zacks Rank #2 (Buy), respectively. As for Embraer, we must wait until we see signs of improvement in the company's performance.

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