Monday, September 15, 2014

Embraer and Bombardier: the tale of different companies, histories and fortunes

Last month we did a situational analysis of Boeing and Airbus and we promised to do the same for Embraer and Bombardier. Our follow-up article took longer than planned, as we wanted to include the rather significant changes that have transpired at Bombardier in recent weeks. Material for the analysis is the first half 2014 financial and operational results of the aircraft manufacturers but also information we got when we sat down with the Marketing managers of the two companies at Farnborough, Embraer’s Claudio Carmelier and Bombardier’s Philippe Poutissou. Unfortunately, the latter is no longer in his job, having been replaced in a series of management and corporate restructurings at Bombardier.

Status first half 2014

The situation in the two companies could not be more different. Embraer is financially healthy with well-selling aircraft programs, both on the commercial aircraft side (E-jet) and the business aircraft side (Phenom, Legacy). Embraer is well positioned for the future with a well-received update to its E-jet program (E-jet E2 ) . Bombardier on the other hand, has problems. Its financial situation is strained with too many new aircraft programs eating up cash (CSeries, Learjet 85, Global 7000/8000) and their currently active programs have in some cases seen their zenith in the market (CRJ, Challenger 600 and, arguably, the Q400).

If one looks on the 2014 first half-year results, things look good on the surface for Bombardier with net profits of $270m and EBIT of 5% on the $9.245bn turnover. Looking a bit deeper in the balance sheet, one sees that the company has consumed around $900m in cash over the last year, invested in the many development programs. Cash stands at $2.9bn with a revolving credit at $1.4bn so there is margin, but the cash consumption is significant and the mentioned development programs do not generate positive cash flow anytime soon.

Embraer on the other hand looks better with a similar EBIT on half the turnover ($3.bn) making for an EBIT margin of 9.3%. Embraer’s balance sheet is strong with investments in development almost balanced by generated cash over the last 12 months; the free cash flow is $140m lower now than a year ago.

These financial situations are a mirror of the operational situation in orders and deliveries. While deliveries increased slightly for Bombardier to 62 aircraft from 57 1H2013, the new orders are shrinking with 48 net orders compared to 82 for the same period last fiscal year. The backlog for the present commercial jet, the CRJ, is at 106 aircraft now, slightly up from a backlog of 91 aircraft around this time last year, but it is a backlog which will only last 2.5 years at present production rates, the CSeries is needed to bolster the commercial jet side. For the other regional aircraft program, Q400, it is worse. The low backlog of 1.4 years production of last year (36 aircraft) has not improved this year (35 aircraft) despite a good market for regional turboprops. (A hoped-for firming up of an order for 100 Q400s in Russia stalled as a result of the current global political situation and commercial terms.)

The business jet side, which has been doing very well in recent years, kept the same order rate for 1H 2014 (76 vs. 74 for 1H 2013) with deliveries slowing down slightly in 1H 2014 to 81 units vs. 84 1H 2013.

For Embraer commercial aircraft deliveries increased from 39 aircraft 1H2013 to 43 aircraft 1H2014. Orders were 120 E-Jets in 1H2013 to 54 in 1H2014. This big difference is explained by the launch orders for the E-Jet E2 last year. The E-Jet backlog has gone from 266 to 440 since this time last year, representing 4.5 years of production. The business jet side, which is dominated by light business jets in contrast to Bombardier who delivers predominately midsize or larger jets, has deliveries increase from 41 to 49 jets.

Program status and how did we get there

The financial situation mirrors well the situation in the civil aerospace parts in the companies. Let’s start with Embraer and then compare with Bombardier.

Embraer
Embraer is today the world’s largest player in regional aircraft, coming from a position as one of the players in 30 seat Turboprops and nearly going under as company 20 years ago. The transformation is remarkable and a story in itself. It involves the passing through a life-threatening transformation from a government-sponsored state-owned company to a private company living from its commercial airplane sales with little or no support from the state. This all happened 1989-1996 and it has influenced the management and the strategy of the company. Part of the crisis was taking on too much technology risk in the pusher turboprop program CBA-123 Vector, which flew 1990 but never came to market.

During these toughest years in the company’s history, the management bet the company on building a regional jet from their Turboprop Brasilia EMB-120. After several iterations, the 50 seat EMB-145 was delivered 1996 and got good sales in a booming regional jet market. The launch of the EMB-145 stopped Bombardier from totally dominating the new 50 seat regional jet segment with their Challenger biz-jet- derived CRJ100, available four years earlier then EMB-145. Fresh out of intensive care, with the EMB-145 racking up sales, Embraer management took another bold decision only two years later, to go after the beyond 50 seat market with a clean sheet design. They had realized the three abreast EMB-145 could not be stretched above 50 seats and the market would move to 50-100 seats over the next 10 years.

E-jet first version, the 170

E-jet first version, the E-170

The result was the E-Jet, a larger aircraft with airliner style cabin and the looks of a big jet with the engines under the wings. It went on to be a winner and has now replaced the EMB-145 completely. Embraer’s path since its crisis days is a combination of taking the necessary steps to follow the market at the right moment but with technology they know or can get to know with acceptable risk. This in turn enables predictable program execution and therefore entering the market at the planned time. When necessary they upgrade conservative technology choices in seconds steps. The E-Jet launched with existing engines (GE CF34) and a Fly-By-Wire which was essentially replacing the cable and pulleys with electrical signaling but not much more. This is then upgraded in the E-Jet E2, which by 2018 will be introduced with the Pratt & Whitney GTF, a new wing and full feedback (i.e. flight mode protection-capable) Fly-By-Wire. Through consistent execution of this strategy, Embraer has built the position of the world’s number three civil airliner company and the leader for aircraft under 130 seats. They have also grown their position in the Biz jet market from a niche player (with converted EMB-145s) to one of the top 4 suppliers.

Bombardier
Bombardier also realized the market would move on from the 50 seat jets and started their BRJ-X program late 1990, but they hesitated and did not move until 2008, then calling the program the CSeries. One can ask, What caused Bombardier to not take the step when Embraer did? It can be traced to their offering at the time. Bombardier had based their regional jet on the four abreast Challenger fuselage, which was superior to the narrower three abreast heritage of the Brasilia and ERJ and more suitable (though not ideal) for further stretches to the 70- or 90-passenger CRJ700 or 900 (it has since been stretched to 100 seats in the CRJ1000).

Regional jet cross sections

Regional jet cross.sections

In retrospect, one can question this hesitation from a company which was in a much healthier situation then Embraer at the time. The market for something larger than the CRJ had been identified and Bombardier now has to fight in the 70-120 seat market with gradually longer and longer versions of which was originally a cross-section for 50 seats. The CRJ series are economical airplanes but they do not offer the customer experience of an airliner style E-Jet. Consequently it gets ordered by existing customer but struggles to win new business.

CRJ900 of Lufthansa Regional

CRJ900 of Lufthansa Regional

When Bombardier finally started the CRJ-X as the CSeries, they saw the need to go for new technology in critical areas of the airplane; structures, engines and electronics/FBW. While constituting a well-conceived design which will have a long active life, each new technology area has a learning curve and sure enough Bombardier has run across challenges in all three areas. The flight test program has clearly showed that they detected structural problems initially. These have since been fixed and the aircraft has now flown the complete flight envelope. On top of these problems, there has been a 1.5 to 2 year delay in getting the advanced Fly-By-Wire system to the state where the main functions can be tested. It has to date been flown in the “electrical cable and pulley mode” we described for the E-Jet. Bombardier calls it direct mode. Fly-By-Wire software version 3.0 has just been loaded on the test aircraft and will allow activation of the advanced modes but the tests have still not been flown with these functions enabled. Finally, the third advanced component, the engine, had problems, not in the critical gear area, rather in a tricky but well understood rear bearing lubrication box. The fix for this problem has now been identified and flight testing can continue.

Except for the Fly-By-Wire problems, these are normal issues that gets detected during flight testing. They seem major but are straight-forward to identify and fix. Implementation can cause retrofit situations if detected late, however. The opposite is true of the type of systems and Fly-By-Wire problems Bombardier and partners are wrestling with. Complex software systems are beasts to get bug-free and reliable. It takes a lot of effort and consumes a lot of time. If one starts with a bad status it is very difficult to say how long the fix will take. The faults are not visible to naked eye or instruments like for the structural or engines problems. Many times, the way out is to cut ambition level and deliver the full functionality in steps like Boeing did for the 747-8i FMS system. Whatever the CSeries program decides to do, the nice thing with software is that the upgrade is a USB hard disk docked to the aircraft and presto: things are up to date.

The real criticism one can direct at the CSeries is that program management has not been able to identify these challenges and planned way to optimistically as a consequence. They allocated themselves five years (2008-2013) for development and flight testing, a too-ambitious schedule for so much new technology. This is the schedule of a regional jet development with standard technology, not an all-new design which raises the bar in all respects. In the end, the time it will take will be more like the 787 and A350 programs, seven to eight years. There is nothing negative in this if this is foreseen and part of the planning from the start, Now the inadequate program management is putting the whole group under considerable strain. It robs the company of cash, which is being drained off to pay for prolonged development, but also of revenue, which is not coming in from deliveries; aircraft are only paid in full at delivery.

It is also unfortunate that the CSeries delays coincides with similar challenges on the business aircraft side. The Learjet 85 all composite clean-sheet development is seeing even more extensive delays and the Global 7000 and 8000 developments will need the CSeries avionics and Fly-By-Wire. All-in-all Bombardier has too much on its plate with grave deficiencies in planning and execution, major restructuring (layoff of 1,800 people and let-go of several managers) is the consequence,  designed to lower the cash burn and organize the company to better master the large development programs.

The companies

How could it come to these two very different situations, and why does Bombardier need to do this radical restructuring? Once again we have to look into the history and see how the airplane companies came about and developed.

Embraer started from an ambition of the Brazilian state and military to build up an aircraft industry in Brazil. Wisely they decided to create an aeronautical center, starting after WW II at San Jose dos Campos outside the country’s industrial city, Sao Paulo. The center comprised the Aeronautical Technical Center (from which Embraer was spun off), an Aeronautical University (ITA) but also testing institutions and flight test facilities, all drawing on graduates coming out of ITA. Embraer gradually grew in this fertile soil, heavily supported by state and military until the 1990s when a country in crisis declared Embraer had to stand on its own feet.

We know they managed this very difficult transition and have grown since. The difficult transition period learned Embraer the lesson to keep things simple with step-by-step advancement of technology and that if you don’t have your own money you don’t control your destiny. The organically-grown company of today is the result of this history, a company which takes steps when needed and keeps money on hand to have the freedom to do that when they see fit. This is also why Embraer has a low “gearing ratio” i.e. return on own capital. Embraer likes to have a high level of its own capital, having learned what happens when you don’t.

Bombardier, started as a recreational equipment and mass transportation company, had no aerospace activities before 1986, when they bought Canadair from the state. They then added Learjet (1989), Shorts Brothers (1990) and finally De Havilland Canada ( 1992) in quick succession. Since then these entities have been gradually integrated but they have kept their identity and product lines intact to a large extent. After recent program misses, top management have decided to restructure the aeronautical activities into a centralized development group, a services and aero structures organization and separate divisions for commercial and biz jet aircraft, all reporting directly to the group CEO.

All aerospace programs are critically reviewed for status, work remaining to certification and cash flow impact. In this process one can foresee hard prioritization and that ambition levels and program schedules will be scrutinized. It is generally expected that the Learjet 85 will be the program that will be pushed forward to safeguard the earliest possible completion of CSeries and Global 7000/8000. These program reviews are not finished and it remains to be seen what changes will be presented for the programs. We will also have to see what will be the outcome of the different cooperation initiatives Bombardier has been working on with China and Russia. Right now these have some bad news with less cooperation around CSeries and Comac 919 than expected and the Russian venture suffering from the Ukraine crisis.

Conclusion

Embraer had their crisis 20 years ago but the learnings are still valid and have created the foundation for a strong and successful company. Bombardier were off to a good start with their quickly assembled Aeronautical division. They captured the trend from regional turboprops to jets earlier then all competitors and built successfully on the business jet foundation that Canadair brought. Somewhere half-time they hesitated when Embraer acted and they are having their crisis today as a result. The programs that give them trouble are technically well conceived and will give them long life cycles once finished. The problem that Bombardier is wrestling with is how to get them to the finish.

By Leeham Co EU


Filed under: Bombardier, CSeries, Embraer, Pratt & Whitney Tagged: Bombardier, Comac, CRJ, CSeries, E-Jet, E-Jet E2, Embraer, GE, GTF, Pratt & Whitney, Q400
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