Embraer's gobal reach extends ever farther afield

 - July 24, 2007, 10:13 AM

Brazil’s Embraer continued to spread its steadily expanding influence among the world’s airlines last month with a 12-aircraft order for 76-seat Embraer 170s from Finnair and the entry into service of a pair of Chinese-built ERJ-145s in the People’s Republic. While the tidy sum of more than $300 million from Finland’s flag carrier will certainly make for a welcome addition to Embraer’s sales ledger, the July 1 service entry of China Southern Airlines’ first pair of Chinese-built ERJ-145s could prove even more valuable, if only in a symbolic sense.

So far having sold only six of the 50-seat jets built in Harbin by the Harbin-Embraer Aircraft joint venture, Embraer hopes the resumption of deliveries to China Southern will help restore the momentum of China’s promising regional jet market, effectively shut down by the Chinese government only three years ago with exorbitant import taxes.

The largest airline in the People’s Republic, China Southern still holds the only firm order for the Brazilian-designed, Chinese-built airplanes, the first of which it based at Guangzhou Baiyun International Airport, situated in the northern region of the Pearl River Delta in Guangdong Province. From there, the eventual fleet of six airplanes will connect 16 cities. China Southern expects to take delivery of the last ERJ-145 next January, by which time it expects to open a dedicated commuter check-in counter at Guangzhou Baiyun to help speed the boarding process for business travelers.

Eager to show its commitment to improving its citizens’ access to air transport, the Chinese government has reduced airport taxes for passengers flying on regional jets from 90 to 10 yuan. For its part, China Southern offered 50-percent discounts during the first 10 days of service. In a near frantic effort to ready its transportation infrastructure for the 2008 Summer Olympics, the government hopes such incentives will lead to more investment in domestic networks, a prospect sure to draw a welcome reception from Embraer and its rivals.

Paucity of Short-haul Traffic
Of the some 660 airplanes registered in China, roughly 70–less than 12 percent–fly short-haul routes, compared with the world average of 35 percent. If government GDP projections hold true, China could conceivably need another 635 airplanes in the 30- to 120-seat category over the next 20 years. Today, other than the two newly delivered airplanes, five Embraer ERJ-145s fly in China with China Southern partner Sichuan Airlines.

Some of the shortest routes on China Southern’s planned network extend no farther than 200 nm. For example, Beihai, on the Gulf of Tonkin; Zhanjiang, on the South China Sea; and Meixian, just northeast of Guangzhou in Fujian province, all lie within reach by car or bus, but not within an acceptable distance for those who travel regularly to Beijing via China Southern’s Guangzhou hub. Early plans call for four to five flights a day from Zhanjiang and one to two round trips from Meixian, allowing more convenient connections from Guangzhou to Beijing.

Medium- and long-range flights will connect Guangzhou with so-called long, thin routes on which China Southern has experienced trouble generating high enough load factors on its Boeing 737s. Some, such as Changzhi, in the northern province of Shaanxi, lie as far away as 1,000 nm. Other medium- and long-range routes will include Lianyungang, Luoyang, Nantong, Nanyang, Xiangfan, Xuzhou, Yichang and Zhoushan.

Since January 13 last year, when Embraer and AVIC II subsidiaries Hafei Aviation and Harbin Aircraft officially consummated their joint venture, the companies managed to refurbish assembly facilities, install jigs and tooling, hire and train 139 employees and build the first airplane all in less than a year. On February 2 China Southern committed to a launch order, ending a tedious month-and-a-half-long wait for the first evidence of the program’s commercial viability.

Although seemingly a breakthrough in Sino-Brazilian relations, the partnership resulted in large part from the Chinese government’s protectionist trade policies. Before the Chinese effectively suspended regional jet imports in 2001, the country had begun to reveal its market potential to all three regional jet manufacturers. Embraer, for its part, had delivered five ERJ-145s to Sichuan Airlines and won firm orders for 20 of the 50-seat jets from China Southern Airlines and 10 from Wuhan Airlines. But when the Chinese regime concluded that the demand could help buttress its own aerospace industry, it placed prohibitive import duties on Western products, effectively closing the market to Embraer and its competitors.

The Chinese then invited the Western RJ builders to bid for co-production agreements with its state-run aerospace agencies. Embraer won the contract for 50-seat jets, and hoped the deal would rescue its canceled contracts with Wuhan and China Southern, while opening new avenues for sales to the likes of Sichuan. Fully aware of the harsh cost environment in China, where high navigation and airport fees and excessive fuel prices disqualify regional jets in many markets, Embraer nevertheless leapt at the chance to stake a claim in the vast and increasingly prosperous country. No one could anticipate the onset of SARS and the resulting collapse in air travel throughout Asia, however.

Introducing Chinese-built ERJ-145 Is a Boost to Asia’s Collective Morale
Although perhaps merely a moral victory in Asia’s battle to recover from three years of industry depression, the first ERJ-145 delivery in China since 2000 has certainly aroused optimism. With the Olympics coming in 2008, the Chinese government will do all it can to paint a clean, progressive image of its country. Ensuring availability of many transportation options will no doubt account for much of that effort.

“Currently, the operation of the ERJ-145 on domestic routes is still in an initial stage,” said China Southern vice president Jianhua Hao. “As China Southern’s operating route structure continues to expand and the civil aviation market further develops, ERJ-145s will provide our passengers with broader and more options for air-transportation services.”

For a country where options for ordinary citizens hardly ranked among the government’s top priorities, not long ago such proclamations would have sounded disingenuous. Today, as a middle class emerges in a country where per-capita GDP (as measured in purchasing power parity) ranks second only to the U.S., a growing proportion does enjoy the luxury of air travel. Embraer can only wait to see whether demand yields the kind of returns it projected when it invested in the project.

In the near term, much depends on the success of airline privatization efforts and the government’s ability to manage an exploding economy in danger of overheating. Such vagaries can’t be comforting to any investor, but to Embraer the potential payoff is evidently worth the risk.