Optimistic Embraer tempers its view of China with caution

 - February 11, 2008, 8:53 AM

Doubts about the future of Embraer’s joint manufacturing venture with China’s AVIC II group were largely laid to rest by the time Harbin-Embraer Aircraft’s biggest Chinese customer, Hainan Airlines Group (HNA) subsidiary Grand China Express, took delivery of its first airplane last September. After all, a firm order for 50 Chinese-made ERJ 145s in August 2006 as part of a larger order that included 50 Brazilian-made E190s had promised three years of work for the new factory. But things had looked a lot less certain only months earlier, when, as the 2006 Asian Aerospace show approached early that year, a backlog that had dwindled to just two airplanes threatened to shut down Embraer production in Harbin altogether.

Thankfully for new Embraer commercial vice president Mauro Kern, he and new chief executive Frederico Curado didn’t have to endure questions about that prospect as we approached this year’s Singapore show. Still, the Grand China Express order accounted for the plant’s entire backlog, meaning that any hiccup at the airline could land Harbin-Embraer back in the same spot it found itself a year ago. Well aware of the implications, a nevertheless “cautiously optimistic” Kern remained in active discussions with other potential customers in China, as well as those in export markets in the region, to ensure that doesn’t happen.

“The regional airlines in China are still forming and [the industry] is far from mature,” said Kern during a pre-Singapore conference call he and Curado held with AIN. “For example, less than ten percent of the flying in China is being done by regionals, while in the United States and Europe, it’s thirty, forty percent. So there is room for growth. But the speed of growth will depend very much on how the markets will evolve.”

Embraer’s market analysts believe that over the next 20 years China will account for 10 percent of all demand for commercial airplanes carrying between 30 and 120 seats. That translates into 730 airplanes and a 7.5-percent rate of growth, making China the fastest developing market in the world and the third-largest overall. Demand throughout the rest of the Asia Pacific region will grow by roughly 5.5 percent, to some 540 airplanes, according to Embraer. By contrast, the company expects that the world’s two biggest markets–the U.S. and Europe–will grow by around 4 percent.

Notwithstanding China’s vast potential, Western regional airplane makers in particular still face the very real risks that come with doing business in a country whose government has proven inclined to intervene competitively on behalf of Chinese industry. Now, with the coming introduction of the Chinese-built ARJ21 regional jet, opportunities to sell airplanes in the 90- to 120-seat capacity class might prove fleeting, although Embraer’s sale of 50 E190s to HNA Group in 2006 seemed to mark a breakthrough in that seat class. Another pleasant surprise came just this past January, when Shenzhen Airlines’ new regional unit, Kunpeng Airlines, said it would order “up to 100” E190s in addition to a comparable number of ARJ21s. That announcement came only a month after Kern told AIN “it would be very difficult to compete head-to-head with an indigenous product.”

In fact, Embraer entered the joint venture with AVIC II mainly in response to China’s decision in 2001 to effectively end imports of regional jets into the country. At the time, Embraer had delivered five airplanes to Sichuan Airlines and had won firm orders for 20 of the 50-seat jets from China Southern and another 10 from Wuhan Airlines. Not until the new Harbin factory delivered its first ERJ 145 in 2004 to China Southern did another Embraer product enter service in China.

Today, China remains an enigma in many ways–a market too large and strategically important to ignore but too unpredictable to embrace wholeheartedly. Embraer has certainly done its part with the opening of the joint venture, which now employs 200 people and plans a production run of 16 airplanes this year. But while the Harbin plant holds the capacity to build 24 airplanes a year, Embraer’s own market outlook projects a demand for fewer than 100 fifty-seat jets over the next decade.

“We don’t have high expectations of big numbers of fifty-seaters being sold there,” admitted Kern. Apart from a “few more” Chinese campaigns, Embraer hopes that export prospects will materialize to help supplement the backlog in Harbin. Kern mentioned India as one possible source of customers, although trends there and throughout the region point to far more interest in turboprops for airplanes designed to hold fewer than 70 passengers.

Not coincidentally, Embraer has started studying the possibility of introducing a new, high-capacity turboprop by the middle of next decade, said Kern, although Curado quickly added that not even conceptual designs exist and that any talk of such a project would amount to pure speculation. Meanwhile, Embraer now faces the prospect of yet another formidable competitor in the regional jet field in Mitsubishi and its MRJ70/90. Scheduled for industrial launch by the end of March, the composite-fuselage airplanes could, of course, threaten every RJ manufacturer’s position in the region, and particularly Japan, where Embraer has just begun to project a presence after years of effort.

Kern stressed the fact that the program and its support structure remained in a quite early, loosely defined stage, however, and Curado made a point to shed doubt about the viability of its proposed engine–the Pratt & Whitney Geared Turbofan concept.

“We are following very closely, of course, all of the conceptual discussions and ideas about future architecture,” said the Embraer chief executive. “We as a company have not yet come to a conclusion…there is an element of uncertainty involved in the engine that the Japanese have selected. Of course, to their benefit, Pratt is an outstanding manufacturer, but this is not an issue about which there is a consensus in the market yet. This adds a little bit of risk to the program.”