Fitch Ratings-New York-25 January 2017: Fitch has assigned a ‘BBB-’ rating to the proposed 2027 senior unsecured notes to be issued by Embraer Netherlands Finance B.V (Embraer Netherlands), a wholly owned subsidiary of Embraer S.A. (Embraer). The notes will be unconditionally guaranteed by Embraer. Proceeds from these unsecured notes, which are expected to reach a benchmark size of USD500 million to USD1 billion, will be used for general corporate purposes, including prefunding debt maturities. Fitch expects little impact on Embraer’s net debt levels. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS
Embraer’s ratings reflect its competitive positions in the commercial and business jet markets; large backlog (USD19.6 billion) covering several years of sales; several promising defense programs; and the generally favorable environment in the global commercial aviation industry. Embraer’s adequate credit metrics, solid liquidity profile, mostly held outside Brazil, and its large export revenues combined with some offshore operating cash flow further support the ‘BBB-’ ratings.

Rating concerns include significant competition in both the commercial and business jet markets; ongoing heavy investment and risks of potential delays related to new aircraft programs; new entrants into the commercial jet market; low operating margins in several business segments; and significant exposure to BNDES. Off-balance sheet contingent obligations, mostly related to the weak market for regional jets with 50 or fewer seats, are also a concern, but this is mitigated by guarantee deposits partly collateralizing the exposure.

Manageable Risk Exposure to Brazil
The bulk of Embraer’s commercial markets are global. Approximately 88% of the company’s revenue is generated from exports or from business operations based abroad. Nonetheless, Brazil’s economic and political environment is a concern as the majority of Embraer’s operating asset base is locally domiciled, the company has significant exposure to BNDES, as it finances more than 40% of its aircraft sales, and Brazilian government spending could affect Embraer’s defense and security business. Brazil is listed as a related party in ERJ’s SEC filings as a result of the Brazilian government’s ‘golden share’ and a direct shareholder stake (approximately 5% of Embraer) via a company controlled by the government.

Fitch considers that Embraer’s ratings could be at least two notches higher than Brazil’s country ceiling if the country ceiling were downgraded; Brazil’s country ceiling is currently ‘BB+’. This means a potential downgrade of Brazil’s IDR (‘BB’/Negative Outlook) and a lowering of the country ceiling would not necessarily trigger a downgrade of Embraer’s ratings.

Negative FCF; Improvements Expected
A tough environment in the executive jet segment, higher capex, and non-recurring cash outflows totaling USD288 million related to both a FCPA settlement agreement and a voluntary dismissal program lead Embraer to generate negative free cash flow (FCF) generation during 2016.

Under Fitch’s base case scenario, Embraer’s cash flow from operations (CFFO), adjusted EBITDA and FCF for 2016 are expected to be approximately USD631 million, USD812 million and negative USD331 million, respectively. These figures compare poorly with BRL863 million and BRL752 million of CFFO and EBITDA, respectively, and positive FCF of USD33 million during 2015. Fitch expects the company’s capex to be about USD650 million in 2016, down from USD769 million in 2015.

Fitch expects Embraer to post neutral to slightly negative FCF during 2017 as the company completes its cost restructuring program and working capital benefits from lower inventory levels.

Solid Credit Profile; Deleveraging Trend

Embraer’s credit metrics based on gross debt are weak for the ratings, but this weakness is offset by solid metrics on net debt basis, as well as the company’s liquidity position. Embraer’s gross leverage (total adjusted debt/EBITDAR) has increased steadily in recent years to approximately 4.9x as of the LTM ended Sept. 30, up from 4.7x as of Dec. 31, 2015, and 3.1x and 2.2x at the end of 2014 and 2013, respectively. Embraer’s adjusted net leverage (total adjusted net debt/EBITDAR) has also climbed to 1.5x as of the end of September 2016 from 1.4x as of December 2015 from and 0.4x at the end of 2013.

Currently, Embraer is challenged to improve operating cash flow generation to support a recovery of its leverage ratios. Fitch projects net leverage to peak at 1.7x in 2016 and then decline to around 1.4x by the end of 2018. Fitch does not expect net leverage to increase with the current bond issuance, as Fitch expects proceeds will be used to enhance ERJ’s cash position and liability management.

FCPA Investigation Concluded
On Oct. 24, 2016, Embraer announced it reached a definitive agreement with U.S. and Brazilian authorities for the settlement of allegations of non-compliance with the U.S. Foreign Corrupt Practices Act (FCPA). Per the agreement, the company will pay USD186 million to U.S. authorities and USD20 million to Brazil. The U.S Department of Justice agreed to defer prosecution for three years, after which charges will be dismissed if the company does not violate the terms.

Fitch considers this settlement as a credit positive as it eliminates rating pressures regarding corruption investigations and the amount is considered manageable for Embraer’s credit profile. Per Fitch’s calculations, Embraer’s pro forma net leverage ratio, measured as net debt/EBITDA, shows a slight increase to 1.7x from 1.5x as of Sept. 30, 2016.

CONTINGENT OBLIGATIONS
Like most aerospace manufacturers, ERJ has a variety of off-balance sheet or contingent obligations because of the significant amount of debt used to finance aircraft deliveries. At Sept. 30 2016, ERJ had maximum guarantees totalling USD496 million (before provisions and before proceeds from the underlying assets), consisting of both financing guarantees and residual value guarantees (RVGs). The company also has some exposure to trade-in obligations. Fitch believes Embraer has the liquidity and cash flow to meet its potential obligations.

There are several factors that mitigate ERJ’s potential exposure from the contingencies. First, ERJ has collateralized some of its guarantees with (USD587 million) in guarantee deposits. Also, some of the exposure can possibly be reduced by selling the aircraft backed by the guarantees. Finally, there is a maturity schedule to the guarantees, at least for the RVGs, in that the obligations are typically staggered over various future periods.

In its financial statement footnotes ERJ lists several special purpose vehicles (SPVs) which are related to aircraft finance transactions. ERJ has no equity interests in these SPVs, but the SPVs are consolidated because ERJ controls the SPVs’ operations or takes a majority share of their risks and rewards. The value of the SPVs’ assets on ERJ’s balance sheet at Sept. 30 2016 was USD344.6 million, and the related debt was USD381.7 million. The debt is serviced with the cash flows from the assets. The maturities of the debt go beyond 2020, but there is a large maturity of USD332.6 million in 2020. In its credit analysis, Fitch are treating the SPV debt as contingent obligations, so it is not included in adjusted debt calculations. Some of the guarantees and guarantee deposits discussed above apply to some of the SPVs.

KEY ASSUMPTIONS
Fitch’s key assumptions within the rating case for Embraer include:
—The positive commercial aviation environment continues in 2017, but the business jet market shows little growth. In 2018 and beyond the commercial outlook is less certain, consistent with Fitch’s global aerospace outlook. Fitch believes global commercial aircraft deliveries could reach a peak in 2018.
—Commercial deliveries are flat to up slightly in 2017 and total revenues rise in the mid-single digits in 2017;
—Margins rise in 2017, with EBITDA in the low to mid-teens;
—ERJ generates marginally negative to neutral FCF in 2017;
—Investment expenditures rise in 2016 and 2017 before declining in 2018;

RATING SENSITIVITIES
Future developments that may individually or collectively lead to a negative rating action include:

Fitch may consider negative rating actions in the event of significant delays and cost increases on the E2, KC-390 or other programs; failure to sufficiently reduce costs in the event of an aviation downturn or aviation shock; substantial order cancellations in certain programs; substantial declines in liquidity without commensurate debt reductions; a multiple notch downgrade of Brazil’s sovereign rating and country ceiling; EBIT margin falling below 7% for several years and FFO-adjusted net leverage remaining above 2.0×.

Future developments that may individually or collectively lead to a positive rating action include:

Events that could trigger a positive rating action include successful retirement of risk in the development of the E2 and KC-390 programs, reduction in debt levels, and EBIT margin consistently above 9%.

LIQUIDITY
Fitch views Embraer’s financial flexibility to be relatively conservative, given its liquidity position, and it is a key factor supporting its ratings. Embraer has a policy of maintaining healthy liquidity, which Fitch considers appropriate given the cost of periodic development programs and the nature of the commercial aerospace industry. Fitch expects that Embraer will remain disciplined with its liquidity position and will maintain its proactive approach in liability management to avoid exposure to refinancing risks.

As of Sept. 30, 2016, the company had USD3.8 billion of debt, of which USD499 million is due in the short term. Embraer’s cash position of USD2.7 billion is sufficient to support debt amortization up to 2021. The company also had $479 million of investments at the end of September. The bulk of ERJ’s debt matures beyond 2022. The company’s debt is mainly composed of cross-border bonds (69%), BNDES (14%) and export finance (9%). Approximately 76% of ERJ’s debt is denominated in U.S. dollars, 23% in Brazilian real and 1% in euros. At Sept. 30, 2016, approximately 56% of the company’s cash, equivalents and financial investments were in U.S. dollars. Embraer does not have a revolving credit facility, which is not uncommon for Latin American corporate issuers

FULL LIST OF RATING ACTIONS

Fitch currently rates Embraer as follow:

Embraer S.A.
-Foreign currency Issuer Default Rating (IDR) ’BBB‘;
-Local currency IDR ’BBB’;
-Long-term National Rating Scale ‘AAA’;
—Senior unsecured debt ’BBB’.

Embraer Overseas Limited
-Senior unsecured debt ’BBB’.

Embraer Netherlands Finance BV
-Senior unsecured debt ’BBB’.

The Rating Outlook is Stable.