Goldman Sachs upgraded shares of commercial jet maker Embraer to the equivalent of Hold from Sell on Thursday. It isn’t Boeing but it isn’t insignificant, either.

“A lot of challenges now priced in,” wrote analyst Noah Poponak in his research report. He has a point. Embraer (ticker: ERJ) shares are down 63% year to date, worse than aerospace peers and far worse than the double-digit declines of the S&P 500 and Dow Jones Industrial Average.

In a joint venture announced in 2018, Boeing (BA) is slated to take an 80% stake in Embraer’s commercial aerospace franchise. It is a $4.2 billion deal, while the entire Embraer organization—including debt—is valued at just $1.4 billion today. The deal might not happen, but if it does, there is upside for Embraer shares, according to Goldman Sachs.

The upgrade isn’t a ringing endorsement. “Regional jet and business jet could be very challenged during this aviation rough patch,” Poponak said. “The impact of the proposed Boeing JV is still an open question”—and it isn’t factored in to his $9 price target.

An aerospace upgrade is unusual these days. Few aviation-related company’s have more Buy ratings from Wall Street analysts than they did a year ago.

General Electric (GE) and Raytheon Technologies (RTX) are two examples of more Buy ratings, but they are special cases. GE has been in turnaround mode under new CEO Larry Culp, while Raytheon—the old United Technologies —just split into three companies and completed a large merger.

The upgrade doesn’t appear to be a wholesale change in Poponak’s views regarding the aerospace industry. He cut FLIR Systems (FLIR) all the way to Sell from Buy.

“From a relative value perspective : many stocks in our [aerospace & defense] coverage now price in very challenging scenarios,” Poponak wrote. While aerospace is challenged, he believes defense outlook is better. “[FLIR] now trades in-line with high quality defense companies.” It is too expensive relative to other stocks in Poponak’s 

“Challenging” might be an understatement regarding commercial aerospace. More than half the commercial jet fleet is parked because of a lack of demand. The aviation value chain has been hammered by the Covid-19 pandemic.

Large U.S. airline stocks are down about 56% year to date on average. Aerospace suppliers that Barron’s tracks are down 43%. Stock in Boeing—the company at the top of the aerospace supply chain—is off 55% year to date.

Aerospace suppliers are trading for roughly 12 times estimated 2021 earnings. (2020 earnings estimates are too volatile to be much help these days.) That is a discount to the 15.7 times multiple of the broader market. FLIR trades for about 14.5 times estimated 2021 earnings.

Large U.S. defense contractors trade for about 13 times estimated 2021 earnings.

Source: Barrons