After 6 Years, Goldman Sachs Drops Bullish View on Aerospace; Slashes Boeing (BA) to Sell

Goldman Sachs analyst Noah Poponak is making waves on Wall Street Monday after downgrading the Aerospace sector and behemoth Boeing (NYSE: BA) to Sell with it.

In a note to clients, Poponak said after being positive on the sector for 6 years they are now moving to Neutral. While they still view Aerospace as a long-term growth industry, downside risk has been heightened after substantial outperformance.

The analyst notes that after a decade of undersupplying the market, production at Boeing and Airbus has risen meaningfully and has finally caught up with the market. "Boeing and Airbus total production in 2015 will be close to double 2008 production," the analyst notes.

In addition, lower fuel price could substantially change things in Aerospace. "Much of that accelerated replacement has been due to fuel economics of new aircraft, and the equation changes at lower prices," the analyst said. It was noted that 50% of current deliveries are for replacement, versus 30% historically.

Also, growth volatility around the world could upset aircraft new growth demand. "China specifically has grown to 20% of current deliveries, and Asia Pacific is almost half," the analyst highlights.

Meanwhile, with metrics in the sector cyclically strong for several years, the bar for upside surprise in simply higher. Stocks in the sector have already gained substantial alpha versus the market. While valuations in the sector are not particularly demanding, they are at or slightly through historical mid-cycle levels, and the denominator is through mid-cycle. So medium-term risk/reward is balanced or even slightly negative, they said.

As noted earlier, Boeing (NYSE: BA) was downgraded to Sell from Neutral and its price target cut to $132 from $146. "If the large commercial aircraft supply/demand framework has moved into oversupply, Boeing is most exposed," the analyst said. "If demand for new aircraft is set to slow, BA shares are highly correlated to new orders. We believe expectations for free cash are too high, and BA could disappoint."

Poponak said over the next 12 months they believe Boeing investors may: (1) see tougher aircraft demand fundamentals due to a lower fuel price and global growth volatility, with potential for a rate change announcement on the 777, (2) see slower rates of growth in both production of, and orders for, new large commercial aircraft, (3) become increasingly concerned with large increases in 787 deferred production, and potentially see the 787 program move in to a reach-forward loss position, and (4) become less comfortable with the medium-term free cash framework.

Meanwhile, Precision Castparts (NYSE: PCP) was cut to Neutral from Buy. "PCP organic growth continues to come in slower than expected, and is unlikely to pick up in the near-term given its exposure to Oil & Gas," he said. "Constant inventory growth, and several years of weaker-than-expected FCF/NI conversion are both also concerning. However, PCP is still one of the highest margin businesses we cover and shares have already re-rated lower."

Goldman's top picks in the sector are Buy-rated rated: BE Aerospace (NASDAQ: BEAV), Esterline (NYSE: ESL), Hexcel (NYSE: HXL), Transdigm (NYSE: TDG) and United Technologies (NYSE: UTX).

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