Friday’s analyst upgrades and downgrades

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Inside the Market's roundup of some of today's key analyst actions

Highlighted by a "strong" wireless outlook, Rogers Communications Inc. (RCI.B-T, RCI-N) had a "solid" fourth quarter, said Canaccord Genuity analyst Aravinda Galappatthige.

In reaction to the release of its financial results on Thursday, Mr. Galappatthige raised his rating for the stock to "buy" from "hold."

"The Q4 result was strong, essentially checking all the boxes we were tracking as key indicators," he said. "Coming into the quarter, we were fairly confident of strong wireless postpaid net adds and internet adds, we were cautiously confident on wireless EBITDA growth and we were less certain of more bullish (versus 2016) guidance for 2017. Fair to say that RCI delivered on all these factors. While the headline financials suggest an in-line quarter, this was primarily due to a sharp miss in Media (EBITDA down 13 per cent), which tends to be rather volatile quarter to quarter. Importantly, both wireless and cable financials were solid and subscriber."

In justifying his rating change, Mr. Galappatthige pointed to a trio of factors:

1. Rogers is poised to be a primary beneficiary of a strong outlook for wireless in 2017. He said: “We have a positive outlook on wireless financials (for incumbents) in 2017 due to the strong subscriber adds through 2016 and the recent uptick in ARPU trends. The RCI quarter further strengthens that view but also highlights the sustainability of Rogers’ recent wireless resurgence. We note that its share of incumbent net adds has risen from 17 per cent in Q4/15 to 37 per cent in Q3/16 and poised to win at least 35-40 per cent in Q4 as well. With a favourable 2/3 business mix in wireless, Rogers is well positioned to benefit from these trends.”
   
   
2. Performance of the cable segment is “steadier” than anticipated. He said: “Management highlighted the fact that ex the recent changes to the internet wholesale tariffs, cable revenue and EBITDA growth would have been up 2 per cent and 5 per cent, respectively. Considering the competitive environment this is commendable and serves to ease our concerns around the cable outlook. Moreover, the strength in the internet product appears to have a rather effective pull through effect on video and home phone resulting in cable PSU being positive for the second quarter running.”
   
   
3. The expectation for strong free cash flow (FCF) growth after 2017. He said: “While FCF growth in 2017 is moderate due to cash taxes, we see little reason why there cannot be meaningful reductions to cable capex post 2017 as the X1 rollout commences and much of the one-time spend related to it is behind RCI. With RCI’s cable capex intensity at 31.5 per cent versus Canadian peers in the 21- 22-per-cent range, there is clearly downside. Management supported this thesis indicating a trajectory towards a ‘sub-20-per-cent’ intensity longer term.”

He raised his target price for the stock to $60 from $58. The analyst consensus price target is $55.23, according to Thomson Reuters.

"While we do remain cautious through the leadership transition period and recognize the likelihood of some volatility, we believe that the fundamentals in wireless in particular appear to be sustainable, and positions the company for strong returns over the next 12 months," the analyst said. "Moreover, RCI's valuations remain relatively attractive vs peers with a 2017E FCF yield of 6.2 per cent."

Elsewhere, the stock was raised to "buy" from "market perform" by Cormark analyst David McFadgen, who raised his target to $63 from $55.

Desjardins Securities analyst Maher Yaghi said Rogers "offers investors something to cheer about," raising his target to $59 from $57 with a "hold" rating (unchanged).

"4Q results showed continued momentum in wireless and cable subscribers, coupled with steady growth in earnings," he said. "The combination of improved product positioning and strong price points is, for now, leading to positive outcomes. For 2017, management expects slight margin pressure, but with 2–4-per-cent growth in FCF [free cash flow] investors should be pleased. While positive momentum could carry the stock up further, valuations temper our exuberance at this point."

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Investors should begin to look to favour Ford Motor Co. (F-N) over its rivals, particularly General Motors Co. (GM-N), according to RBC Dominion Securities analyst Joseph Spak.

He raised his rating for the U.S. auto maker to "outperform" from "sector perform."

"This is a tactical call, as we still see some longer-term secular concerns facing Ford and all traditional automakers," he said. "Since Ford's analyst day on Sept. 14, which pointed to lower 2017 earnings on higher investment, Ford has underperformed GM stock by more than 2,100 basis points. Since the U.S. election, Ford has underperformed GM by more than 1,000bps. This is not to diminish the impressive performance and guidance put up by GM. However, we believe the valuation for Ford looks as attractive as it has been for a while (2 times 2018 estimate enterprise value to earnings before interest, taxes, depreciation and amortization), and we see a number of factors that could cause investors to begin to look to favor Ford, especially relative to GM."

On Thursday, Ford reported earnings per share of 30 cents (U.S.), higher than Mr. Spark's projection by 2 cents but a cent lower than the consensus. Total company pre-tax profit of $2.1-billion topped the consensus of $2-billion.

In the wake of the results, Mr. Spak said the expectations for Ford remain low, while the probability of a new earnings revision is "likely higher."

"Management maintained their 2017 guidance, which was initially issued in September 2016 (although we have gained additional details/color since then)," he said. "Consensus expectations seem properly set, and excluding a macro shock, we see limited downside risk to forecasts. However, since September, expectations for U.S. economic growth (or for auto, greater confidence in a U.S. demand plateau) have increased. Ford never changed its China outlook despite assuming the purchase tax incentive completely went away. Additionally, Russia could help to offset Brexit issues in Europe (GM exited Russia). Thus, the next Ford earnings revision in our view skews to the upside. Yes, a U.S. rising tide would help all players, but at least versus GM, with 2017 guidance out of the way we believe buyside expectations are raised (even though consensus sell-side estimates may still need to move higher)."

The analyst also believes Ford sits in a strong relative position for tax reform, citing the fact that 72 per cent of its North American production volume currently takes place in the United States (in comparison to 62 per cent for GM).

"Ford continues to indicate that it finds U.S. tax reform 'intriguing' even if border-adjusted tax is implemented," said Mr. Spak. "Most of what Ford sells in the U.S. is made in the U.S. (including F-Series, some GM pickups in Mexico); it exports high-value vehicles and imports low-value vehicles. Considering border-adjustability along with other factors like a lower corporate rate and capex deductibility, Ford believes that it come out neutral to positive and better than competition. We agree. Ford even stated that a border-adjusted tax itself could be neutral this decade and positive 2021+. Secondary impacts on supply base, higher prices, trade war, and FX are unknown but impact everyone. As this comes to a congressional vote (Speaker Ryan indicated August goal), investors may pay more attention."

"August tax reform timeline could also line up with Ford NA production starting to look relatively more attractive. In 1H17, IHS expects GM's NA production to be up 10 per cent year over year as it builds ahead of changeovers and fills new product, while it expects Ford's NA production to be down 6 per cent (although Ford's 1Q17 guidance is not as bad as IHS forecast). However, in 2H17 GM faces very difficult comps and is taking K2XX downtime, so production is expected to be decline 16 per cent year over year. IHS has Ford 2H17 flattish. However, given that Ford has gone through the work of destocking, it would seem that there is upward bias to Ford's production. New Navigator/Expedition could also help in 4Q17."

Mr. Spak raised his target price for Ford stock to $14 (U.S.) from $13. The analyst consensus price target is $12.83.

"Investors seem to want to penalize Ford for playing 'catch up,'" he said. "Management doesn't believe they are. We, quite frankly, aren't sure even if we tend to side more with investors. But, we believe this is already reflected in the stock. Dividend yield at 4.9 per cent and relative to GM is as wide as at any point over the last two years."

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Methanex Corp. (MEOH-Q, MX-T) is "riding the wave" of higher methanol prices, said RBC Dominion Securities analyst Robert Kwan.

On Wednesday, the Vancouver-based company reported adjusted fourth-quarter earnings before interest, taxes, depreciation and amortization of $139-million (U.S.), topping both Mr. Kwan's projection of $118-million and the consensus estimate of $112-million. Sales of produced methanol (1.75 million tonnes) narrowly missed Mr. Kwan's forecast (1.868 million), while average realized price ($278 per tonne) was slightly higher ($272 per tonne).

"Methanol prices are steady into February 2017 following a sharp increase throughout Q4/16 and into January 2017," said Mr. Kwan. "Methanex updated its February 2017 North American and Asian posted prices for methanol at $416 per tonne and $430 per tonne, respectively, with pricing in both regions being flat from January levels. Prices in both regions increased each month during Q4/16 and into January with North American pricing up about 30 per cent over the past three months."

Mr. Kwan said what he deems to be the company's "conservative" approach to capital allocation is "prudent," adding "things could become clearer next quarter."

"At current methanol prices, we expect the company to generate sufficient free cash flow to consider both raising the dividend (which we had previously forecast would result in a 5-per-cent increase to be announced concurrent with releasing Q1/17 results) and funding a share buyback," said Mr. Kwan. "Management noted that it has historically instituted a share buyback when it actually plans to regularly buy back shares and after it has already earned the cash that it wants to return to shareholders. On the conference call, the company stated that it does not yet have any excess cash and that despite higher methanol prices, it does not expect to generate much excess cash in Q1/17 due to increasing working capital requirements."

Mr. Kwan raised his estimates for the company based on higher methanol prices. His EBITDA projections for 2017 and 2018 increased to $961-million and $986-million, respectively, from $523-million and $552-million. His EPS expectations moved to $5.46 and $5.49 from $1.55 and $1.62.

"Long-term methanol market fundamentals appear attractive and Methanex is the industry leader," he said. "With solid forecast demand growth from both traditional chemical market uses and increased use as an energy source, coupled with a modest supply addition outlook that mostly includes higher marginal cost capacity, the long-term methanol market is attractive and we see relatively high commodity prices persisting for several years. Methanex has facilities on four continents, which allows it to optimize production and sales to serve its global customers. The company's facilities generally sit at the lower end of the cost curve, which also provides a competitive advantage."

"We remain on the sidelines balancing positive management steps against the current stock valuation. We are torn between positive management steps to drive value (e.g., capital efficiency) and a stock that we see as fairly valued at current levels relative to trading multiples observed when methanol prices have been near current levels. As such, we remain on the sidelines."

With a "sector perform" rating for the stock, Mr. Kwan's target jumped to $57 (U.S.) from $42. Consensus is $48.09.

Elsewhere, Raymond James analyst Steve Hansen raised his target to $53 (U.S.) from $48 with a "market perform" rating.

"While 4Q16 was clearly a 'solid' quarter that surprised many investors, we expect 1Q17 will be significantly larger — benefitting from the full effect of the recent pricing 'fly-up'," said Mr. Hansen. "Still, despite this future event, and other non-price related catalysts that could also emerge, we continue to believe that methanol's upside momentum is largely exhausted and that a price fade will ultimately emerge this Spring — a transition that will likely introduce a stiff headwind for Methanex shares. It is in this context that we believe trimming into recent strength is still prudent."

BMO Nesbitt Burns analyst Joel Jackson increased his target to $57 from $53 with a "outperform" rating.

"Our 2017 estimates fall slightly (though we expect consensus to near our estimates) but 2018 estimates rise slightly," he said. "Despite sharp outperformance, we still think MEOH can move higher (even if methanol prices top out, which could prove conservative) considering FCF and NAV support, the buyback potential (the wait continues), and that methanol supply/demand could actually tighten in 2017."

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RBC Dominion Securities analyst Walter Spracklin expects former Canadian Pacific Railway CEO Hunter Harrison to take over U.S. rival CSX Corp. (CSX-Q).

"While nothing official has surfaced to confirm that Hunter Harrison will be instated at CSX, enough evidence exists in our view to suggest that the likelihood is high, and we think it increasingly likely that this comes in a friendly manner," he said.

Mr. Spracklin said Harrison's appointment will lead to an "operational" transformation, which he expects will generate "compelling" earnings growth.

Based on that assumption, Mr. Spracklin raised his target price for Florida-based CSX's stock to $65 (U.S.) for $42. The analyst consensus is $41.54.

"Underpinning our new price target, we assume that Mr. Harrison will implement the Precision Railroading model to transform CSX's cost base and drive a 12- point improvement in the O/R [operating ratio] to 58 per cent by 2020," the analyst said. "Together with a meaningful buyback, this translates into a 2020 EPS of $4.02 that when applied to our target multiple of 17.8 times (unchanged) and discounted back two years results in a price target of $65."

He added: "We consider the risk of cost reduction to be low and the risk to pricing and tax rate as consistent with other railroads. Instead, the key risk in our view is on volume, as: 1) we have recorded evidence of service disruption following similar cost transformations; 2) the challenges associated with a now underutilized coal network; and 3) the nature of the CSX network lends itself to higher propensity for customer shifts, either to truck or to a competing rail."

On the sector as a whole, Mr. Spracklin said: "Our constructive outlook on the rail sector is based on the industry's unique characteristics: 1) limited and rational competition; 2) high barriers to entry; and 3) sustainable growth in demand. We expect these attributes to drive real rate increases, volume growth, and margin expansion over the long-term supported by service improvements, efficiency initiatives, and the implementation of smart technology. With stable capital expenditure requirements and clean balance sheets, we believe that the industry is positioned to generate increasing free cash flow that will in turn drive up shareholder returns through sustained growth in dividends and share repurchases."

He maintained an "outperform" rating for CSX stock, called the company his preferred U.S. railway.

"Over 2015 and 2016, CSX meaningfully reduced costs to offset top-line weakness through labour right-sizing and asset rationalization," he said. "Combined with significant investment in the network to drive business mix improvements, we believe that CSX is well positioned for earnings growth as volumes recover. Critically, we believe that these improvements will come at a greater pace than those of regional peers, particularly should the expected management change take place."

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Centric Health Corp. (CHH-T) is "perfectly positioned" to benefit from the impact of aging baby boomers, according to Beacon Securities analyst Doug Cooper.

He initiated coverage of the Toronto-based healthcare services provider with a "buy" rating.

"The impact of aging Baby Boomers on the healthcare system is still very much in the early innings," said Mr. Cooper. "One unassailable fact is that the average annual spend per person accelerates as we age. With the oldest Baby Boomer now 71 and the youngest 52, it is not hard to see why healthcare expenditures should continue to rise. Those companies that are positioned  to service this demographic trend will benefit.

"The other major healthcare trend in Canada is that the aging demographic is having an impact on the quality of services provided by the government-run system. Wait times for surgeries have never been longer and healthcare costs as a percentage of GDP continue to trend higher. As this trend (unfortunately) continues, the government may be forced to change the way it offers such services, including outsourcing of procedures to independent surgical facilities."

Mr. Cooper said there is "good visibility" for Centric to grow its bed count in its Specialty Pharmacy segment (from 27,500 beds as of Sept. 30) through both organic growth and acquisitons (both new and previously announced). As well, he thinks its Surgical segment is poised for "greater" utilization.

"The combination of these two factors should drive revenue growth and significant operating leverage over our projection period," he said.

"Centric is in the final stages of a financial turnaround and, as such, is in the early stages of attracting investor recognition. Consequently, we believe the shares trade at a significant discount to its peers; a valuation gap that should narrow over our projection period."

He set a price target of $1.25. Consensus is 80 cents.

"Centric has been off investors' radar screens for the past few years as it battled with the after-effects of a roll-up strategy that was funded with too much debt and a leverage ratio of [almost] 10 times EBITDA at the end of FY15 and consequently interest costs more than taking-up all of the reported EBITDA. After the stock hit a high of $3.00 in mid-2011, it trended lower over the following 5 years before hitting a record low of 19 cents in summer 2016. Over this latter period, however, the company was doing yeoman's service in right-sizing the balance sheet, thus paving the way for it to become free cash flow positive and return to growth mode. The key in this turnaround was the sale of its physio and rehab business for $245-million in cash that closed in December 2015."

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In other analyst actions:

TD Securities analyst Scott Treadwell downgraded Savanna Energy Services Corp. (SVY-T)  to "hold" from "buy," citing "share price appreciation since the announced re-financing and Total Energy Services Inc. (TOT-T) takeover bid as well as what we view as an appropriate takeover price range." His target of $2.25 did not change. The average is $2.83.

Encana Corp. (ECA-T, ECA-N) was cut to "hold" from "buy" by TD Securities analyst Menno Hulshof with a target of $19.66, down from $19.83. The analyst average is $19.06, according to Bloomberg.

Celestica Inc. (CLS-T) was raised to "outperform" from "neutral" at Macquarie by analyst Gus Papageorgiou. His target rose to $20.50 from $18, compared to the average of $17.76.

Canadian Natural Resources Ltd. (CNQ-T) was upgraded to "buy" from "hold" by TD Securities analyst Menno Hulshof with a target of $48 (unchanged). The average is $49.79.

DH Corp. (DH-T) was rated a new "buy" by Canaccord Genuity analyst Kevin Wright with a target of $28. The average is $24.55.

MacDonald Dettwiler & Associates Ltd. (MDA-T) was rated a new "hold" by Canaccord Genuity analyst Doug Taylor. His target is $75, while the average is $86.70.

Tembec Inc. (TMB-T) was raised to "buy" from "hold" at TD Securities by analyst Sean Steuart with a target of $3.25 per share, up from $2.50. The average is $2.67.