Friday’s analyst upgrades and downgrades

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

Though he is a "big fan" of Cenovus Inc.'s (CVE-T, CVE-N) decision to consolidate its Foster Creek Christina Lake (FCCL) position, Desjardins Securities analyst Justin Bouchard is not as "keen" on its move to "dive head first" into the Deep Basin.

On Tuesday, Cenovus announced it has made "significant progress" toward executing on its financing plan for the $17.7-billion purchase of assets in Western Canada from ConocoPhillips (COP-N), which is expected to close in the second quarter. Since the agreement was announced on March 29, Cenovus has completed a planned $3-billion bought-deal common share financing and priced a $2.9-billion offering (U.S.) of senior notes.

"We think we understand the business case for the deal — in addition to consolidating FCCL and Narrows Lake to obtain complete control of its oil sands assets, CVE is trying to provide a level of diversification (both from a capital flexibility and investment cycle time frame perspective) through its purchase of Deep Basin assets," said Mr. Bouchard. "However, from our perspective, the Deep Basin component of the acquisition misses the mark on a number of fronts: the acquisition price does not suggest an opportunistic acquisition; the pro forma company has a less compelling investment thesis; it moves CVE away from its core competency (in situ development and operations); the acquisition results in higher leverage; CVE is targeting asset divestitures at an inopportune time to sell; and the issuance of 400 million shares (47-per-cent dilution) results in a stock overhang. That said, we still really like the oil sands assets; the decision to double down on FCCL and Narrows Lake makes sense ― we just wish CVE had focused on that exclusively. Nevertheless, its production remains 60-per-cent weighted to the oil sands and there is a clear pathway to increase the oil sands weighting over time through the continued development of the FCCL and Narrows Lake projects; as a result, CVE still provides meaningful upside to higher oil prices."

Mr. Bouchard believes the price of the transaction does not suggest it is an "opportunistic" acquisition for Cenovus.

"We find it difficult to justify the deal price both using comparable transaction multiples and a NAV [net asset value] approach," he said. "In contrast to a number of recent deals that were done at significantly less than replacement cost or at implied oil prices in and around current levels, the $17.7-billion price tag is neither in our view. Meanwhile, using a NAV approach, we need to use a long-term oil price of $65–70 (U.S.) per barrel WTI — in addition to concurrently assuming the full development of Narrows Lake and the remaining FCCL expansion projects — to justify the purchase price."

He added: "We have always viewed Cenovus as the 'best in class' in situ operator and the leader in the space (despite some missteps along the way), both from an operational and technological development perspective. However, this view does not extend to the conventional side of the business. Prior to the acquisition, Cenovus's track record on the conventional side had become a moot point to a large extent since there had not been any material spending on the natural gas assets in southern Alberta, and the Polymer Flood at Pelican Lake had effectively been put on hold owing to the massive historical spend profile which generated lacklustre results. However, with the deal, Cenovus has now acquired a vast amount of Deep Basin assets — assets it has every intention of growing — despite having demonstrated very little expertise in that area. The Deep Basin may ultimately prove to be a very good asset, but even accounting for COP's technical team which will be brought over with the acquisition, our concern is whether Cenovus is the right company to develop this particular type of asset."

Mr. Bouchard maintained his "buy" rating for Cenovus stock, but he lowered his target to $20 from $24. The analyst consensus price target is $20.62, according to Thomson Reuters.

"Despite the concerns we have with the acquisition … we believe the current stock price is an attractive entry point for long-term investors; unfortunately, that is little consolation for existing shareholders who have a higher cost basis," he said. "The bottom line, in our view, is that the new Cenovus should trade at a lower multiple than the majority of its peers to reflect the risks inherent in the new business model ― and that is reflected in our new target price."

Elsewhere, BMO Nesbitt Burns analyst Randy Ollenberger lowered his target to $17 from $20 with a "market perform" rating (unchanged).

"At current prices, the shares are trading at a 2017 estimated EV/EBITDA [enterprise value to earnings before interest, taxes, depreciation and amortization) multiple of 11 times, which is well above its Canadian peer group average of 7.8 times," said Mr. Ollenberger. "We believe that the share price upside could be limited in the near term by the company's elevated debt levels and uncertainty regarding the shift in strategy. Cenovus has limited experience operating and developing natural gas assets, particularly complex plays such as the Deep Basin. The combination could see investors take a 'wait and see' strategy toward the shares."

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The outlook for Corus Entertainment Inc. (CJR.B-T) remains "heavily dependent" on a turnaround in advertising, said Canaccord Genuity analyst Aravinda Galappatthige.

On Thursday, the media company reported second-quarter financial results which the analyst deemed "light," however ad trends "improved somewhat."

Quarterly revenues of $368.2-million fell below Mr. Galappatthige's projection of $386.2-million as well as the consensus of $378-million, but represented an increase of 86.2 per cent year over year.

"On a pro forma basis (i.e., including contribution from Shaw Media assets, excluding contribution from Pay TV and adjusting for the one-time BCE payment in the base period), overall revenues declined 5 per cent year over year," said Mr. Galappatthige. "The revenue miss versus our estimates was largely in the TV segment, driven by greater than expected weakness in Nelvana (down 44 per cent on a pro forma basis) as the base period (i.e., Q2/F16) included sizable contributions from SVOD [streaming or subscription video on demand) deals and significant studio service work which were not repeated in the quarter."

Corus reported adjusted earnings per share of 13 cents, meeting expectations. Adjusted earnings before interest, taxes, depreciation and amortization of $102.7-million missed the estimates of both the analyst ($111.3-million) and the Street ($105-million), due largely to the revenue miss.

"Corus painted a rather specific and positive picture of H2/17, calling for low single digit growth in TV advertising (compared to a 6-per-cent decline in H1), low single digit growth in subscriber revenue and strong double-digit growth in Nelvana," said Mr. Galappatthige. "Naturally, the improvement in ads has been discussed for a while now, and there is a broad market expectation of a turnaround here starting Q3. In fairness, we see no reason why low single-digit growth is unattainable given the extra ad agency this calendar year (from 4 to 5), better economics with agencies, and the general rebound in TV ads we are seeing in the U.S. as the flow of ad dollars to digital platforms appears to have slowed somewhat.

"On the other hand, we are slightly cautious on positive growth in sub revenues given that growth in this line item has eased from 10 per cent in Q4/16 to 1 per cent in Q2/17 with the positive impact of the ramp-up in Disney Channel easing. However, management anticipates affiliate fee growth from new BDU [broadcasting distribution] agreements to continue to be a tailwind and offset low single-digit subscriber count declines. With respect to Nelvana, given its small size, we do expect a sharp rebound in H2. However, we believe the key for this group is the ability to reintroduce a more meaningful M&L component, something Nelvana enjoyed several years ago."

Mr. Galappatthige raised his EBITDA projections for 2017 and 2018 to $587.2-million and $587.3-million, respectively, from $584.2-million and $576.7-million. His EPS estimates rose to $1.20 and $1.18 from $1.16 and $1.13.

"Despite the miss in Q2, given the clear positive indications offered for H2 and the improvement in ad trends in Q2, we have opted to slightly strengthen our revenue and EBITDA numbers," he said. "However, our FCF [free-cash flow] outlook improves more meaningfully as Corus' capex trends are tracking well below initial expectations, and we are seeing less restructuring costs than originally expected. This suggests good cover for its current dividend."

He maintained a "hold" rating and increased his target by a loonie to $12. Consensus is $13.51.

"While recognizing that Corus may see a period of stabilization in the near term supported by the above as well as the Shaw synergies, we continue to see long-term headwinds in both advertising and subscriber revenues," the analyst said. "With respect to advertising, it is not unnatural to see positive corrections that occur after a sharp swing in allocations into new digital platforms, perhaps too prematurely in some cases. However, this does not necessarily indicate a change of a secular trend. In terms of subs, we are even more convinced that low single-digit declines will soon be the norm, considering the ~2 per cent annual reduction in subs in Canada as well as ongoing cord shaving which we believe can only accelerate with the proliferation of new OTT [over the top] platforms and the introduction of pick and pay. This, combined the Corus' 3.8-times leverage, forces us to remain on the sidelines. Moreover, with a valuation of 7.6 times enterprise value/EBITDA 2018 estimate, this cannot be described as a bargain multiple, in our view."

Elsewhere, CIBC World Markets analyst Robert Bek maintained a "neutral" rating and $13 target.

Mr. Bek said: "Corus reported Q2 results that were light across the board. However, given the massive transformation underway, this quarter's results do not carry much weight (Q2 is still considered a transition quarter), as investor focus remains squarely on H2/17, where management is targeting a return to growth. While our estimates do suggest improvement into the back half of the year, given the pace of structural change, we believe there remains some risk not only to street estimates but also target valuations for traditional media assets and that Corus shares remain fairly valued at current levels."

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An inflection point has arrived in the growth of the beer segment for Constellation Brands Inc. (STZ-N), according to Credit Suisse analyst Laurent Grandet.

On Thursday, the Victor, N.Y.-based alcoholic beverage company reported fourth-quarter earnings per share of $1.48 (U.S.), topping the consensus projection of $1.36. Organic sales rose 7 per cent, driven by a 10-per-cent rise in the beer segment and 4 per cent in wine and spirits.

"We are projecting 10-per-cent organic beer growth in fiscal 2018, at the mid-point of the 9-to-11 per-cent guidance," said Mr. Grandet. "This compares to 14-per-cent organic beer growth in fiscal 2017, a material slowdown especially given that Ballast Point is now in the organic base. Management said that it expects 70 per cent of this growth to be driven by distribution gains that we figure will come mostly from the Modelo brand and, to a lesser extent, Corona cans. The remaining 30 per cent is from velocity growth with some mix of higher turns and increased shelf space, likely at the expense of domestic brands. In terms of margins, we are not projecting significant expansion in FY18 (a rise of 50 basis points) as most of the benefit from the termination of the Interim Supply Agreement with ABI will be offset by incremental costs of owning Obregon and an increase in A&M to support innovations. We also note that beer operating margins are already at 36 per cent, inline with ABI US [Anheuser Busch Inbev SA NV], which is a benchmark in the category, despite Constellation having significantly higher COGS [cost of goods sold] per hectolitre."

Citing a lower projected tax rate, Mr. Grandet raised his 2018 and 2019 EPS projections to $7.83 and $8.67, respectively, from $7.30 and $8.02.

He maintained a "neutral" rating for the stock and increased his target to $182 (U.S.) from $165. The analyst average price target is $190.94, according to Bloomberg.

"Management guided to another strong year of sales and earnings growth in FY18, implying 8 per cent on the top line (excluding the Canadian wine divestiture) and EPS growth of 16 per cent at the midpoint," he said. "We agree that Corona and Modelo are the outright stars across the beer category in the U.S. and we expect that outperformance to continue, but we remain cautious that growth of the Mexican beer portfolio is decelerating and the company doesn't have many additional levers to pull."

Elsewhere, Citi analyst Wendy Nicholson bumped her target to $183 from $164 with a "neutral" rating (unchanged).

Ms. Nicholson said: "We very much like STZ's strong portfolio of leading brands, and welcome STZ's initiatives to improve their results by: (i) taking over full control of the Crown Imports business following ABI's purchase of Modelo, (ii) driving continued depletion growth through new brand and product introductions, and (iii) selectively adding accretive, margin-enhancing brands to its existing portfolio of alcoholic beverages. While our enthusiasm for the business had been somewhat tempered by the weak results seen over the last few years for the company's wine business, having control of the beer business should prove to be highly accretive and drive an acceleration in earnings growth. That said, we believe this good news is largely priced into the stock."

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Costco Wholesale Corp.'s (COST-Q) Canadian segment could continue to improve, said BMO Nesbitt Burns analyst Kelly Bania, reacting to the retailer's March sale results.

"Canada base comps (ex-FX) slightly accelerated 3 per cent (versus 2 per cent in February) while the two-year stack remained strong at 12 per cent," she said. "Easier comparisons in Canada could support better trends in the next few months (we forecast 5-per-cent Canada comps in F3Q17). Other International comps of 6 per cent accelerated sequentially and are well above the prior six-month average of 3 per cent (we conservatively forecast 3 per cent other International comps in F3Q17)."

Ms. Bania called the company's U.S. results "impressive" given a "challenging" retail backdrop.

"Costco reported March U.S. base comps (ex-fuel) of 6 per cent (versus consensus estimate of 3.1 per cent)," she said. "We estimate the 6-per-cent comps would have been 5-5.5 per cent excluding the Easter shift boost of 1.0 to 1.5 per cent and 0.5-per-cent drag from weather (East Coast snow/ice storms). U.S. customer traffic of a 4.5-per-cent increase was also affected by the calendar shift and weather; we estimate U.S. traffic of 4 per cent excluding these factors. We think this is a very strong start to F3Q17, where we forecast 3-per-cent U.S. base comps (ex-fuel) and particularly impressive considering the weak volume trends across the broader grocery and c-store [convenience store] channel. This also provides continued support for our thesis that Costco's significant price gap versus Amazon (Costco prices 26 per cent below Amazon in household consumables) continues to help insulate it from the convenience of online shopping."

She maintained her "outperform" rating for the stock and it remains her top pick. Her target rose to $195 (U.S.) from $180. Consensus is $181.74.

"Costco's low gross margin philosophy, combined with product nimbleness (given its limited less-than 4,000 stock keeping units or SKUs) and growing convenience, supports an outlook for the company to remain highly relevant in a fast-changing consumer environment," said Ms. Bania. "Costco's unique membership-based model, strong return on invested capital (ROIC), healthy balance sheet, product nimbleness, and growing convenience support its premium valuation."

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In other analyst actions:

Based on the progress of its turnaround, Goldman analyst Noah Poponak upgraded Bombardier Inc. (BBD.B-T) to "buy" from "neutral," expecting continued margin growth. He raised his target to $3 from $2.26. The analyst average is $2.76, according to Bloomberg..

Echelon Wealth Partners Inc. analyst Ryan Walker downgraded Osisko Mining Inc. (OSK-T) to "hold" from "speculative buy" with a target of $5.50. The average is $5.88.

TD Securities analyst Bentley Cross downgraded DHX Media Ltd. (DHX.B-T) to "hold" from "buy" with a target of $6.50, down from $8.50. The analyst average target is $7.80.

Cormark Securities Inc. analyst David Novak upgraded Centric Health Corp. (CHH-T) to "top pick" from "buy" with a target of $1.05 (unchanged). The average is $1.02.

Telsey Advisory Group analyst Joseph Feldman upgraded Wal-Mart Stores Inc. (WMT-N) to "outperform" from "market perform." He raised his target to $82 (U.S.) from $73, compared to the average of $75.56.

Redburn analyst Martin Viecha initiated coverage of Tesla Inc. (TSLA-Q) with a "buy" recommendation. He did not specify a target price. The average is $264.50 (U.S.).