Monday's analyst upgrades and downgrades

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

The reports swirling around Toronto-Dominion Bank's (TD-T, TD-N) sales practices increase the short-term risk for investors, according to RBC Dominion Securities analyst Darko Mihelic.

TD stock fell almost 6 per cent on Friday in reaction to a CBC report that employees were pressured to meet high sales revenue goals.

Based on the controversy, Mr. Mihelic downgraded his rating for the stock to "sector perform" from "outperform," suggesting there are opportunities to invest in TD's peers with similar exposure, both domestically and internationally, and "less reputational risk."

"Any potential impact from recent allegations on sales practices could in our view, have an important and material impact on TD's reputation." the analyst said. "TD has historically been known for its strong Canadian franchise and its best-in-class customer service. Amidst a very competitive environment in Canada, we believe significant damage to TD's brand could have a material impact on both earnings and TD's premium relative valuation to peers. Recent allegations, whether true or false, will likely take time to investigate and we are unlikely to receive full clarity or comfort over the shorter term."

"Recent media reports have suggested that there is widespread pressure placed on TD employees to upsell customers, which have resulted in unethical sales practices (e.g. upgrading customers to higherfee accounts and increasing credit limits without customer consent, amongst other practices). It is impossible to know at this early juncture just how prevalent improper sales practices were and if there truly is a troublesome culture that is pervasive at TD. Until we know however, we pose a simple question - why take the risk on a premium priced stock, especially when there are similar alternatives? In our view, we can take our time and sit on the sidelines to see how this plays out. At this very early stage, we believe, the worst case scenario (problematic culture that needs to be addressed and thus, TD's 'secret sauce' was all along actually problematic) is far too damaging versus the best case scenario (small instance of a few disgruntled employees and the stock regains its prior premium)."

Mr. Mihelic lowered his target price for TD stock to $68 from $73. The analyst average price target is currently $71.53, according to Bloomberg.

"For the time being, until full clarity is received on allegations, TD's premium valuation relative to peers will likely be challenged in our view," he said. "TD currently trades at 12.7 times our 2017 core EPS estimate. This represents an 8-per-cent premium to the average of the other large Canadian banks that we cover, slightly higher than a historical premium of 6 per cent."

Elsewhere, the stock was lowered to "sector perform" from "outperform" by National Bank analyst Gabriel Dechaine, who dropped his target to $69 from $74.

Eight Capital analyst Stephen Gordon Theriault downgraded the stock to "neutral" from "buy" with a target of $69 (down from $72).

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Existing Canadian licensed producers of medical marijuana have a "substantial first-mover advantage," said Canaccord Genuity analyst Neil Maruoka in a research report in which he initiated coverage of five companies in the growing industry.

"These companies are attracting capital now, and are deploying these funds to advance strategies to capture the rapidly growing medical market, while also positioning themselves for a potential windfall if recreational cannabis is approved," said Mr. Maruoka. "However, if legislation is tabled as expected this spring, we believe there could be significant lag time before legalization occurs; we therefore recommend that investors look for companies with differentiated strategies and stock-specific potential catalysts over the next year. While fundamentals remain strong, we believe that valuations may be stretched amongst the larger players."

Mr. Maruoka called cannabis "one of the most exciting areas of investment to emerge in recent years," but he expressed concern about current valuation.

"If evaluated using traditional metrics, admittedly, valuation of cannabis stocks can be challenging; however, given high barriers to entry, lower regulatory risk, and expected industry capacity expansion, we believe that significant near-term growth should be viewed through a different lens," he said.

"Most companies take differentiated approaches and add value at different points of the value chain, in our view. If the Liberal government tables legislation to legalize the recreational use of marijuana in the spring as expected, we fear that there may be a dearth of industry catalysts until this becomes law, likely within 12-18 months. We encourage investors to seek companies with differentiated strategies and company-specific catalysts over the next year. While fundamentals for most names remain strong, we nonetheless believe that valuations are stretched amongst the larger players."

Saying it's "ahead of the pack," Mr. Maruoka called Canopy Growth Corp. (WEED-T) a potential industry leader, but it currently trades at 12.4 times its funded estimate capacity, the highest among its peers. Accordingly, he gave the stock a "hold" rating with a $12 target. The analyst consensus price target is $14.16, according to Thomson Reuters.

"Canopy is the dominant player in the Canadian market, leveraging its large production footprint and strong brand to build its medical patient base," he said. "With the legalization of recreational marijuana potentially right around the corner, we believe that Canopy has its sights set on this lucrative opportunity. We estimate that the company has the balance sheet to build its capacity to over 150,000 kilograms of cannabis per year (a 400-per-cent increase from its current capacity of 30,000 kg), and has the brand recognition to become a major participant in this opportunity. However, given the current valuation and expected timelines to the implementation of the rec market, we believe that Canopy appears fairly valued at this point."

"We believe Canopy is making a concerted effort to differentiate itself within the Canadian industry through its focus on brand management and marketing. Well ahead of legalization, the company has begun promoting itself under its Tweed banner to individuals and groups that could comprise a sizeable portion of the recreational demographic. Nonetheless, we believe that brand differentiation could be more restrictive within the Canadian market, with possible limitations on colourful packaging and sponsorships/endorsements."

The analyst gave Aphria Inc. (APH-X) a "hold" rating and $6.50 target. Consensus is $7.02.

"Although we believe the company ranks favourably compared to many of its peers in its funded capacity and as one of the lowest-cost producers in the industry, its current valuation provides investors with a fair value ahead of the expected legalization of the recreational market later this year, in our view," he said.

Though he said product recalls have damaged its reputation, Mr. Maruoka initiated coverage of OrganiGram Holdings Inc. (OGI-X) with a "speculative buy" rating and $3.25 target, suggesting a discounted valuation brings a "compelling" entry point and a buying opportunity. Consensus is $4.11.

"After announcing a sizable product recall and a pending lawsuit following discovery of a pesticide not approved by Health Canada, OrganiGram has seen its share price trade down 18 per cent thus far in 2017 (versus its peer group that is up 15 per cent year to date)," said Mr. Maruoka. "However, we believe the company still lines up nicely to many of its peers with a 5x facility expansion currently underway and a leading oil/extract strategy. At its current valuation, we believe these recent troubles could serve as a compelling entry point as the company takes remedial action to safeguard its production practices and looks to repair its reputation and reinstate its Ecocert certification."

Supreme Pharmaceuticals Inc.'s (SL-CN) "higher-quality" and low-cost production support a premium valuation, said Mr. Maruoka, who gave it a "speculative buy" rating and $2.15 target. Consensus is $2.31.

"Although the company is still waiting on its sales license from Health Canada, we believe Supreme's hybrid greenhouse provides one of the best trade-offs between high quality cannabis and a competitive cost structure," the analyst said. "Further, the company has a fully funded expansion plan that should see its capacity increase to 50,000 kilograms (or more) over the next two years. We believe Supreme's current valuation is attractive ahead of a potential major catalyst in the near term should its sales license be granted by Health Canada. Management believes the cannabis produced in its facility should meet the requirements for final approval and our de-risked valuation for this overhang indicates a fair value closer to $2.50 per share."

Mr. Maruoka started coverage of Emblem Corp. (EMC-X) with a "speculative buy" rating and $3.75 target. Consensus is $4.58.

"Although Emblem is a higher-cost indoor grower, we believe the company's medical focus differentiates this LP from its peers," he said. "Emblem employs a patient acquisition strategy through its GrowWise clinic network that we expect will allow new patient recruitment to keep pace with its growth in capacity. Further, through its pharmaceutical development focus, Emblem is developing novel cannabinoid formulations that are likely to command premium pricing, which we expect could be almost three times the average wholesale price for peers. Although the company is awaiting Health Canada approval to sell cannabis oil, we believe this could be a significant catalyst for investors in the near term. We forecast Emblem's revenue will grow at a three-year CAGR [compound annual growth rate] of 140 per cent to $148-million in fiscal 2021. Emblem currently trades at 10.2 times its projected funded capacity, compared to peers at 9.1 times. However, we believe that the company's medical focus, forecast product mix and premium pricing support a higher multiple. Emblem is the only LP in our coverage universe where our valuation of medical alone supports our rating."

Mr. Maruoka had previously given Aurora Cannabis Inc. (ACB-X) a "speculative buy" rating and $3.15 target, which is also the consensus target.

"Aurora is our Top Pick," he said. "Of the six LPs now under coverage, Aurora Cannabis is our Top Pick. Aurora has the funded capacity to rank amongst the leaders of the industry, and should also be counted amongst the lowest-cost producers. We believe that Aurora ranks well for the other aspects of its strategy, but, most importantly, provides a relatively attractive return."

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New Gold Inc. (NGD-T) is "refuelled for a final stretch run" in the development of its Rainy River project, said Desjardins Securities analyst Michael Parkin.

Upon resuming coverage of the stock following its $150-million (U.S.) equity financing, Mr. Parkin upgraded the Toronto-based mining company to "buy" from "hold."

Under the financing, which was raised to $173-million with overallotment, the company issued 61.6 million new shares at $2.80 (U.S.) each. The funds will be used to complete the Rainy River project in northwestern Ontario.

"We estimate initial production at Rainy River in 3Q17 and a conservative commercial production date of January 1, 2018, at which point we forecast that the asset will be generating free cash flow," said Mr. Parkin. "Based on our current metals and currency assumptions, we estimate that the company should end the year with $101-million (U.S.) in cash (after drawing another $60-million on its revolver) and $960-million in debt. By year-end 2018, we estimate that the company would have built its cash position up to $308-million and reduced debt to $860-million. We believe it can fully repay its revolver by year-end 2019, and generate sufficient free cash flow to repay the $300-million of notes due in 2020 and the $500-million due in 2021. This also assumes the development of the New Afton C-Zone during this period."

In reaction to the financing, Mr. Parkin lowered his cash flow per share projections for 2017 and 2018 to 62 cents and 83 cents, respectively, from 64 cents and 85 cents.

He raised his target to $4.75 from $4.50. Consensus is $4.

"We believe the Rainy River project will increase EBITDA by 30 per cent year over year, which could drive the share price to outperform the peer group," the analyst said. "In our view, the biggest risk to the stock is any further delay or significant cost overrun on the Rainy River project."

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Though he called its fourth-quarter results "disappointing" and its outlook weaker, Desjardins Securities analyst Michael Parkin said Tahoe Resources Inc.'s (THO-T, TAHO-N) valuation is "attractive."

On March 9, Tahoe reported lower-than-expected quarterly earnings and cash flow per share, which Mr. Parkin attributed to lower revenue as well as higher depreciation and expenses. Its 2017 and 2018 guidance brought higher-than-anticipated capital expenditure expectations, while its reserve update brought a 10-per-cent year-over-year drop in gold and silver ounces.

"The stock underperformed the S&P/TSX Global Gold Index by nearly 10 per cent on March 10 as a result of the negative news," said the analyst. "We've lowered our target price multiples and believe the company needs to demonstrate execution to plan to potentially be able to recapture historical premium multiples. One major risk we still see as possible is further M&A, which we do not believe the current shareholders are willing to support. We estimate Tahoe will borrow a total of $120-million (U.S.) on its credit facilities by year-end 2017 to maintain a cash balance of $80–90-million, fully repaying it by year-end 2019."

With a "buy" rating (unchanged), Mr. Parkin lowered his target price to $14 from $16.75. Consensus is $12.51.

"Our target price fell 16 per cent to $14.00, but with the shares down [approximately] 7.5 per cent during Friday trading, the closing price implies 41-per-cent upside to our target and we are maintaining our buy–speculative rating," he said. "We believe that if management can execute on guidance, the risk of further negative surprises is limited in the near term. With the stock trading at 6.5 times and 5.9 times enterprise value-to-EBITDA on a 2017 and 2018 basis, respectively, and at 1.09 times our revised [net asset value], we believe the valuation is reasonably attractive at current levels."

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Though its fourth-quarter results exceeded his expectations, BMO Nesbitt Burns analyst Ray Kwan sees "little reason" to own shares of Northern Blizzard Resources Inc. (NBZ-T) versus "other beaten down" exploration and production (E&P) companies.

Accordingly, he downgraded his rating for the stock to "underperform" from "market perform."

"We see a lower probability of a take-out, given the financial leverage post the share buy-back," the analyst said.

On Friday, the Calgary-based company reported quarterly cash flow per share of 32 cents, exceeding both Mr. Kwan's projection (29 cents) and the consensus (27 cents). He attributed the beat to lower operating costs, royalties and gains on financial derivatives.

Northern Blizzard reported production of 18,281 barrels of oil equivalent per day (boe/d), slightly below Mr. Kwan's estimate (18,383) and the Street (18,317).

Mr. Kwan lowered his price target for the stock to $3.50 from $4.50. Consensus is $4.46.

"Given the recent weakness in WTI oil prices with front month contracts now trading below $50 U.S. per barrel and the company's leverage post share buyback of 3.2 times (strip) versus peers of 2.0 times, we see better opportunities in other beaten down Canadian E&P names that have fallen precipitously in 2017," he said.

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After "years of challenges," SNC-Lavalin Group Inc. (SNC-T) is "on stronger footing," said BMO Nesbitt Burns analyst Devin Dodge.

He initiated coverage with an "outperform" rating for the stock.

"In our view, SNC's current share price represents an attractive entry point into a top-tier E&C firm," the analyst said. "We expect financial performance to improve, underpinned by a pickup in activity levels across many of its core end markets and more runway from cost-improvement initiatives. Past legal issues remain a concern but we believe the extensive changes made by the company in recent years have helped to reduce this risk to more manageable levels."

Mr. Dodge said the activity level of the company's oil and gas business has proven to be "relatively resilient" despite a drop in oil prices.

"We believe this reflects SNC's breadth of services, strong relationships with its clients, and an increased focus on sustaining capital projects," he said. "We expect activity levels for SNC's O&G services to remain near current levels, with potential upside should growth capital spending rebound."

He said SNC is "well positioned" for earnings growth, led by its infrastructure and construction segment "underpinned by a strong pipeline of Canadian infrastructure projects."

"We expect an improving outlook for the mining sector to push M&M segment revenues higher while increased activity levels for nuclear projects should offset lower contributions from other services in the Power segment," the analyst said. "Supported by additional cost reduction initiatives and an improving revenue mix, we expect margins to push higher over the next two years. Our 2018 EPS estimate of $2.19 for the E&C segment implies a two-year CAGR of 21%. In addition, we believe the company's investment in 407 International will continue to generate attractive results, which would be positive for SNC's dividend income and valuation."

Mr. Dodge called its ownership interest in 407 the "crown jewel" of its capital segment and helps "de-risk" SNC shares.

"Based on our DCF [discounted cash flow] analysis, SNC's stake in 407 International is valued at approximately $4.2-billion, or $28 per SNC share (after tax)," he said. "In our view, 407 International is an attractive and maturing investment that helps to offset at least a portion of the volatility inherent in the E&C business. We also believe the assumptions for revenue growth to be conservative and note that a 100-bp increase in our pricing growth assumptions over the next 15 years would add ~$4/share. After considering a sale of its stake in 407 International in recent years, current SNC management views the investment as a core holding and we believe the threshold for selling the asset prior to maturity to be high."

"Beyond the 407 International, SNC has a number of other investments in its Capital portfolio. Based on the sale of other concession agreements over the past two years, we suspect the market value of its investments could be higher than book value. If we assume a level of gains consistent with prior concession sale agreements, there could be up to $2/share in value above our current estimate. In addition, we believe the proceeds from potential sale agreements could be redeployed into other concession agreements and/or M&A opportunities."

Mr. Dodge set a target price of $63 for the stock. Consensus is $63.15.

"Though we believe the company has made significant progress in strengthening its risk management, legal, and compliance standards, the potential for adverse developments related to prior legal issues remains a key risk for the stock," he said. "Beyond the legal issues, SNC is also subject to a number of risks relating to overall activity levels in its key end-markets, potential cost overruns from fixed price contracts, and the performance of third parties (i.e., subcontractors, JV partners, etc.)."

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CIBC World Markets analyst Jacob Bout upgraded Chemtrade Logistics Income Fund (CHE.UN-T) to "outperformer" from "neutral" after reinstating coverage following its acquisition of Canexus Corp.

"As for Mark Davis, CEO of Chemtrade, he is getting back to his roots in the pulp chemical business (Mark was previously the head of Erco)," said Mr. Bout. "We believe Mark's expertise could provide solid cost-cutting opportunities and revenue and cost synergies associated with Canexus acquisition."

Mr. Bout raised his target to $22 from $19. Consensus is $21.23.

"We have adjusted our estimates to reflect the acquisition of Canexus (closed March 10), the $400-million equity financing, synergies of $15-million to $20-million by 2018 and the sale of Chemtrade's legacy International business. While 2017 is expected to see some weakness from Sulphur Products & Performance Chemicals (reduced volumes from Augusta, Vale Copper Cliff), we expect both SPPC and Water Solutions & Specialty Chemicals  to perform better in 2018 as industrial activity in North America picks up. Chemtrade should also benefit from WSSC margin improvement given more higher-margin ACH/PAC chemicals in the mix."

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ARC analyst Harriet Li downgraded Labrador Iron Ore Royalty Corp. (LIF-T) to "hold" from "buy" based on valuation.

"Although iron ore prices have continued to defy expectations thus far into 2017, we believe there is downside risk driven by new supply coming online and concerns over the sustainability of demand. Despite the downside risk, we believe iron ore prices will remain at a level that will support robust free cash flow generation by IOC and the payment of IOC dividends which in turn supports the payment of Labrador's special dividend, which we anticipate will total $1.50/share this year, consisting of a regular dividend of $1.00/share and a special dividend of $0.50/share."

Ms. Li's target is $17, up from $15. Consensus is $19.25.

"We have raised our 2017 earnings estimate from 88 cents per share to $1.58 per share, mainly reflecting stronger than expected iron ore prices. We also introduce our 2018 earnings estimate at $1.29 per share, with the year-over-year decline in earnings driven by an anticipated weakening in iron ore prices later this year as more supply comes online and a reduction in the pellet premium in 2018."

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In other analyst actions:

Element Fleet Management Corp. (EFN-T) was downgraded to "market perform" from "buy" by Cormark analyst Jeff Fenwick, who lowered his target to $13.25 from $15.50. The average is $15.14.

McCoy Global Inc. (MCB-T) was raised to "speculative buy" from "market perform" by Cormark analyst Jesse Pytlak with a target of $2.30 (up from $2.20). The average is $2.35.

Haywood Securities analyst Pardeep Sangha initiated coverage of Nanotech Securities Corp. (NTS-X) with a "buy" rating and $2 target. The analyst average is $1.88.