Thursday's analyst upgrades and downgrades

Share

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

Canadian oil and gas companies have adopted a "balance sheet first approach," according to Citi analyst Fernando Valle, noting they've cutting capital expenditures and dividends to maintain independence and flexibility.

Mr. Valle predicted there should be "significant" free cash flow generation across the group as crude climbs to between $50 (U.S.) and $60 per barrel.

Given their underperformance compared to their peers thus far in 2016, Mr. Valle sees Suncor Energy Inc. (SU-T) and Husky Energy Inc. (HSE-T) trading at high adjusted FCF yields.

"With unsanctioned growth projects out of the money, we believe FCF will flow to shareholders," he said.

Accordingly, Mr. Valle upgraded both stocks to "buy" from "neutral."

"Low-sustaining capital thermal heavy oil is now an even larger proportion of the sector after this cycle's M&A activity," he said. "This should increase free cash flow leverage to rising oil prices at the cost of cash flow stability. The exposure to low oil prices is mitigated by strong balance sheets, improved through asset sales and equity increases. Cash requirement have also decreased as major capital projects are completed and supply chain deflation drives down sustaining capital needs.

"Part of the leverage to oil prices will be offset by the Canadian dollar, which Citi economists expect to appreciate, though at a slower pace than oil prices. We estimate 65-75 per cent of operational costs are CAD based, while the majority of the sector's revenues are U.S. dollar linked. This should translate to a 10-15-per-cent increase in operational costs. Natural gas prices on the other hand seem less likely to rebound, as demand from SAGD [steam assisted gravity drainage] projects will be slower than anticipated."

Mr. Valle raised his target for Suncor to $44 from $40. Consensus is $40.13.

"SU has shrewdly increased free cash flow sensitivity to WTI prices with their acquisitions of Syncrude stakes from COS [Canadian Oil Sands Ltd.] and Murphy Oil," he said. "The $2.9-billion bought deal completed this week and subsequent debt repurchase have lowered leverage to 2.1x 2016 estimated net debt/EBITDA and should bridge the gap to higher oil prices in 2017."

For Husky, his target rose to $20 from $18. Consensus is $18.80.

"HSE's transactions have improved the balance sheet significantly and put the company in sound footing to resume limited growth investments in its thermal heavy oil portfolio," he said. "Though there are still short-term concerns with Liwan, we think that risk is priced-in, barring an unlikely complete breakdown of the contract. HSE trades at a considerable discount to its Canadian peers."

Mr. Valle also raised his target price for Cenovus Energy Inc. (CVE-T) to $20 from $19, compared to a $20.85 consensus. He maintained a "neutral" rating.

His target for Imperial Oil Ltd. (IMO-T) fell to $43 from $44 with a "neutral" rating (unchanged). Consensus is $45.27.

=====

Morgan Stanley's Adam Jonas is the latest analyst to criticize Elon Musk's $2.86-billion (U.S.) plan to combine Tesla Motors Inc. (TSLA-Q) with SolarCity Corp. (SCTY-Q).

Considered one of the Street's bullish analysts on the automaker, he downgraded his rating for the stock to "equal-weight" from "overweight" on Thursday.

"While there may be any number of lucid arguments supporting the strategic rationale of a combination, we believe many of the benefits could have been achieved through arm's length/strategic partnership and without the risks inherent in exposing Tesla shareholders to the financial and capital markets risks faced by SCTY," said Mr. Jonas.

He lowered his target price for the stock to $245 (U.S.) from $333. The analyst average is $266.86, according to Bloomberg.

At the same time, Mr. Jonas's Morgan Stanley colleague Stephen Byrd downgraded his rating for SolarCity to "equal-weight" from "overweight" with a target of $25, down from $34. The average is $28.

=====

In a research note on infrastructure and construction companies, Raymond James analyst Frederic Bastien downgraded Hydro One Ltd. (H-T), citing a full valuation.

"We see further upside as the utility transitions to a performance-based framework beyond our forecast horizon, but aren't ready to reflect that in a higher target price just yet," said Mr. Bastien, who moved his rating to "market perform" from "outperform."

His target price for Hydro One remained $25, compared to an analyst consensus of $24.17.

At the same time, Mr. Bastien said his three top picks for the second half of 2016 are Canam Group Inc. (CAM-T), Brookfield Infrastructure Partners LP (BIP-N, BIP.UN-T) and SNC-Lavalin Group Inc. (SNC-T).

On Canam Group, he maintained his "outperform" rating and a $19 target. Consensus is $18.46.

"On the macro front, evidence continues to point to an expanding U.S. construction sector well into 2017," he said. "The commercial portion of the Dodge Momentum Index rose in May for a second straight month, just as the ABI accelerated to its highest monthly score in nearly a year. This is transpiring as industry utilization and labour availability continue to tighten — leaving prices with nowhere to go but up, in our view. On the strategic front, investments in added services are enabling Canam to not only play an increasingly larger role in the construction industry, but also earn better returns for its shareholders. On the execution front, disappointing bridge results haven't kept the firm from beating consensus in each of the last two reported quarters. Knowing tremendous efforts are being expended to ensure the bridge team earns a fair return on its backlog in 2H16, we think now is the time to buy. Canam appears to be of the same view, having purchased over 800,000 shares for cancellation under its NCIB [normal course issuer bid] since Feb. 26. If those most in the know are buying back stock actively, why wouldn't you?"

He also maintained a "strong buy" rating for Brookfield Infrastructure with a $54 (U.S.) target. Consensus is $47.75.

"By that we mean BIP has the biggest potential for same-store growth and M&A upside among the stocks we cover," said Mr. Bastien. "On the organic front, an exploding U.K. regulated distribution platform and a revived North American natural gas transmission unit (NGPL) have us convinced the partnership can achieve high-single-digit growth through 2017. On the strategic front, BIP is currently working on five exclusive deals in Brazil. Management knows it must strike while the iron is hot, however, as the opportunity window will likely shut the moment the county starts showing signs of stabilization. To this end, it stands ready to deploy up to $1-billion in fairly short order."

For SNC, he kept an "outperform" rating while raising his target to $60 (Canadian) from $57. Consensus is $55.50.

"By rolling our valuation to 2017, we derive a new target … for SNC's stock," the analyst said. "We advance, however, that another $5.00 to $6.00 of upside is achievable should the firm deliver on its 2017 E&C EBITDA margin goal of 7 per cent and sector multiples revert back to the industry's 10-year average of 7.5x (something $60-$70 crude oil could fix). Expect the next catalyst to come from SNC Capital, however, with the new structure for the mature North American concessions to be unveiled around mid-year. We are confident this announcement will support a valuation for SNC Capital (ex-407) that is significantly greater than the $3.33 per share carried by the Street. This, at least, is what is implicit in our valuation of $4.78 per share for the portfolio."

He also made the following target changes:

- Pattern Energy Group Inc. (PEGI-Q, PEG-T, outperform) to $26 (U.S.) from $25. Consensus is $25.03.

- Aecon Group Inc. (ARE-T, outperform) to $19 (Canadian) from $17.50. Consensus is $19.40.

- IBI Group Inc. (IBG-T, outperform) to $6 from $4.50. Consensus is $4.90.

- WSP Global Inc. (WSP-T, outperform) to $50 from $45. Consensus is $45.91.

=====

Valeant Pharmaceuticals International Inc. (VRX-N, VRX-T) has a "long road to recovery," said JPMorgan analyst Chris Schott.

Citing the potential for a "further deterioration in business fundamentals," he downgraded the stock to "neutral" from "overweight."

"While we have admittedly supported the stock through recent controversies on a valuation basis (and we continue to see an attractive SOTP [sum-of-the-parts] valuation case), we are moving to the sidelines as we see a number of uncertainties around core business trends that are unlikely to be resolved in the near-term," the analyst said.

Mr. Schott said he projects earnings to be back-weighted as the embattled drugmaker struggles through disappointing results from Xifaxan, which he said "continues to underperform our expectations.

"We do not see a clear path to re-acceleration for the product," he said.

He lowered his target to $35 (U.S.) from $50. The average is $36.

=====

Despite the announcement of the $625-million sale of its Gordondale Montney assets, Encana Corp. (ECA-N, ECA-T) requires further asset sales to aid its balance sheet, said Macquarie analyst Chris Feltin.

Though he said the sale modestly improves the company's debt-to-cash flow multiple to 3.9 times from 4.1, he downgraded his rating for the stock to "underperform" from "neutral."
He raised his target to $7.50 (U.S.) from $6.50. The average is $8.60.

Elsewhere, CIBC World Markets analyst Arthur Grayfer raised his target to $6.75 from $5.75. He kept his "sector underperformer" rating "due to the higher relative oil price required for sustainability."

"While we carried the asset in our strip NAV [net asset value] at $540-million (U.S.), the recent Bloomberg article suggested a price of as much as $774-million for the Gordondale assets, which sent the stock soaring," said Mr. Grayfer. "As a result, we anticipate the lower than suggested consideration may weigh on the stock."

=====

Canaccord Genuity analyst T. Michael Walkley said, based on his surveys, consumers are delaying purchases of iPhones ahead of the launch of the iPhone 7.

Though he projects steady overall sales due to increased promotions and a stronger contribution from the lower-cost iPhone SE, Mr. Walkley dropped his target price for Apple Inc. (AAPL-Q).

"While we anticipate a lower replacement rate through September as consumers delay upgrading their iPhones ahead of the anticipated iPhone 7 launch, we do anticipate recovering sales with the iPhone 7 launch," the analyst said. "Longer term, we believe the current iPhone 6 and iPhone 6s products have enabled Apple to materially increase its share and installed base of the premium tier smartphone market. We believe these trends resulted in the iPhone installed base growing to over 500 million exiting 2015 with overall connected Apple devices exceeding 1 billion users. This impressive installed base should drive strong future iPhone replacement sales and earnings, as well as cash flow generation to fund strong long-term capital returns programs of $250-billion through the 2018 fiscal year. However, we anticipate a stronger upgrade cycle in 2018 versus our modest expectations for the iPhone 7, resulting in our lowered estimates."

Mr. Walkley lowered his 2017 replacement rate estimate to 28.4 per cent from 29 per cent "due to our expectations the iPhone 7 is more of a modest improvement to the iPhone 6S." Accordingly his 2017 fiscal year iPhone estimate fell to 222 million units from 230 million. His iPhone ASP [average sale price] assumptions for 2016 and 2017 fell to $651 (U.S.) and $627, respectively, from $653 and $637.

"While we have tempered our iPhone 7 sales expectations, we anticipate improving sales versus the iPhone 6S and then eventually stronger sales with the iPhone 8," he said. "Further, with an installed base of over 500 million iPhone consumers, we believe Apple should sell 200 million to 250 million iPhones annually with the 6S cycle near the low-end of the this range and the iPhone 8 near the high-end."

Mr. Walkley reduced his target price for the stock to $120 from $130 with a "buy" rating (unchanged). The analyst average is $123.38.

=====

After the release of its first-quarter 2017 financial results, which featured a cut in its full-year profit forecast, on Wednesday, BMO Nesbitt Burns Keith Bachman said he's left "wanting more" from Red Hat Inc. (RHT-N)

"Given that RHT shares had performed relatively well over the past few weeks, we believe that guiding in line with the prior revenue outlook will cause the stock to move lower near term," said Mr. Bachman. "However, current fiscal year guidance has remained relatively stable after RHT has reported past May quarters."

He noted the U.S. tech company reported a decline in deferred revenue of 1.8 per cent quarter over quarter, compared to a decline of 3.1 per cent in the same quarter a year ago and 1.3 per cent two years ago. Accordingly, he said deferred revenue growth of 17.2 per cent year over year "is solid performance given current valuation."

Mr. Bachman pointed to two areas for concern.

"First, top-25 renewal rates were 105 per cent (110 per cent excluding large government contracts), compared to recent trends of 115-120 per cent," he said. "Second, infrastructure growth was 13.3-per-cent year over year in CC [common criteria], compared to an average of 17.4-per-cent year-over-year CC growth over the past three quarters. We note that the May, 2015, quarter included a $5-million adjustment related to cloud accounting. Excluding the change, infrastructure growth would have been in the 15-16-per-cent range. We project infrastructure subscription revenue (which includes Red Hat Enterprise Linux or RHEL) will slow to 9-per-cent year-over-year growth in fiscal year 2018. As our revenue estimates are roughly in line with consensus, we believe that other sell-side analysts and investors project a moderation in infrastructure growth as well."

He kept his "outperform" rating for the stock, noting an "attractive" enterprise value to free cash flow multiple relative to 2017 fiscal year revenue growth of 13 per cent.

His target price for the stock fell to $85 (U.S.) from $88 due to lower financial estimates and his concern about the potential for slowdown in RHEL. The average is $88.12.

=====

In other analyst actions:

Home Depot Inc. (HD-N) was raised to "buy" from "neutral" by Nomura analyst Jessica Schoen with a target of $155 (U.S.), from $140. The analyst average is $148.97.

PPG Industries Inc. (PPG-N) was upgraded to "buy" from "neutral" by Longbow Research's Dmitry Silversteyn with an unchanged target of $130 (U.S.). The average is $125.22


With files from Bloomberg News