Thursday’s analyst upgrades and downgrades

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

Citing a softening operating outlook, BMO Nesbitt Burns analyst Heather Kirk downgraded Canadian Apartment Properties Real Estate Investment Trust (CAR.UN-T) to "market perform" from "outperform."

"Since CAP REIT went public in the late 1990s, no margins have increased from below 49 per cent to [about] 60 per cent with 600 basis points of that improvement since 2009," said Ms. Kirk. "The REIT's significant investment of capex over the last seven years has driven revenues and reduced operating costs, which has driven solid organic growth and margin expansion. But Q2/16 SP [same property] revenue growth of 1.4 per cent and a SP expense increase of 1.8 per cent suggest the margin expansion story has run its course.

"We continue to view CAP REIT as well positioned in the long term with a high quality national platform and a nascent development pipeline but we expect the REIT's near-term growth to moderate on more stable operating expenses and revenue pressures in Alberta and Saskatchewan. The Quebec market is also moderating and significant construction of condo properties is expected to limit growth."

Ms. Kirk noted the REIT's second-quarter same property net operating income growth of 1.1 per cent was 2.1 per cent below its average since the end of 2014. She added only British Columbia is currently running above that average, however that accounts for less than 15 per cent of its net operating income.

"All CAP's other markets are now running below recent trends, highlighting a slowing of momentum," she said. "With interest rates on CMHC insured financing below 2.5 per cent, we expect slower NOI growth to be partially offset by interest savings on refinancings and as a result there is only limited change to our 2016 and 2017 FFO [funds from operations] estimates. We are maintaining our NAV of $31, which we view as well supported by market cap rates, which have continued to compress, particularly in the Vancouver and GTA markets."

She maintained her target price of $32.50 per unit. The analyst consensus price target is $32.93, according to Thomson Reuters.

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In a research note on the telecom, media and tech sector, Desjardins Securities analyst Maher Yaghi upgraded Telus Corp. (T-T) to "buy" from "hold" to "reflect upside in the stock given the new valuation parameters and given it is still relatively cheaper than Rogers and BCE."

"We reviewed upcoming bond maturities for large incumbents, and juicy savings are still possible over the next 5–10 years if rates stay low," he said. "Taking into consideration the continued low-rate environment, we are upgrading Telus and increasing our targets on most companies. These stocks are still producing generous income, unlike a lot of commoditized fixed-income products, but risks do exist in the event rates rise significantly or increased competition creates a pricing shock."

He added: "Including the dividend yield, we now forecast an 18-per-cent potential total return from the current stock price, which is more than enough to justify a Buy rating, in our view. We also highlight that TELUS now trades at a significant discount versus its peers on an EV/EBITDA (2017) basis (Telus 8.0x, RCI 8.7x and BCE 8.6x), despite providing industry-leading EBITDA growth. We also note that Telus is one of the few companies in Canada that is actually reporting revenue growth in its wireline division, underscoring the company's strength. The firm also enjoyed a strong wireless performance in the most recent quarter, which should support future profitability. We do not see Shaw's entry in the wireless market impacting Telus more than the other large players. Actually, we believe TELUS will not be as impacted as the other large players. In Québec, Vidéotron has struggled to attract more than 20% of its wireless clients out of its wireline customer base. We believe the same situation might happen for SJR in western Canada. Coupled with our view that SJR's wireline clients may have been more prone to use Rogers' or BCE's service rather than Telus', we believe the impact on RCI and BCE in terms of subscribers will be larger. While we acknowledge that TELUS's FCF is currently under pressure, we believe the capex run rate should be much lower after 2018 once the FTTH [fibre to the home] deployment fades away."

Mr. Yaghi said the decline in interest rates is a "win-win" situation for telcos as well as shareholders, providing more attractive valuations.

"With more than $10-trillion (U.S.) of debt trading globally with a negative yield, investors, who historically allocated a portion of their portfolio to fixed-income securities, now find those securities acting more like commodities," he said. "Warren Buffett famously described this problem by saying: 'it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income ... over time.'

"Facing this dire situation, investors have been forced into corporate bonds in order to find a substitute for lost income. In so doing, the cost of debt for Canadian telcos has declined significantly. We estimate that cash flow for BCE, Rogers and TELUS is being lifted by about $500-million (Canadian)/year each from these low rates versus what they would have paid if rates were at levels of 10 years ago. If rates stay at current levels for another five years, we estimate an additional benefit of $70–120-million/year on the bottom line for these companies from debt refinancing alone. As we reviewed the current situation, it became evident that our previous valuation metrics needed to be polished. In essence, we reduced our WACC [weighted average cost of capital] for companies that would benefit from this situation by about 0.2 per cent, and increased the multiples we apply in our NAV [net asset value] calculations to reflect the higher multiples on terminal values generated from the difference between ROIC [return on invested capital] and WACC."

Mr. Yaghi made the following changes to his target prices:

- BCE Inc. (BCE-T, hold) to $68 from $64. Consensus is $60.97.
- Quebecor Inc. (QBR.B-T, buy) to $45 from $44. Consensus is $43.64.
- Rogers Communications Inc. (RCI.B-T, hold) to $61 from $56. Consensus is $54.67.
- Shaw Communications Inc. (SJR.B-T, buy) to $30 from $28. Consensus is $26.40.
- Telus (T-T, buy) to $50 from $46. Consensus is $43.90.

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Though the outlook for Superior Plus Corp. (SPB-T) was lowered, its M&A plans are poised to accelerate, said Raymond James analyst Steve Hansen.

On the heels of the release of its second-quarter earnings, Mr. Hansen upgraded the stock to "outperform" from "market perform."

The Toronto-based company reported quarterly earnings per share of 8 cents, meeting the analyst's forecast. Its adjusted operating cash flow of 19 cents topped Mr. Hansen's estimate by a penny and the consensus by 2 cents. He said the beat was due largely to a better-than-expected specialty chemicals margins.

"Coinciding with [Thursday's] release, SPB announced the completion of its CPD [construction parts distribution business] divestiture for total consideration of $428-million ($400-million net of expenses), with proceeds earmarked for the pay-down of its credit facility and early redemption of its 6.0-per-cent convertible debentures due June 30, 2018 ($150-million)," said Mr. Hansen. "As a result, SPB expects total debt-to-EBITDA ending Dec. 31 to drop to 1.8-2.2 times, well below the firm's 3.0-3.5x targeted range, positioning the company with ample flexibility to reinvigorate its M&A efforts, in our view."

Mr. Hansen called the quarter "solid," but he noted the management's decision to lower its AOCF per share guidance to $1.40-$1.60 from $1.50-$1.80 due to the CPD sale to Foundation Building Materials, LLC as well as a reduced outlook for its specialty chemicals business in the second half of 2016 (based on lower-than-expected chlor-alkali gross profit outlook and chlorate sales.

"Based upon 2Q call commentary, it's clear to us SPB management intends to use its renewed financial flexibility to pursue propane-related acquisitions," he said. "While timing/magnitude remain difficult to predict, management signaled its pursuit of both small ($1-5-million EBITDA) and medium-sized ($6-25-million) transactions across Canada and the U.S. northeast. Large acquisitions (greater-than $25-million) will also be contemplated, likely to include Gibson's Energy CanWest business (for sale), in our view. Finally, dovetailing on SPB's recent organic success in Wholesale, management indicated its desire to double its upstream presence given very attractive returns. Management expects to lay out all of its M&A plans in greater detail later this year (November Investor Day)."

Mr. Hansen raised his target price for the stock to $12.50 from $12. Consensus is $12.44.

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The issues faced by Alamos Gold Inc. (AGI-T, AGI-N) during the second quarter are "short-term in nature," said Desjardins Securities analyst Michael Parkin.

Viewing the company's quarterly results as "good on a financial basis and weak on an operational basis," Mr. Parkin upgraded his rating for the stock to "buy" from "hold" with an eye on a better second half of 2016 amid a number of potential catalysts for the coming 12 months.

On Wednesday, Alamos reported a quarterly loss of 4 cents (U.S.) per share. Adjusting for non-cash items, Mr. Parkin said the loss came in at one cent, versus the consensus projection of nil. Cash flow per share of 15 cents beat the 13-cent consensus. Gold production of 92,500 ounces fell below the Street's estimate (97.9 koz), while cash costs of $775 per ounce beat expectations ($793).

"Alamos produced 187.1koz of gold in 1H16 or 48.6 per cent of the mid-point of guidance, which remains unchanged at 370–400koz," said Mr. Parkin. "We have tempered our estimate for 2016 to 397koz (from 414koz), mostly a function of 2Q production coming in 10koz below our estimate, but this still lies at the upper end of the guidance range. We expect Y-D [Young-Davidson] to improve sequentially in 2H16 as the mining rate moves toward 7ktpd. Mulatos should be relatively flat or possibly up slightly in 3Q despite the rainy season due to improving grades, and 4Q should be strong. El Chanate should remain fairly constant. We expect further updates on La Yaqui's exploration will be a positive catalyst, and the original satellite zone is due to be producing in about a year with Cerro Pelon about six months later. We also look forward to the Lynn Lake feasibility study due out in about a year, which we believe, from conversations with management, could indicate an attractive after-tax IRR [internal rate of return] at $1,250/oz gold. Further catalysts could come from advancing the Turkish projects."

In reaction to the results, Mr. Parkin made slight tweaks to his financial models, with the most noteworthy change being a "modestly more conservative" 2016 production forecast of 397 koz (414 koz).

He maintained his target price of $13.50 for the stock. Consensus is $13.01.

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Reacting to a vast improvement in its outlook following its second quarter, Desjardins Securities analyst Keith Howlett upgraded KP Tissue Inc. (KPT-T) to "buy" from "hold."

"KPLP, the operating entity, posted notably stronger 2Q16 EBITDA than our estimate, consensus or management guidance," said Mr. Howlett. "This was a marked improvement from 4Q15 and 1Q16. The performance was driven by volume growth in the U.S. and Mexico, stable volume in Canada, lower input costs, internal cost reductions and some impact from a price increase in Canada. 2H16 will benefit from a new private-label customer in the U.S. and the full impact of the price increase. We see early signs of improving performance ahead."

The company reported operating EBITDA for the quarter of $35.9-million, ahead of Mr. Howlett's estimate of $30.9-million and management's guidance of a slight improvement from the same period in 2015 (which brought in $30.2-million). Mr. Howlett pointed to lower input costs and improved efficiences for the result.

"The relatively small AFH segment (away-from-home market for tissue) posted lower EBITDA vs a year ago as it absorbed business building spending, primarily related to installation of two new converting lines," the analyst said. "The much larger consumer segment increased EBITDA by 17 per cent. Management expressed confidence it will achieve its objective of $60-million of EBITDA from the TAD (through air dried) machine in the U.S. in 2017. Production commenced for a new US private-label customer in July 2016. Management has increased the FY16 capital budget (by $10–15-million) to $80–$95-million. Management indicates that 75 per cent of the spending has 3–4-year payback periods."

Mr. Howlett raised his target price for the stock to $15 from $13.50. Consensus is $14.67.

"The outlook improved markedly in 2Q16 with the successful implementation of a price increase in the consumer segment in Canada and engagement of a new private label tissue customer in the U.S.," he said. "Ongoing investment in manufacturing efficiency enhancements, as well as cost-reduction programs, also appears to be generating results. Management has guided that 3Q EBITDA will be higher than that generated in 2Q. We will be seeking confirmation of the improved trends in coming quarters."

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The second-quarter results for Stella-Jones Inc. (SJ-T) exhibited strong execution, said Acumen Capital Finance analyst Brian Pow, who cautioned investors about a "more muted" outlook going forward.

On Wednesday, the Quebec-based producer and marketer of pressure treated wood products reported earnings before interest, taxes, depreciation and amortization of $89.9-million, ahead of Mr. Pow's expectation ($82.5-million) and an improvement of 34.9 per cent from the same period in 2015 (from $66.6-million). Earnings per share of 79 cents topped his projection by 2 cents and was a 40.4-per-cent increase year over year (from 56 cents), while sales of $563.1-million also exceeded the analyst's expectations ($542.3-million) and represented an increase of 31.5 per cent year over year (from $428.1-million).

"The company reported strong sales growth, benefiting from recent acquisitions and strong demand for railway ties and consumer lumber," said Mr. Pow. "The change in gross margin reflects sales mix but was still in the historical range. EBITDA was better than expected and up year over year, driven by higher sales and the leverage expected from a fairly steady cost base."

However, management's guidance suggests a softened demand for railway ties in the second half of 2016 and into 2017 due to slowing demand. Mr. Pow also expects pricing pressures to dampen results.

"SJ expects some of the regional weakness for utility poles to continue as a number of their utility clients are not getting expected rate increases that help support maintenance spending," the analyst said. "This is seen as a temporary setback as the installed pole inventory is reaching its useful life. We also adjust margins in response to the railway tie outlook. Our updated estimates drive EBITDA margins of 15.3 per cent for 2016 and 15.4 per cent for 2017 which are well with in ranges provided by management."

Mr. Pow slightly raised his 2016 sales forecast to $1.939-billion from $1.934-billion, but he lowered his 2017 estimate to $2.119-billion from $2.123-billion. His EPS projections fell for both years to $2.54 and $2.86, respectively, from $2.58 and $2.94.

He did not change his "buy" rating for the stock, but he reduced his target price to $54.25 from $56. The analyst consensus price target is $55.43.

"We expect SJ to show strong execution, and leverage its competitive advantages, as it enters a slowing period of demand," said Mr. Pow. "The stock responded to the weaker outlook which we believe is now priced into the shares, providing investors a reasonable price range for longer-term oriented shareholders. We expect the company to focus on bringing down debt levels in the near term, and recharge the balance sheet for potential future acquisitions. In the absence of any meaningful acquisitions, we expect that the company will reward shareholders with additional increases in the dividend."

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Cargojet Inc. (CJT-T) is "ready for lift-off" with its dominant position in Canada's air cargo industry providing the potential for future growth according to Acumen Capital analyst Brian Pow.

Calling it a market leader in the Canadian air cargo industry with 90-per-cent in market share in the domestic time-sensitive business, Mr. Pow initiated coverage of the stock with a "buy" rating.

"The company's market share is defended against domestic rivals by a dedicated fleet of cargo aircraft that is unmatched within Canada, a demonstrated ability to operate a co-load network, and long term contracts that ensure revenue certainty until at least 2020. International rivals are prevented from competing in the domestic air cargo market due to cabotage restrictions that prevent them from operating point-to-point within Canada.

"We estimate that the core network contributed approximately $250-million or 80 per cent of Cargojet's revenue over the trailing twelve months ended March 31, 2016 (including fuel and other cost pass through). Without a catalyst, we expect revenues from the core network to increase at a rate in line with GDP growth."

Mr. Pow cited a pair of catalysts to Cargojet's core network which could increase revenue in excess of GDP. They are:

- The growth of e-commerce. He said: "The amount of e-commerce transactions has grown at a rate well in excess of GDP growth. Cargojet's co-load network has provided retailers, such as Amazon, the ability to ship on its network to a location closer to the end customer at which point a courier company completes the delivery. This practice of managing the "middle mile" provides significant upside to Cargojet going forward as no other air cargo company can compete in terms of cost or scale."

- The potential for 100-per cent market share. He said: "The remaining 10-per-cent market share in the time-sensitive overnight air cargo network is controlled by Edmonton-based Morningstar Air Express Inc. ("Morningstar"). Morningstar operates a fleet of approximately six aircraft on a dedicated network for FedEx Express. This contract was signed in 2009 for a period of 10 years. Given the significant cost advantages of operating a co-load network over a dedicated network, we see potential for Cargojet to win this contract in 2019. This view is confirmed by the fact that FedEx Express utilizes Cargojet's network on the secondary and tertiary routes that Morningstar does not operate."

Mr. Pow noted the company's fleet sits idle during the daytime, providing an opportunity for further growth if it can grow its market share in its non-core business during that period.

He set a target price for $38.50 for the stock. Consensus is $36.

"For reference, we include a peer basket consisting of international couriers, ACMI [aircraft, maintenance and insurance] and charter operators, less-than- truckload ground shippers, and aviation and specialty manufacturing companies," he said. "Based on P/EBITDA, Cargojet is trading at a significant discount due to the amount of finance leases and debt in its capital structure. This is in line with Atlas Air Worldwide Holdings (AAWW-Q) that has a similar capital structure. Based on EV/EBITDA, Cargojet is trading at a slight premium to the peer group for both 2016 and 2017 estimates which we think is reasonable given its dominant market position. We believe the Company has the ability to backfill the premium now that many of the one-time costs associated with the network build out are complete, the possible revenue catalysts for the core network, the potential for revenue growth in its non-core business, and the strong free cash flow yield (estimated at 10.6 per cent for the twelve months from Q316 to Q217 based on the last closing price of $33.60/share)."

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In other analyst actions:

Pine Cliff Energy Ltd. (PNE-T) was raised to "sector perform" from "sector underperform" at Scotia Capital by analyst Cameron Bean with a 12-month target price of $1.20 per share (up from 80 cents). The analyst average is $1.33, according to Bloomberg.

Peyto Exploration & Development Corp. (PEY-T) was downgraded to "neutral" from "outperform" at Macquarie Research by analyst Brian Bagnell. His target rose to $36 from $32, versus the average of $39.86.

Linamar Corp. (LNR-T) was raised to "buy" from "speculative buy" by Cormark Securities analyst David Tyerman. His target rose by a loonie to $59. The average is $64.67.

Essential Energy Services Ltd. (ESN-T) was downgraded to "hold" from "buy" by Clarus Securities analyst Stephen Kammermayer with an 18-month target price of 70 cents per share (down from 80 cents). The average is 92 cents.

CAE Inc. (CAE-T) was downgraded to "neutral" from "outperform" at Macquarie Research by analyst Konark Gupta. His target remains $18.00, compared to the average of $18.60.