Thursday's analyst upgrades and downgrades

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

The uncertainty surrounding the softwood lumber dispute "trumps" solid fundamentals and is likely to continue to weigh on Canadian forest stocks, said Raymond James analyst Daryl Swetlishoff.

"Another 6 to 12 months of trade dispute uncertainty – Lumber V (a reference to the 5th major softwood lumber trade dispute in the past 35 years) is expected imminently with the U.S. launching an investigation of Canadian lumber exports," said Mr. Swetishoff. "While some investors have considered this to be a tradeable event, Canadian lumber stock reactions have been fairly muted as we expect the Department of Commerce action is widely anticipated by the market. Despite solid fundamentals, trade dispute uncertainty has pressured lumber share values all year. The key question facing the stocks now is 'when does the uncertainty abate'? Unfortunately, the trade investigation process tends to be bureaucratic and plodding. Preliminary countervailing duty (CVD) rates are not expected until late 1Q17 (at which time cash deposits will be collected on the value of lumber shipped from Canada to the USA). We highlight that having to put up cash (instead of bonds) is different this time around – which could put extra pressure on Canadian lumber exporters in a weaker financial position.

"The potential preliminary CVD rate is unknown although last time around (during Lumber IV; 2001–6) it came in at 18.79 per cent and consensus of industry observers suggest a similar rate could apply again. Preliminary anti-dumping duty (ADD) amounts would apply approximately 2 months later (May 1, 2017) and while again of unknown magnitude, in Lumber IV the 'all other' dumping margin was 8.43 per cent for a combined average total export charge of 27.22 per cent. For this round the final CVD determination is expected during early fall 2017 with final ADD determinations by year end. Hence, barring a negotiated settlement, we don't see trade-related uncertainty surrounding the abating for 6–12 months."

In a research note on the industry, Mr. Swetishloff downgraded his rating for stock of Western Forest Products Inc. (WEF-T) to "outperform" from "strong buy" to reflect a lack of near-term upside due to the uncertainty over the dispute. He also made number target price changes to other stocks.

"We expect trade dispute uncertainty has prompted incremental investors to largely abandon the building materials space – backstopping deeply discounted valuations," he said. "We note that year-over-year lumber prices are up an average 30 per cent but the average 30-day trailing lumber share price performance is up only 3 per cent year over year. To determine what lumber stocks are currently pricing in, we apply our target multiples to current market caps to estimate implied 2017 EBITDA and estimate the duties implied by the lower earnings. Based on our analysis, we estimate lumber stocks are currently pricing in 25-per-cent average duty rates with no offsetting price increase (i.e., based on spot Spruces, Pines and Firs (SPF) lumber pricing of $325 (U.S.) per thousand board-feet (mfbm). We highlight that during Lumber IV we estimate roughly half of the average 27.22-per-cent combined duties were offset by higher U.S. lumber pricing. During this period we characterize lumber markets as 'balanced' with increasing demand offset by production increases. Looking ahead we expect modestly higher U.S. housing activity and reduced Canadian production to offset U.S. production increases leading to tight U.S. markets. Under these conditions we expect at least 50 per cent of lumber duties to eventually be offset by higher pricing. That said, we expect factors such as a desire to convert timber inventories to cash and integrated producers running for byproduct wood chips have the potential to delay production curtailments until 2H17."

Mr. Swetlishoff did keep his target price for Western Forest Products at $2.50. The consensus price target is $2.55, according to Thomson Reuters.

"The downgrade reflects our expectation for lumber trade related uncertainty to continue to dominate investor behavior over our investment horizon," the analyst said. "Looking further out Western's stable free cash flow, healthy dividend, strong balance sheet, non-core asset sales potential, and high proportion of specialty lumber products remain attractive investment attributes."

His other target price changes were:

- Canfor Corp. (CFP-T, outperform) to $18 from $19.50. The analyst average: $19.46.

- Conifex Timber Inc. (CFF-T, outperform) to $4 from $5. Consensus: $4.40.

- Norbord Inc. (OSB-T/OSB-N, strong buy) to $46 from $42. Consensus: $37.61.

- West Fraser Timber Co. Ltd. (WFT-T, outperform) to $49 from $56. Consensus: $51.80.

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In a third-quarter earnings preview for the precious metals sector, Desjardins Securities analyst Michael Parkin said he's "constructive" on gold prices heading into the new calendar year, but he expects near-term volatility due to a potential rate hike by the U.S. Fed in December.

He lowered his fourth-quarter gold price assumption to $1,255 per ounce from $1,365 and his silver price assumption to $17.30/oz from $20.25/oz.

Mr. Parkin upgraded a quartet of stocks based on revised prices, foreign exchange assumptions and valuations. He also lowered target prices for most of his coverage universe to reflect lower EBITDA estimates for the next 12 months.

His ratings changes were:

- First Majestic Silver Corp. (FR-T) to "buy" from "hold" with a target of $14 from $23. Consensus is $24.01.

He said: "Our target price dropped by 39 per cent to $14.00; however, with the stock down [almost] 50 per cent in the last month, the target implies a potential return of 25 per cent. As a result, we are upgrading the stock … In a rising gold price (and thus likely silver price) environment, we believe First Majestic could outperform based on the Au:Ag thesis, but we acknowledge this as a very speculative trade and thus assign our highest risk rating to the company. We do not believe First Majestic is valued on fundamentals, as it is trading at nearly 4.23x NAV."

- Goldcorp. Inc. (G-T) to "buy" from "hold" with a target of $26 from $28. Consensus is $28.91.

He said: "Our NAV [net asset value] estimate was helped by significant exposure to our now weaker Mexican peso assumption, as well as flat long-term gold and silver prices and higher by-product price assumptions. As a result of these changes, our target price fell 7 per cent to $26.00; however, with a potential return of 29 per cent, we are upgrading our recommendation."

- MAG Silver Corp. (MAG-T) to "buy" from "hold" with a target of $22 from $22.50. Consensus is $23.88.

He said: "The main operational tweak we made to our model was pushing back the start of major capex spending on Juanicipio to 2Q17 from 1Q17, as we now expect a delay in the construction decision after attending MAG's technical session on Oct. 14. As a result of these changes, our NAV fell by 2 per cent and our target price also fell by 2 per cent to $22.00. With the share price down 11 per cent over the past month, we are upgrading our recommendation."

- Primero Mining Corp. (P-T) to "buy" from "hold" with a target of $2.70 (unchanged). Consensus is $3.34.

He said: "Our NAV increased by 22 per cent, mostly because we now assume taxes will be paid as per the APA for FY1 and FY2. This change should make our estimates more comparable to consensus. Due to these adjustments, our target price is flat at $2.70. With an implied potential return of 23 per cent, we are upgrading the stock."

Mr. Parkin's target changes included:

• Agnico Eagle Mines Ltd. (AEM-T, buy) to $77 from $85. Consensus: $67.98.
• Alamos Gold Inc. (AGI-T, buy) to $12.50 from $13.50. Consensus: $13.74.
• Argonaut Gold Inc. (AR-T, buy) to $3.70 from $4.70. Consensus: $4.30.
• Detour Gold Corp. (DGC-T, buy) to $31.50 from $36. Consensus: $40.67.
• Mandalay Resources Corp. (MND-T, buy) to $1.50 from $1.70. Consensus: $1.57.
• New Gold Inc. (NGD-T, buy) to $6.25 from $7. Consensus: $7.09.
• Richmont Mines Inc. (RIC-T, buy) to $15 from $16.50. Consensus: $15.
• Tahoe Resources Inc. (THO-T, buy) to $21.50 from $23. Consensus: $26.01.

He said: "We have rolled our models forward and base our NTM [next 12-month] EBITDA estimate on the 4Q16–3Q17 period, which was negatively impacted by our new price deck. We have high conviction that Agnico and Alamos can report good quarters and/or positive outlooks for 4Q16, and thus we prefer these two names going into earnings season. Of the companies that have reported 3Q16 operating results, we prefer Richmont — our top pick — as 4Q could be very strong at Island Gold. At Tahoe, we will be looking for an update on the water shortage at Shahuindo, at New Gold any construction/capex update on Rainy River, at Primero progress on Black Fox grades and the ramp-up at San Dimas, and at Detour the status of the open pit, which recently flooded."

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Mullen Group Ltd. (MTL-T) proves "good things come in threes," said Raymond James analyst Andrew Bradford.

In reaction to its third-quarter earnings and a trio of acquisitions, Mr. Bradford upgraded his rating for the Alberta-based supplier of trucking and logistics services to "outperform" from "market perform."

On Wednesday, the company reported quarterly earnings before interest, taxes, depreciation and amortization of $54-million, beating both Mr. Bradford's projection ($46-million) and the consensus ($49-million).

Mr. Bradford emphasized the company "quietly" bought two small companies during the quarter and followed that up with another acquisition following the quarter.

He feels the first acquisition, a $1-million deal to buy Mortux Inc., is unlikely have a material impact on its results. However, the $3.5-million acquisition of Northern Frontier Logistics came at "a price that we reckon might prove to be a substantial bargain," and he added $3-million in incremental EBITDA to his 2017 and 2018 estimates.

The company also purchased Caneda Transport in a deal he estimates to be worth $15-million to $20-million.

"Given MTL's $260-million war chest, we suspect this is only the beginning of its acquisition campaign," he said.

Mr. Braford raised his 2016, 2017 and 2018 earnings per share projections to 62 cents, 98 cents and $1.20, respectively, from 53 cents, 80 cents and $1.02.

He also increased his target price for the stock to $18.75 from $16.50. The analyst average is $18.64, according to Bloomberg.

"Mullen's stock has been moving steadily higher over the last month, but we expect it will leg-up further following these results and acquisitions," he said.

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DragonWave Inc.'s (DWI-T, DRWI-Q) newly announced contract with Sprint Corp. (S-N) brings the potential for "strong" improvement to its cash generation abilities as well as support to its balance sheet, said Desjardins Securities analyst Maher Yaghi.

He upgraded the stock to "hold" from "sell."

On Wednesday, DragonWave, a Kanata, Ont.-based company, announced the U.S. telecom giant has selected its microwave backhaul equipment for network deployment as part of the company's densification and optimization strategy. Mr. Yaghi said revenue from the purchase orders should begin to ramp up by the fourth quarter of the 2017 fiscal year.

"We anticipate this agreement could quickly improve DWI's free cash flow (FCF) profile, allowing the company to reach the cash flow breakeven point in FY18," he said. "We believe the type of products DWI will sell through this contract are likely to generate high margins, unlike the most recent sales the company made in India, where it sold mostly low-end products.

"It is difficult to quantify the total revenues the agreement will generate at the moment, but it could have the potential to cover the revenues lost from the Nokia channel. Moreover, this deal could significantly boost the confidence of any potential client that might have shied away from DWI because of its weak credit profile, in our view."

Mr. Yaghi raised his 2017 adjusted earnings per share forecast to a loss of $2.72 from a loss of $2.79. His 2018 projection moved to a loss of $1.02 from a loss of $2.08.

He also increased his target price for the stock to $4.40 from $3. The analyst average is $4.77.

"We had been cautious on DWI given the continued decline in revenues in recent quarters and its weak balance sheet," the analyst said. "The contract with Sprint has the potential to improve both issues at once but until we see the actual ramp-up in sales, it is hard to become bullish on the shares. We are, however, upgrading the stock to Hold at this point until we receive more clarity about the contract.

"Another important point is that the deal could provide significant support to DWI in the process of negotiating its credit facility. Recall that before the Sprint contract was announced, the company was in a difficult liquidity situation, having to renew its credit facility by April 1, 2017. Even though we still believe it will be an important step for the company to ink a new financing deal, we think this should be much easier now that the revenue growth path could improve and the company could be FCF positive in 2H FY18. The announcement also gives us confidence in the state of the technology developed by DWI, as demonstrated by Sprint's vote of confidence; DWI had recently cut R&D significantly."

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While the third-quarter results for Canadian Pacific Railway Ltd. (CP-T, CP-N) were hurt by the late harvest, it is still on track to delivery best-in-group volume, revenue and earnings-per-share growth in 2017, according to RBC Dominion Securities analyst Walter Spracklin.

On Wednesday, CP reported adjusted earnings per share of $2.73, versus Mr. Spracklin's estimate of $2.80 and the consensus of $2.79. Revenue dropped 9 per cent, which the analyst blamed largely on lower volumes due to crude and the late harvest.

"Our focus now shifts to 2017, where we think CP's book of business is better positioned than any given the strength in Bulk and team has the highest chance of delivering best-in-class productivity," he said.

"Our view is supported by the following:  1) Expected EPS growth is best in the group. Fine-tuning our estimates based on management's new guidance, we see CP outperforming the group in EPS growth. Based on our new estimates, we are forecasting a 4-year compound annual growth rate of 17 per cent, compared to 8 per cent for the group. 2) Greatest potential in group to deliver on O/R improvement. We have heard from investors the position that CP has less room for O/R improvement as it has already reached the mid-50s, while other rails have ample room to improve on O/Rs that are in the mid to high 60s. In our view, the O/R equation is more complicated than simply where the current level is. Central to our view that CP is more likely to drive further O/R improvements is 1) its proven operating model; 2) deep bench strength; 3) leadership that has been groomed under the precision railroading model; and 4) low exposure to structurally challenged thermal coal market. Finally, we point out that O/R for some peers have nearly flat lined in recent quarters."

Mr. Spracklin reduced his 2017 and 2018 EPS estimates by 3 per cent due to "continued sluggish volumes and slower harvest." Accordingly, he dropped his target price for the stock to $230 from $237 with an "outperform" rating. The average is $218.99.

"CP's book of business is best positioned for the commodities showing the most favourable trends; the operating team is one of the best in the group; and as a result, CP's expected EPS growth over the next 2 years far outpaces the industry," he said. "Yet the price-to-earnings multiple on 2018 estimate of 14.8x is well below its closest peer of 16.4x and only in line with the slower growth U.S. peer average of 14.6x. Accordingly, we continue to see the shares as meaningfully undervalued."

Elsewhere, BMO Nesbitt Burns analyst Fadi Chamoun raised his target to $220 from $215 with an "outperform" rating.

"CP Rail reported strong cost performance in Q3/16 and appears well positioned to deliver positive operating leverage on a volume recovery in 2017," he said. "In fact, we estimate Q4/16 EPS growth in the low to mid teens (ex. real estate gains) on flat y/y revenues. With a positive outlook for bulk commodities (grain, potash, coal), easy comparables through H1/17, and a lowered cost curve, we believe that CP Rail could deliver strong EPS growth in coming quarters."

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In other analyst actions:

Canopy Growth Corp. (CGC-T) was downgraded by M Partner analyst Mason Brown to "hold" from "buy" with a target of $5.80 (unchanged). The analyst average is $5.39.

Fairfax Financial Holdings Ltd. (FFH-T) was cut to "market perform" from "buy" by Cormark analyst Jeff Fenwick. He lowered his target to $800 from $810. The average is $764.12.

Kinder Morgan Inc. (KMI-N) was raised to "outperform" from "neutral" by Credit Suisse analyst John Edwards, who raised his target to $26 (U.S.) from $23. The average is $23.56. Stifel analyst Selman Akyol upgraded the stock to "buy" from "hold" with an unchanged target of $24.

Guggenheim Securities analyst Eric Wasserstrom downgraded Goldman Sachs Group Inc. (GS-N) to "neutral" from "buy". Mr. Wasserstrom did not specify a target price, while the consensus target is $188.59 (U.S.).