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The logo for the Bank of Montreal is seen at its branch in Toronto.© Mark Blinch / Reuters

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

Headwinds are turning into tailwinds for Canadian banks, according to Citi analyst Ian Sealey.

"Canadian banks have been global outperformers both year to date (up 25 per cent) and over the past 12 months (up 16 per cent), helped by the rising oil price (WTI up 40 per cent year to date) but also continued strong capital generation," said Mr. Sealey. "While the environment remains difficult (low interest rates and commodity prices, and rising political risks, etc.), Canadian banks have had the lowest 2017 earnings downgrades of any global banking sector (down 2 per cent versus U.S. down per cent and Europe down 24 per cent). We believe the strong profitability of the Canadian banking system will lead to continued outperformance, driven by organic capital growth, dividends and M&A.

"The Canadian banks face challenges from the low interest rate environment, increasing competitive pressures, and rising risks in the Canadian housing market (in particular Vancouver and Toronto on prices, and Alberta on oil exposure). The Canadian banks are dealing with this in two ways: firstly they are allocating capital to higher return businesses such as auto finance and Commercial in order to protect margins, and secondly they are cutting costs in Canada through better technology, and headcount and branch reductions (an ongoing theme for the sector). However, headwinds are turning into tailwinds, with higher commodity prices year to date (oil up 40 per cent) and higher expectations of rate rises and faster growth in the U.S. This is likely to lead to margins stabilizing and then slowly rising as books rollover, and to reduced impairments going forward."

Mr. Sealey emphasized the banks' asset quality is "highly" correlated to oil prices. Accordingly, given a recent price stabilization, they have benefited through improved provisions for credit losses (PCLs), particularly in the wholesale and capital markets segments.

"There is a lag in the retail books (particularly Alberta) as higher unemployment continues to impact cost of risk," he said. "We believe that going forward asset quality will move from earnings headwind to tailwind."

He added: "When looking at direct exposure to oil & gas, it is the banks most exposed to Canadian business (BMO) and those whose international exposure is predominantly to other commodity-exporting countries (BNS) that have the highest direct exposures, with BNS and BMO having exposure as a percentage of CET1 capital of 67 per cent and 59 per cent, respectively. On the retail side, the most affected province in Canada is Alberta (where the majority of the tar sands lie) and we have assessed the residential mortgage exposure to this area. TD has the highest exposure at 19 per cent of total mortgages (although this is to the Prairie Provinces rather than just Alberta), with 68 per cent of these mortgages insured. It should be noted that Alberta is one of the few provinces that offers nonrecourse mortgages, and this is only on those over 80 per cent LTV [loan-to-value] and therefore unable to be insured by the CMHC. The average LTV of new uninsured mortgages for TD in the prairies is 73 per cent. A combination of mortgage insurance and relatively low LTVs for new uninsured mortgages should offer some protection to a downturn, although investors will watch this market closely."

Mr. Sealey expects Canadian banks to remain acquisitive, utilizing "strong" organic capital generation domestically.

"We expect further M&A to be welcomed by investors as a way to deal with the increasingly competitive and commoditized nature of the lending and savings markets," he said. "Banks will have two ways to deal with these threats: firstly investing in new technology and systems (eg digitalization, automation, customer platforms, etc.), and secondly economies of scale. We expect to see continued bolt-on and asset acquisitions."

Based on what he billed "strong" fourth-quarter results, he made target changes to a pair of bank stocks. They were:

- Bank of Montreal (BMO-T, "neutral" rating) to $100 from $95. Consensus is $89.85.

- Bank of Nova Scotia (BNS-T, "neutral") to $82 from $76. Consensus is $78.92.

He did not change his targets for Royal Bank of Canada (RY-T, buy) of $100 (consensus: $90.56) and Toronto-Dominion Bank (TD-T, buy) of $70 (consensus: $65.48).

"Canada is likely to remain a very profitable market for the Canadian banks, as they strive to continually increase efficiency while low risk weights (a consequence of the mortgage insurance regime) means that the domestic Canadian businesses have very high ROTEs [return on tangible equities]," he said. "This will continue to support both book value and dividend growth, but also give flexibility for further M&A. The global banking markets are becoming increasingly competitive, while lending and savings markets are increasingly commoditized. There are two key ways to deal with these threats: firstly investing in new technology and systems (eg digitalization, automation, customer platforms, etc.), and secondly scale. Scale is likely to be achieved through a combination of organic growth and M&A, with M&A creating economies of scale, and further diversifying business models (reducing the overall risk profile of groups and therefore cost of capital). We expect the Canadian banks to continue to be acquirers, and for investors to take this positively."

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Better-than-expected third-quarter results from Lululemon Athletica Inc. (LULU-Q) did little to alleviate Canaccord Genuity analyst Camilo Lyon's concerns about 2017 for the retailer.

On Wednesday, the Vancouver-based company reported adjusted earnings per share of 47 cents (U.S.), ahead of Mr. Lyon's 42-cent estimate and the consensus projection of 43 cents. Gross margin improvement of 4.28 per cent also topped the analyst's expectation (2.34 per cent) and the company's own guidance (2 per cent to 2.5 per cent).

"Gross margin expansion … was driven by stronger-than-expected product margin (up 450 basis points from lower product costs and higher AUR) and FX (up 20 basis point), partially offset (down 50 basis points) by an increase in fixed costs (design, merchandising, and supply chain functions)," said Mr. Lyon. "Also, Q3 gross margin benefited from the timing of store openings, which kept occupancy expense flat, as well as favourable clearance markdown comparisons versus last year's warehouse sale. We expect occupancy to de-lever in Q4. For the next three quarters, we expect gross margin to continue to benefit from costing improvements (as better demand planning should reduce cancellations and late-stage order changes), and other efficiencies from a more disciplined go-to-market process (lower fabric liability and improved development ratios). That said, looking to the 2H17, these benefits will be fully realized with limited opportunity to drive further meaningful expansion, we believe. More likely, should comps decelerate (as we believe they will), occupancy deleverage will accelerate."

In reaction, Mr. Lyon raised his full-year 2016 and 2017 EPS projections to $2.14 and $2.48, respectively, from $2.02 and $2.22.

He also noted the company's "cautious" commentary from November, which he said stated "trends were choppy but then rebounded last week post Thanksgiving and Cyber Monday."

He added: "We suspect comp trends will moderate off that strong holiday week. Our SELL thesis is predicated on the athleisure trend decelerating as demand for 'technical denim' gains momentum and thus disproportionately hurts LULU's ability to maintain its MSD comp trajectory. While Q3 was better than we anticipated, we did not see anything that would alter our thesis, particularly as we expect the denim trend to materialize in a greater way next year. As such, we reiterate our SELL as we believe the 15-per-cent move in the stock after the close skews the risk/reward further to the downside based on up 10 per cent (30 times our 2017 estimated EPS) versus down 35 per cent (20x our 2017E EPS)."

With his "sell" rating, Mr. Lyon raised his target price to $47 (U.S.) from $44. The analyst average is $71.69, according to Bloomberg.

Elsewhere, BMO Nesbitt Burns analyst John Morris raised his target to $65 from $55 with a "market perform" rating (unchanged).

"LULU continues to invest in its supply chain, which has allowed it to improve its approach to clearance," he said. "LULU recently expanded its ship from store capability to 80 stores. This new initiative has allowed the company to sell slow-moving clearance items on its website, whereas previously these items would have been marked down at a higher rate in store. The ship-from-store initiative increased the number of SKUs on markdown on LULU's website (which BBD picked up), but margins were helped by this new capability. LULU should continue to benefit from these new infrastructure initiatives but we believe results could be volatile as management perfects its inventory algorithm."

Credit Suisse analyst Christian Buss kept a "neutral" rating but raised his target to $64 from $53.

"Lululemon top-line results showed significant upside surprise relative to expectations, as our concerns regarding a lack of strong response to new women's tops product were clearly offset by strength in other areas and benefits from the supply chain restructuring," he said. "A string of encouraging numbers like a 7-per-cent comp including DTC, 4-per-cent store comps, gross margin up 430 basis points year over year, and inventories up 2 per cent year over year on 12-per-cent sales growth suggest that operational turnaround initiatives remain on track. Guidance also looks solid with comps expected to remain up mid-single digits. This suggests that many of our concerns about slowing top-line trends were misplaced."

Evercore ISI analyst Omar Saad upgraded his rating for the stock to "buy" from "sell" and raised his target to $80 from $50.

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In a research note on Canadian asset managers, Canaccord Genuity analyst Scott Chan raised his target multiples from "trough levels."

"For large cap managers, we are marking Q4TD/16 assets under management (generally above our prior estimates), and rolling forward our valuation one quarter (to Q2/17 – Q1/18)," said Mr. Chan. "Further, we are increasing our target multiples (from trough valuations) to reflect: (1) continued strong equity markets (post U.S. election); (2) expected net flow traction improvement (i.e. could see shift from Fixed Income into Equities); and (3) higher P/E [price-to-earnings] valuation multiples for global asset managers."

With a "hold" rating, Mr. Chan raised his target price for AGF Management Ltd. (AGF.B-T) to $5.50 from $5, saying it remains "cheap and could be a re-rating story next year." The analyst consensus price target is $5.35.

"AGF.b remains one of the cheapest asset manager stocks in the world," said Mr. Chan. "Currently, AGF.b trades at P/E of 11.0x (2017E). We are more optimistic on AGF.b heading into next year as we continue to get better traction on: (1) fund performance; (2) retail net flows, albeit still negative; (3) institutional (net flows appear to have stabilized); and (4) alternative (strong start to InstarAGF Essential Infrastructure Fund and Midstream energy fund). AGF has a large proportion towards Equity AUM [assets under management], which has supported AUM growth. For Q4/F16 (ending Nov), AGF's total AUM increased 2 per cent year over year."

He said CI Financial Corp. (CIX-T) has "better" momentum heading into 217. With a "buy" rating, he raised his target price for the stock to $29.50 from $27. Consensus is $28.50.

"We are increasing our target P/E multiple to 14.0 x (from 13.0x), which is still a discount to its historical average of 15.7x, and well below its domestic benchmark and global peer averages," the analyst said. "After significant net redemptions year to date (i.e. $5-billion related to sub-advisory mandates), we believe CI has better net flow momentum heading into 2017, particularly for Q1. We believe positive net sales in Q1/17 would represent a stock catalyst, and supported by (1) better near-term fund performance; (2) solid distribution capabilities (i.e. Assante, Sun Life, Edward Jones); (3) higher demand towards ETFs (well situated through First Asset); and (4) Institutional (record institutional pipeline of 20 mandates on short lists cited on Q3 conference call). We expect CIX to be a beneficiary of industry consolidation supported by a strong balance sheet and low leverage. With better EPS visibility (we don't factor in potential acquisitions), we could see a dividend increase over the next few quarters (last one occurred in Q1/16) with an expected payout ratio of 64 per cent (2017 estimate). Q4 to date, CI continues to buy back stock through its NCIB, albeit at a slightly slower quarterly pace."

Mr. Chan said IGM Financial Inc.'s (IGM-T) earnings growth will be challenged. Maintaining a "hold" rating, he raised his target to $39 from $35.50. Consensus is $38.40.

"We have trouble identifying EPS growth characteristics for IGM outside of higher equity markets," he said. "We believe future earnings will be challenged due to: (1) Mackenzie (MKF) net redemption trend (unlikely to reach positive net sales target next year; in our view); (2) Investors Group flow trend (expect IG discontinuation of DSC fund purchases to negatively impact gross sales and redemptions); (3) potential for IG management fee declines (MKF recently lowered management fees on 3 Symmetry Managed solutions totaling $3-billion in AUM, while lowering trailer fees by the same amount; net neutral impact to IGM); (4) SG&A growth target of high single digits in 2017 (similar to this year); and (5) historically less acquisitive (i.e. compared to CIX)."

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Alphabet Inc. (GOOGL-Q) replaced Amazon Inc. (AMZN-Q) atop Citi analyst Mark May's ranking of favourite U.S. Internet stocks.

Alphabet moved from No. 3 on the list, while Amazon falls to that spot. Facebook Inc. (FB-Q) remains at No.2 on the list, which is based on company fundamentals, near-term set-up, recent stock performance and investor sentiment.

Mr. May said: "Relative to AMZN & FB, we see five key factors likely favoring GOOGL shares near term: 1) our recent checks suggest core search growth may not slow as much as most are forecasting, which could drive upside to Q4 and CY17 estimates; 2) in addition to search, Pixel handset sales could also drive revenue upside, though margins would also be impacted; 3) press and industry commentary continues to suggest that YouTube could launch a competitive OTT linear TV offering in 1H17, which could improve both growth and investor sentiment; 4) GOOGL could benefit from corporate & consumer tax reform, though the corporate regulatory reform impact remains uncertain; and 5) at [approximately] 11-times forward EBITDA, the valuation is attractive and slightly below its 3-year avg. EBITDA PEG [price/earnings to growth] ratio."

Rounding out the top five are ebay Inc. (EBAY-Q) at No. 4 and Yahoo! Inc. (YHOO-Q) at No. 5. Both remained in the same positions.

Mr. May kept his "buy" rating for Alphabet stock with a $910 (U.S.) target price. The consensus price target is $963.63.

He also maintained a "buy" rating for Amazon and $960 target. Consensus is $921.85.

"While recent datapoints pertaining to topline growth in both the retail and AWS segments are quite positive (e.g., here and here), the stepped up investments that we've highlighted here and here could continue to weigh on profitability and investor sentiment in the near-term, as well as create risk to consensus forecasts (especially in 1H17)," the analyst said. "As such, relative to the near-term setup for GOOGL & FB (our other two Buy-rated large cap names) we move AMZN from first to third in our preferred rankings. That said, we remain quite positive on the mid- and long-term outlook."

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Lowe's Companies Inc. (LOW-N) should continue to benefit from a "solid" home improvement market, said RBC Dominion Securities analyst Scot Ciccarelli, despite concerns about sustained. weakness in the do-it-yourself segment.

"While we remain bullish on the broader home improvement segment, we recognize that parts of Lowe's business have slowed, particularly the DIY business, with particular softness in the highly dense Northeast region," said Mr. Ciccarelli in a research note summarizing the company's 2016 analyst day, held Wednesday in Mooresville, N.C..

"Lowe's management team would attribute the DIY softness to weather impacts on their seasonal categories and lower levels of effectiveness in their digital marketing strategies. Nevertheless, given the high levels of competition in these territories from other bricks and mortar competitors, and the fact that their DIY sales are weakest in many areas that likely have the highest levels of e-commerce penetration, it's hard not to wonder if Lowe's issues aren't more competition based. As a result, we continue to view HD as the better risk/reward opportunity."

The company reiterated its 2016 guidance, which includes sales growth of 9 per cent to 10 per cent and comparable same-store sales growth of 3 per cent to 4 per cent. Adjusted earnings per share are projected to be $3.92 (U.S.), versus Mr. Ciccarelli's estimate of $3.90.

"The company also introduced a new roadmap outlining plans through 2019," he said. "For 2017-2019, management is expecting average annual sales growth of [about] 4.0 per cent, with comp growth of 3.0 per cent to 3.5 per cent per year and 25 basis points of EBIT [earnings before interest and taxes] expansion per point of comp above 1 per cent (this assumes SG&A grows at 50 per cent the rate of sales). EBIT margins are expected to improve 150 bps to 11.2 per cent by 2019, for adjusted annual EPS growth of 15 per cent (using $3.92 as a starting point). Additionally, guidance assumes $10-billion in planned share repurchases over this timeframe, and $4-billion in dividends (15 per cent to 20 per cent annual growth/35-per-cent payout ratio). The new roadmap is modestly below the prior guidance of roughly 4-per-cent comps and 11-per-cent EBIT margins by 2017, with the bulk of the difference in GMs (plan assumes only slight improvement)."

He added: "With the vast majority of the 150 bps of planned EBIT margin improvement as the company progresses towards its new 2019 goal of 11.2-per-cent EBIT margins, it's no surprise management was excited about its profitability improvement opportunities. The company sees opportunities through improving labour productivity, centrally managing indirect spend, and adopting processes to improve speed to market. One example called out by the company were its plans to begin using its store cameras, which now capture customer traffic data, to better manage labor on a storeby-store basis. This would enable the company to better align staffing needs with store activity/customer traffic (moving to and activity-based model from a sales tiered model)."

In response to the presentation, Mr. Ciccarelli raised his target price for the stock to $83 (U.S.) from $77, saying the guidance update "helps alleviate some near-/medium term uncertainty surrounding shares." The analyst consensus price target is $78.30.

He did not change his "outperform" rating for the stock.

"Lowe's executives remain bullish on the duration opportunity of the housing/home improvement cycle upswing. Housing inventory levels remain low, which is supportive of home prices appreciation, and people tend to spend more on their homes when they are going up in value," he said. "The company also pointed to an aging housing stock (nearly half of homes are 40 years or older), and homes need more maintenance as they age. Assumed in the company's 2019E roadmap are expectations for GDP growth of 2 per cent, 2.3-per-cent growth in disposable income, modest home price appreciation (3 per cent) and continued expansion in housing turnover."

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As the amount of freight moving by train grows, the picture brightens for the shares in both large Canadian railways.

National Bank Financial has raised the share price targets for Canadian Pacific Railway Ltd. (CP-T) and Canadian National Railway Co. (CNR-T), citing a rise in carloads in the past month as manufacturing and trade perk up.

CP's 12-month share-price target has been raised to $226 from $210.  The shares have risen by 15 per cent year-to-date and traded at $204 on Thursday.

For Montreal-based CN, National Bank has raised the price target to $91 from $85. CN's shares have climbed by 19 per cent in the past and traded at $92 on Thursday.

"A positive turn in volumes is clearly good news for both CN and CP and for investor sentiment towards the rails more generally," National Bank analyst Cameron Doerksen said in a note to clients.

He prefers CP stock to CN because he expects CP's profit to rise by 15.4 per cent in 2017, compared with CN's 10 per cent. CP's is also trading at a lower price-to-earnings ratio of 17, versus CN's 18.3.

"Both CN and CP are trading at a discount to the U.S. Class 1 railroads average of 18.6," he said.

However, Bloomberg Intelligence notes CN is benefiting more from a large North American grain harvest. CN's carloads rose by 10 per cent in the week ending Dec. 3, outpacing CP and its U.S.-based rivals. CN's agriculture carloads are up by 24 per cent in the latest week and 14 per cent quarter-to-date, compared with CP's 4-per-cent rise for the quarter, Bloomberg says.

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In other analyst actions:

Cequence Energy Ltd. (CQE-T) was raised to "speculative buy" from "hold" by GMP analyst Stacey Mcdonald with a target of 45 cents, up from 40 cents. The average is 49 cents.

Delphi Energy Corp. (DEE-T) was downgraded to "hold" from "buy" at GMP by Cody Kwong with a target of $1.75, up from $1.50. The average is $1.66.

DH Corp. (DH-T) was upgraded to "buy" from "hold" at Industrial Alliance by analyst Dylan Steuart. His target rose to $26.50 from $21. The average is $22.56.

Franco-Nevada Corp. (FNV-T) was bumped to "buy" from "neutral" by Dundee analyst Josh Wolfson with a target of $110 (unchanged). The average is $101.92.

Canyon Services Group Inc. (FRC-T) was raised to "buy" from "hold" by GMP analyst Ian Gillies. His target rose to $9.50 from $5.75. The average is $7.42.

Imperial Oil Ltd. (IMO-T) was downgraded to "hold" from "buy" by GMP's Michael Dunn with a target of $50, up from $44. The average is $47.61.

Mainstreet Equity Corp. (MEQ-T) was downgraded to "hold" from "buy" by TD Securities analyst Jonathan Kelcher. His target fell to $38 from $43. The average is $40.80.

ProntoForms Corp. (PFM-X) was rated a new "speculative buy" at Industrial Alliance by Blair Abernethy with a target price of 75 cents per share.

Perpetual Energy Inc. (PMT-T) was upgraded to "buy" from "hold" at GMP by analyst Robert Fitzmartyn. His target rose to $3 from $2.25. The average is $2.19.

Suncor Energy Inc (SU-T) was raised to "hold" from "reduce" by GMP analyst Michael Dunn. His target rose to $43 from $32, compared to the average of $47.53.

With a file from Eric Atkins

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