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 lack of progress toward asset sales, Morgan Stanley analyst David Risinger downgraded Valeant Pharmaceuticals International Inc. (VRX-N, VRX-T) to "equal-weight" from "overweight."

"When we upgraded VRX shares from equal-weight to overweight on Aug. 17, 2016, we expected business stabilization and material divestitures," he said. "Neither has happened to date. Additionally, Valeant announced the departure of certain executives on Dec. 12, and we no longer believe the shares can outperform."

Mr. Risinger cut his target price for the stock to $17 (U.S.) from $25. The analyst average target is $22.91, according to Bloomberg.

"Although we have been disappointed in the progress, divestitures could still occur at any time, and management could enhance business performance," he said.

He added: "We move to the sidelines as we await future corporate updates."

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In reaction to its announcement that it is withdrawing its financial guidance and will be unable to achieve its 2019 sales targets, Raymond James analyst Ben Cherniavsky downgraded his rating for Héroux-Devtek Inc. (HRX-T).

On Wednesday, the Longueuil, Que.-based manufacturer of aerospace products announced production rate adjustments for several programs, including its work for Boeing's 777 and 777X. It was ramping up its work on complete landing gear systems for both models prior to Boeing's Monday announcement that it was reducing its own production rate.

Accordingly, Héroux said it won't reach its objective of annual sales of approximately $500 million for its 2019 fiscal year.

"Although this contract still represents considerable longer-term value for the company, we find it more difficult to justify the stock's valuation at these levels without clear visibility on earnings over the next couple years," said the analyst. "We have maintained a high degree of valuation-sensitivity to this story, downgrading it from outperform to market perform in our May. 25, 2016 comment as it breached our target and then upgrading it back to outperform five months later in our Oct. 7 comment on a pullback. Our downgrade today is therefore consistent with our past actions and reasoning for this stock, especially in light of the revised outlook."

Mr. Cherniavsky moved the stock to "market perform" from "outperform."

"With the majority of Héroux's future earnings growth linked to this program, a downward adjustment to the company's financial forecasts is required ," he said.

"There has been much speculation over the outlook for Boeing's prized 777 program. Order activity has dried up (only 17 orders have been booked year to date versus 58 in 2015 and 283 in 2014) in part because of the planned introduction of the 777x model in 2020 (which Héroux also supplies) and also because of the growing glut of wide-body aircraft on the market. While we had factored the former variable into our model, the latter variable was always considered to be the biggest extraneous risk to it - i.e. we believe macro considerations account for the bulk of Boeing's production cut (as noted in our recent CAE research, this aerospace cycle looks rather 'toppy' to us)."

Mr. Cherniavsky lowered his earnings per share projections for 2017 and 2018 to 76 cents and 88 cents, respectively, from 78 cents and 95 cents. His revenue estimates fell to $409-million and $428-million from $416-million and $428-million.

"One of the reasons we liked Héroux's stock in spite of some macro risks was that the 777 program, starting from zero, represented a needle-moving opportunity for the company regardless of how many planes Boeing opted to produce," he said. "This still holds true. However, we must remain mindful of how much future growth is already priced-into the stock, which is why our valuation is still based our F19 forecasts."

His target price fell to $15 from $15.50. The analyst consensus price target is $17.10, according to Thomson Reuters.

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Athabasca Oil Corp.'s (ATH-T) $582-million acquisition of the Canadian thermal oil assets of Statoil ASA is an "excellent" deal, according to Desjardins Securities analyst Justin Bouchard.

He upgraded Athabasca stock to "buy" from "hold."

Under the agreement, announced Wednesday, Athabasca is set to pay $435-million in cash as well as 100 million in common shares for the assets, which include the Leismer Thermal Oil Project (currently producing 24,000 barrels per day), the delineated Corner lease and related strategic infrastructure.

"Athabasca has been truly transformed over 2016—the Murphy deal was good, the royalty deals with Burgess were excellent and, in our opinion, the deal with Statoil takes it to another level," said Mr. Bouchard. "The acquisition metrics for the Leismer facility alone work out to $26,000 per barrel per day—which is significantly lower than it would cost to build a brownfield SAGD facility. And, when accounting for the approved Corner project, potential Leismer expansion and infrastructure assets included in the deal, the metrics look even more compelling.

"The addition of Leismer significantly high grades ATH's thermal portfolio — well rates are 700–800 barrels per day with SORs (steam-to-oil ratios) of slightly below 3.0x, which we view as indicative of an upper mid-tier project. We estimate the Leismer project generates free cash flow (after sustaining of $9 per barrel) at around $50 (U.S.) per barrel WTI. If ATH is able to lower the cost structure (very likely, in our view), the breakeven (after sustaining) could fall to $40– 45/bbl WTI."

With the deal, Mr. Bouchard raised his 2017 diluted cash flow per share projection to 21 cents from 7 cents.

"If there is any pushback, it is that ATH's debt metrics are still elevated," he said. "We have 2017 D/CF [debt to cash flow] at the strip at 4.0 times, but we see it moving to 2.5 times in 2018. However, we note that the company has $550-million of gross debt on a production base of near 40,000 barrels per day, which puts it in a much better position to refinance its debt and it still has $225-million of cash on the books to serve as a safety net if needed. And, let us not forget that the light oil portfolio should now benefit from the cash flow from a stable wedge of low sustaining capex production."

He raised his target price for the stock to $2.50 from $1.75. Consensus is $2.03.

"This is a transformative acquisition," said Mr. Bouchard." We have been apprehensive about the story; however, given the deals that have been executed this year, management has from our perspective turned the page."

Elsewhere, RBC Dominion Securities analyst Shailender Randhawa upgraded the stock to "outperform" from "sector perform" with a target of $3, up from $1.75.

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Quality and longevity are a "premium combination" for Bonterra Energy Corp. (BNE-T), said Canaccord Genuity analyst Anthony Petrucci.

He initiated coverage of the Calgary-based oil and gas company with a "buy" rating.

"Founder and CEO George Fink has made a career of placing contrarian bets: establishing a gold company (Comaplex) as prices fell in the 80's, an oil company (Bonterra) as prices capitulated in the late 90's, and a gas company (Pine Cliff, PNE-T, 'buy' rating) through multi-year low prices in 2012. Today's oil price provides an opportunity for investors to participate with Mr. Fink and Bonterra in another potential commodity price rebound. BNE produces [approximately] 13,000 boe/d [barrels of oil equivalent per day] focused on the Pembina Cardium and has a market cap of $950-million."

Believing Bonterra will outperform peers going forward, Mr. Petrucci emphasized several reasons for his stance, including its low sustaining costs.

"The key to the sustainability of any oil and gas business is the relationship between decline rates, capital efficiencies and netbacks (cash flow)," he said. "The decline rate represents how much production must be replaced each year, and the capital efficiency is the cost to add back each barrel. Bonterra has amongst the lowest decline rates in the sector and one of the best capital efficiencies, which give it a significant advantage over peers. Combined, these give Bonterra the lowest sustaining costs of any light oil producer in our coverage universe."

He also sees the potential for "robust" dividend growth, noting: "Bonterra has been a dividend-paying company since August 2001, with a current annual dividend of $1.20 per share. We believe Bonterra has the potential to increase its dividend by nearly 150 per cent in two years' time, to $2.90 per share, which should lead to material share price appreciation. While we recognize this is a substantial increase, we believe it is more than possible."

He set a price target for the stock of $35. Consensus is $30.50.

"After peaking at nearly $70/share in 2014, BNE's share price came under pressure (along with the space), as the oil price dropped from $100+ (U.S.) per barrel to sub $30 (U.S.) per barrel. Through the drop BNE had to lower its dividend twice, which put additional pressure on the stock. The company also completed a relatively significant acquisition in early 2015, which added leverage to the balance sheet. BNE's most recent private placement raised $31-million, and helped to largely address the company's debt position. With the company now generating significant free cash flow, we believe the company will continue to pay down debt, leading to further multiple expansion."

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Citing rapid volume declines, RBC Dominion Securities analyst David Palmer downgraded General Mills Inc. (GIS-N) to "sector perform" from "outperform."

"We are shifting to sector perform … to reflect our increasing concern that accelerating volume declines will limit EPS growth and stock upside," said Mr. Palmer. "While the company's U.S. retail (78 per cent of EBIT) sales trends can begin to improve in fiscal 2H17 behind upcoming innovation, this improvement will be start from a dismal recent run-rate. U.S. measured channel sales and volume declines have accelerated to 7 per cent and 12 per cent from 6 per cent and 9 per cent over the last three months.

"We now believe it is unlikely that Mills will meet its full-year forex-neutral global sales growth target of flat to down 2 per cent (RBC estimate down 3 per cent), and this may pressure full-year adjusted EPS (RBC estimate up 6 per cent versus up 8 per cent prior; guidance of 6 per cent to 8 per cent). While centre-store food category sales trends have broadly eroded, it appears that Mills' yogurt declines (as well as cereal, soup, and dough) are too much to overcome near-term."

Mr. Palmer called the decline in yogurt "alarming amid a poor volume environment."

"Our long-term investment thesis has been based upon three factors: 1) the high margin cereal business could stabilize, 2) high accountability to peer performance given relatively low shareholder protections, and 3) strong free cash flow (5-per-cent free cash flow yield)," he said. "While it is conceivable that cereal growth can return to growth, the recent deterioration in yogurt has been concerning — especially since it has coincided with lower competitive price pressure. Future upside risks to GIS include: 1) cost reduction plans beyond the 20-per-cent EBIT margin target by FY18, 2) accretive M&A (2.3 turns of debt on balance sheet), and 3) potential for improving fiscal 2H sales due to innovation and renovations."

Ahead of the release of the company's earnings on Dec. 20, he reduced his second-quarter and full-year EPS projections to 84 cents (U.S.) and $3.10, respectively, from 86 cents and $3.14. The consensus estimates are 87 cents and $3.09.

He dropped his target price for the stock to $69 from $73. Consensus is $66.13.

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Based on the company's assumption that 2017 will be a transition year, CIBC World Markets analyst Prakash Gowd lowered his rating for Merus Labs International Inc. (MSL-T) to "neutral" from "outperformer."

"In the absence of further acquisitions, there is likely to be a lack of catalysts for at least the next couple of quarters," he said,

On Wednesday,  the Toronto-based specialty pharmaceutical company reported fourth-quarter 2016 revenue that met the analyst's expectations. However, earnings before interest, taxes, depreciation and amortization fell slightly below his projections due to one-time costs.

Mr. Gowd expressed concern over Meru's 2017 adjusted EBITDa guidance of $44-million to $48-million, which was well below his expectation of $57-million. He pointed to "elevated forward-looking expenses and a further delay in the completion of the Sintrom manufacturing tech transfer" as the chief causes of the difference. He added the declining euro will also weigh on results.

"With the expectations of expense hits, the weaker exchange rate, and manufacturing transfer delays, we don't foresee 2017 fiscal EBITDA margins coming in any higher than the figure reported in FQ4," he said. "Organic growth will not come from MSL's current portfolio. With overall market demand for current products eroding at mid-single digits, the company will need to acquire growth assets to stay relevant.

"Management stated that the company is in active discussions to acquire such assets, but we did not get the sense that there was anything close to being finalized."

Mr. Gowd lowered his target price for the stock to $1.50 from $2.40. Consensus is $2.22.

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Penn West Petroleum Ltd. (PWT-T) has had a challenged past, but its renewal is "almost complete," said CIBC World Markets analyst Adam Gill.

He initiated coverage of the stock with a "neutral" rating.

"With oil prices weakening from [the second half of 2014] to today, Penn West has had to sell down the majority of its portfolio to right-size the balance sheet," said Mr. Gill. "The company has made significant progress in its efforts, with our model now reflecting a 2017 estimate D/CF [debt-to-cash flow] of 2.4 times on strip (peer median is 1.5 times), which is down meaningfully from 6.1 times in [the first quarter of 2015.

"With the improvements in leverage and a new CEO at the helm, the company can once again focus on creating value rather than preserving what it could. Accordingly, Penn West is targeting 10-per-cent growth from its core plays next year. While we believe Penn West is in a decent position to deliver on this target, after 20 consecutive quarters of production declines, this growth is very much a 'show me' story."

He set a price target of $2.60 for the stock. Consensus is $2.50.

"We believe more asset sales that drive down leverage and enhance the impact from the growth in the core plays would swing our view to the upside, while a slide back in cost improvements and/or the recovery in crude prices could skewer our view to the negative side," he said.

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In other analyst actions:

BP PLC (BP-N) was downgraded to "sector outperform" from "focus list" at Scotia Howard Weil by analyst Blake Fernandez with an unchanged target of $42 (U.S.). The analyst average is $37.78, according to Bloomberg.

Mr. Fernandex raised his ratign for ConocoPhillips (COP-N) to "focus list" from "sector perform" with a target of $60 (U.S.), up from $47. The average is $55.52.

Chevron Corp. (CVX-N) was raised to "outperform" from "neutral" by Macquarie analyst Iain Reid. His target rose to $130 (U.S.) from $90. The average is $121.92.

Deere & Co. (DE-N) was rated a new "hold" by Aegis Capital analyst Igor Maryasis with a target of $110 (U.S.). The average is $101.67.

Halliburton Co. (HAL-N) was raised to "sector outperform" from "sector perform" at Scotia Howard Weil by equity analyst William Sanchez. His target is $62 (U.S.), up from $57. The average is $57.32..

Kinaxis Inc. (KXS-T) was rated a new "buy" at Industrial Alliance by analyst Blair Abernethy with a target of $68 (Canadian). The average is $72.20.