Thursday’s analyst upgrades and downgrades

Share

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

Netflix Inc.'s (NFLX-Q) original content strategy continues to work despite increasingly difficult competition, said Canaccord Genuity analyst Michael Graham.

On Wednesday, the company reported "strong" fourth-quarter financial results.

It attracted 7.1 million new subscribers globally in the quarter, beating the Street's expectation of 5.2 million. Los Gatos, Calif.-based Netflix added 5.12 million new customers in international markets, ahead of analysts' estimates of 3.78 million, and signed up 1.93 million new U.S. customers, exceeding projections of 1.38 million.

"This combined with the impact of ASP [average subscription price] increases (from ungrandfathering) to help streaming revenue grow 41 per cent year over year while contribution margins expanded by 383 basis points year over year to 20 per cent," said Mr. Graham. "These improvements are encouraging, as viewers are embracing Netflix's original content around the world. We note that Netflix plans to continue to invest more in original self-produced content, which has higher upfront cash expenditures, and is the driving reason behind the divergence between FCF [free cash flow] and operating income. Meanwhile, the company still plans on demonstrating operating leverage as it is targeting 2017 operating margin of 7 per cent, up from 4 per cent over the last two years and above our prior estimate of 6 per cent. We believe Netflix is still quite early in penetrating international markets, and its content strategy seems poised to continue to help subscriber growth as we enter a phase of heightened SVOD [subscription video on demand] competition, especially in the U.S.."

Revenue of $2.478-billion (U.S.) topped Mr. Graham's estimate of $2.465-billion (and the consensus of $2.468-billion). Earnings per share of 15 cents beat both the analyst and the Street by 2 cents.

Mr. Graham said the company's original and local programming is driving engagement, complimenting its "Hollywood-focused" library and helping to grow its market share abroad.

"Notably, many originals have found followings outside their local countries, and this should help drive content leverage over time," he said. "Netflix is also releasing 42 originals in Q1, which bodes well for engagement for this year and 2018. The impact of this, however, will lead to contracting contribution margins throughout the year from a high Q1."

Mr. Graham raised his subscriber projections, particularly internationally. Accordingly, his revenue and margin estimates also rose.

His earnings per share estimates for 2017 and 2018 increased to $1.05 (U.S.) and $2.03, respectively, from 84 cents and $1.65.

With a "buy" rating, he raised his target price to $160 from $140. The analyst average is $150.26, according to Bloomberg.

Elsewhere, Evercore ISI analyst Ken Sena upgraded his rating for the stock to "hold" from "sell" and raised his target to $140 from $101.

Macquarie analyst Timothy Nollen raised Netflix to "neutral" from "underperform" with a target of $130, up from $85.

RBC Dominion Securities analyst Mark Mahaney raised his target to $175 from $150 with an "outperform" rating (unchanged).

"Based on our Global Broadband Rollout Analysis, we believe that Netflix can amass a global subscriber base of 160 million-plus by 2020, assuming a range of adoption scenarios for each of its different markets, from roughly 60-per-cent penetration in its U.S. to over 10-per-cent penetration in its 2016 launch markets," said Mr. Mahaney. "There are a lot of puts and takes to this conclusion, but if we are reasonably accurate in this forecast, we see this leading Netflix to generate at least $8.00 in GAAP EPS by 2020, and perhaps as much as $10.00. Our stock-picking belief is that a secular growth, high-visibility subscription model with $8.00-$10.00 in GAAP EPS power would carry at least a market premium P/E multiple of 20X, which implies the ability for NFLX to achieve a $200-plus stock price by 2019. "

=====

With improved hopes for its Model 3, Morgan Stanley analyst Adam Jonas upgraded Tesla Motors Inc. (TSLA-Q) to "overweight" from "equal-weight."

Mr. Stanley is projecting a "soft" fourth-quarter launch for the much-anticipated vehicle and a significant ramp-up in production in 2018. He is now estimating 2018 volume of 183,000 (up from 114,000) following recent discussions with management and suppliers.

The analyst expects a "surprisingly supportive political environment" based on chief executive officer Elon Musk's role on U.S. president-elect Donald Trump's advisory council, noting a "strategic relationship between Tesla leadership and the new administration."

He also cited a push from manufacturers to increase the electrical vehicle (EV) market as well as a lack of push from tech giants, like Apple and Google, to make automobiles.

"The market is moving Tesla's way on EVs," he said, expecting the EV market to grow by 23 per cent by 2030 (versus an earlier estimate of 16 per cent).

Mr. Stanley raised his target price for the stock to $305 (U.S.) from $242. The analyst average is $244.

=====

There are limited near-term catalysts for multiple expansion for AGF Management Ltd. (AGF.B-T), said Canaccord Genuity analyst Michael Chan.

Ahead of the release of its fourth-quarter financial results on Jan. 24, Mr. Chan downgraded his rating for the Toronto-based investment management company's stock to "sell" from "hold."

Mr. Chan is forecasting quarterly earnings per share of 13 cents, which would be flat from both the previous quarter and previous year, as well as a "continued material net redemptions at retail and institutional segments."

"Although earnings appear stable near term, we believe EPS medium to long term will ultimately be impacted by lower management fees at retail, in addition to headwinds towards net flows (i.e. not looking for material improvements)," he said.

He added: "For Q4/16E, we are forecasting AGF's total average management fees at less-than 1.15 per cent (flat quarter over quarter), mostly due to AUM (assets under management) mix (retail versus institutional). Over the NTM [next 12 months], we model a fee decline of greater-than 2 basis points to greater-than 1.12 per cent. However, we are concerned about AGF's fee structure over the medium to long term, as most of their legacy retail products (i.e. Class A) ranks at the high end versus peers. Further, AGF's management fees on their Class F line-up (Fee-based; no trailer fees) are lower than their Class A. Either way, we feel that management fees at AGF have to come lower at a larger amount than peers. However, we don't think this will be material to EPS during our forecasted period. … Longer term, we can envision a scenario where total average management fees could decrease to lower end of our range. At this time, we don't believe that AGF's other platforms (i.e. ETFs, HNW, Alternative) can support a shortfall in EPS."

The analyst emphasized the potential ban on trailer fees could also have a significant impact on AGF and its peers going forward.

"Last week, [the Canadian Securities Administrators] published a consultation paper which pushed for a potential ban on embedded commissions (including trailer fees)," he said. "In our view, we believe an ultimate ban of trailer fees will occur medium term and significantly impact the way mutual funds are bought and sold. In this scenario, we envision a deceleration of actively managed mutual fund sales and higher demand towards passive products (i.e. ETFs). Independent fund companies that have higher fee products and lower relative fund performance will be disadvantaged. Out of the large cap asset managers, we believe AGF will be the most materially impacted."

Mr. Chan maintained a $5.50 target price for the stock. The analyst consensus price target is $5.59, according to Thomson Reuters.

"On their last quarterly results (Sept. 16), AGF.B stock traded at price-to-earnings (2017) of less-than 10.0 times," he said. "Since then, AGF.B stock has increased 21 per cent, significantly outpacing peers (i.e. CIX, IGM) and the TSX Composite. The higher stock price fully reflects a multiple re-rating as we expect flat EPS growth quarter over quarter. Currently, AGF.B trades at a P/E (2017) of 12.3 times versus its peer average of 13 times. We believe a discount is warranted based on; (1) limited EPS growth visibility near term; (2) lower relative Fund performance which should continue to impact retail and institutional net flows; (3) management fees are at high-end versus peers and we expect retail fee compression medium to long term; and (4) early-stage growth opportunities (ETF, Alternative) are unlikely to contribute to earnings over our forecasted period."

=====

In reaction to "underwhelming" 2017 guidance, CIBC World Markets analyst Cosmos Chiu lowered his rating for Tahoe Resources Inc. (THO-T) to "neutral" from "outperformer."

"CIBC's previous Outperformer rating had been predicated on strong free cash flow beginning in 2017," he said. "This is no longer the case: CIBC's new model shows that 2017 FCF may be negative and 2018 FCF may also be much less than expected."

Mr. Chiu said the company's guidance brought higher operating costs and higher capex [capital expenditures] than projected. This comes with the expectation of flat production year over year.

Mr. Chiu lowered his price target for the stock to $15 from $18. Consensus is $19.88.

"Tahoe's share price lagged in 2016, up only 11 per cent during a year when the Gold Miners' Index was up 65 per cent," he said. "The share price underperformance has continued into 2017, with Tahoe's share price down 7 per cent year-to-date.

"Despite a share price that lagged peers in 2016, Tahoe continues to trade at a premium multiple. Tahoe shares trade at 1.5 times price-to-net asset value  and 10 times price-to-cash flow, versus the peer group at 1.4 times P/NAV [price to net asset value] and 9 times P/CF [price to cach flow], at spot gold."

=====

There is "deep value potential" for Stuart Olson Inc. (SOX-T), according to Canaccord Genuity analyst Yuri Lynk.

He raised his target for the Calgary-based construction and industrial services company's stock and recommended it despite expecting fourth-quarter 2016 results, scheduled to be released March 7, to fall below expectations.

Mr. Lynk is projected quarterly earnings before interest, taxes, depreciation and amortization of $5-million, in comparison to the Street's estimate of $6.9-million. He expects a "particularly weak" result from its Industrial Group due to early shutdowns from several oil sands clients.

"However, we believe the stock's widely discounted valuation vis-a-vis the group and its 9.2-per-cent dividend yield afford it a certain measure of downside support," said Mr. Lynk. "Stuart Olson shares are down 11 per cent year to date, perhaps in anticipation of a weak print. The stock now trades at a 14-per-cent discount to the group and a 10-per-cent discount to its closest comparable, Bird Construction (BDT-T, 'hold' rating), whereas it has normally traded at just a 5-per-cent discount. In short, it appears weak Q4 numbers are priced into the stock."

Mr. Lynk sees a " a more sanguine investment backdrop for the company," noting: "Firstly, crude oil prices have nearly doubled over the past year, which should allow Stuart Olson's oil sands clients to resume more normalized MRO [maintenance, repair, and operations] activity. Secondly, the number and value of Institutional, Commercial, and Industrial (ICI) projects in Alberta, Stuart Olson's key end-market, ended 2016 higher by 29 per cent and 20 per cent, respectively. In short, we believe the worst of the macroeconomic pressure that has battered Stuart Olson's bottom line may be behind us."

With a "buy" rating, his target price rose to $7.50 from $7. Consensus is $6.06.

"Stuart Olson shares have underperformed the broader engineering and construction (E&C) group as macroeconomic events have largely conspired against the company," the analyst said. "In 2016, the stock delivered a respectable 11-per-cent total return. However, this trailed the 21 per cent delivered by the S&P/TSX Composite Total Return Index. The company, essentially a pure play on the Western Canadian industrial markets, has been particularly hard hit by lower maintenance, repair, and operating (MRO) and infrastructure spending, the former the result of lower crude oil prices and the latter the result of delayed fiscal stimulus at all levels of government. In addition, Stuart Olson experienced deferred revenue and cost impacts from the Alberta wildfires."

=====

Seeing positives already priced in, Citi analyst Alexander Hacking downgraded the U.S. steel sector to "neutral" from "bullish."

"The U.S. steel sector has rallied 68 per cent since mid-October which captures the majority of cyclical upside, in our view," said Mr. Hacking. "Implied EBITDA per Tons are close to peak 2007-08 levels in the case of [United States Steel Corp.] and [AK Steel Holding Corp.]. We expect U.S. steel prices to decline in 2H17 based on increased domestic supply, limited demand growth, lower raw materials and import parity. Yet, we avoid turning outright Bearish given potential structural positives that could generate further upside, specifically Chinese supply-side reform and U.S. government policy."

Mr. Hacking raised his 2017 average HRC (hot rolled coil) steel price forecast to $567 (U.S.) per ton from $514.

"Prices are expected to remain robust in 1Q17 with potential for another price increase," he said. "Yet, we would be cautious of buying into the 'last price increase'; and expect $100/ton downside on prices in 2H. Import arbitrage is now at greater-than $150/ton with Turkey and Black Sea exports."

"We forecast U.S. steel demand growing at 3.5 per cent in 2017. Current capacity plus new supply from Big River and others should be adequate to absorb this demand, even with structurally lower imports, in our view."

At the same time, Mr. Hacking downgraded AK Steel Holding Corp. (AKS-N) to "sell" from "neutral" with a target of $8 (U.S.), up from $5. Consensus is $10.11.

"We see more risk than reward on AKS at current levels. 2017 earnings will benefit strongly from low priced coking coal contracts but earnings face risk in 2018 as these roll off," said Mr. Hacking.

He lowered his rating for United States Steel Corp. (X-N) to "neutral" from "buy" with a target of $37, up from $21. Consensus is $32.40.

"We see risk-reward for X equally balanced at current levels with potential upside from a recovery in the energy sector but downside if steel prices roll-over as expected in 2H," he said.

He also downgraded Commercial Metals Co. (CMC-N) to "neutral" from "buy" with a target of $21, up from $20. Consensus is $20.70.

"CMC shares have risen following the election on prospects for increased infrastructure spending and we see limited upside, absent a new import tariff on Turkish rebar," the analyst said.

Mr. Hacking maintained his "buy" rating for Steel Dynamics Inc. (STLD-Q) with a target of $43, increasing from $30. Consensus is $39.47.

"STLD remains our Top Pick and the stock we recommend for investors seeking a long-term holding in the sector," he said. "The company generates the highest ROIC [return on invested capital] in the group and has levers to improve earnings in 2017 independent of steel prices."

He also kept a "neutral" rating for Nucor Corp. (NUE-N) with a target of $65, up from $50. Consensus is $63.53.

"NUE earnings are increased with potential upside from infrastructure spending and lower taxes but at this point we feel that the stock is fairly valued at  about 8 times EBITDA," said Mr. Hacking.

=====

Calling it a "best-in-class asset management story," Citi analyst William Katz initiated coverage of Brookfield Asset Management Inc. (BAM-N, BAM.A-T) with a "buy" rating.

"BAM's Asset Management business is relatively young versus peers, having launched its first third party fund in 2001," said Mr. Katz. "We see significant expansion ahead as FBAUM [fee-bearing capital assets under management], fee-rates, and margins all grow at best-in-class levels. We expect FRE to double to over $1/share in three years, driving double-digit FFO [fund from operations] growth, and with BAM currently trading with an essentially free 'call option' on Carry, we see the shares priced at an attractive entry point."

He added: "We view BAM's asset management business as a premier Real Asset franchise, with four catalysts that should drive outsized FRE growth through 2018, and potentially beyond: 1) powerful compounding from an accelerating Private Fund fundraising cycle; 2) fee-rates that should migrate higher across all channels (Listed Partnerships, Private Funds and Public Markets); and, 3) Favorable IDR (incentive distributions) inflection dynamics – combining to, 4) potentially drive margins higher."

He set a target price for the stock of $39 (U.S.). Consensus is $40.94.

"Historically an owner operator, we believe investors may be missing the sizable growth opportunities within the relatively nascent Asset Management business," said Mr. Katz.

=====

In other analyst actions:

In reaction to the reports  outgoing Canadian Pacific Railway Ltd. chief executive Hunter Harrison is in advanced talks to join a former Pershing Square Capital partner, seeking to shake up rival railroad CSX Corp. (CSX-Q), CSX stock was raised to "sector outperform" from "sector perform" by Scotiabank analyst Turan Quettawala with a target of $43 (U.S.), up from $39. The stock was raised to "equal-weight" from "underweight" by Morgan Stanley's Ravi Shanker with a target of $37 (from $24). The analyst average is $39.33.

Innergex Renewable Energy Inc. (INE-T) was rated new "sector perform" by Alta Corp Capital analyst Mark Westby with a target of $15.50. The average is $16.33.

UBS analyst William Featherston downgraded Exxon Mobil Corp. (XOM-N) to "sell" from "neutral." His target fell to $77 (U.S.) from $86, versus the average of $89.71.

Cummins Inc. (CMI-N) was raised to "buy" from "neutral" at Longbow Research by equity analyst Neil Frohnapple with a target of $165 (U.S.). The average is $140.62.

Verizon Communications Inc. (VZ-N) was raised to "buy" from "hold" by HSBC analyst Sunil Rajgopal with a target price of $61 (U.S.), up from $54. The average is $53.59.