Tuesday's analyst upgrades and downgrades

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

Desjardins Securities analyst Justin Bouchard said investors in the Canadian midstream energy sector are best served focusing on the long-term growth potential of companies once commodity prices and producer activity recovers.

"Our sense is that when oil prices recover, things will not be as they once were," said Mr. Bouchard, who initiated coverage of the sector by saying it's "on shaky ground" given the pullback in commodity prices and without visibility on the magnitude and timing of a recovery.

"Contracts, however, are something of a double-edged sword," the analyst said. "Long-term, fixed-fee contracts are great for protecting exposure to the downside but offer little in the way of upside. Although there is some solace in protective contracts, at this point in the cycle we have gravitated to names that are more exposed to an oil price recovery (GEI, PPL, TWM and VSN), given our view that there is more upside than downside to oil prices from current levels (although we still expect a great deal of volatility). We also like Enbridge Income Fund Holdings, given our valuation and its high-quality assets.

"That said, when we look at the Canadian midstream sector, the location of each company's assets is important — geography and geology matter a great deal. The fundamental premise of this report is to look at the midstream sector through the lens of the E&P business to understand from a bottom-up perspective which midstream companies are best positioned in the Western Canadian Sedimentary Basin (WCSB) given our views on anticipated activity levels."

Mr. Bouchard initiated coverage of the following eight midstream stocks, calling them "the key cogs" that could make the WCSB function:

- AltaGas Ltd. (ALA-T) with a "hold" rating and $34 target. The analyst consensus is $34.28.

The analyst said: "AltaGas has an attractive dividend yield, high-quality and diversified cash flows, and a business model that allows for stable growth, even in a low commodity price environment. Additionally, we note the management team has a strong track record of success, the company is shareholder-friendly and the business model has proven to deliver growth through the cycle. That said, we believe the stock is trading at levels reflective of fair value and — while there is nothing wrong with buying high-quality companies at a fair price — the current expected return to our target is not sufficient to warrant a Buy rating at this time."

- Enbridge Income Fund Holdings Inc. (ENF-T) with a "buy" rating and $34 target. Consensus is $33.75.

The analyst said: "We believe Enbridge Income Fund Holdings features the highest quality of cash flows among the midstream companies, owing to its strong contracts, counterparties, asset quality and asset locations. The entity also has a strong suite of near-term growth projects associated with the Enbridge Mainline and Regional Oil Sands systems. That said, the pushback to the story is growth — the Enbridge Mainline is already oversubscribed and we see slow growth in the oil sands, even in a $60–80 (U.S.) per barrel WTI world. Thus, after the current slate of growth projects is completed in 2019, it is unclear when the next opportunities for growth may come — beyond incremental growth projects to expand the Enbridge Mainline and the potential for acquisitions, there seems to be little. However, even accounting for our concerns over growth, the potential return to our target looks attractive at current levels, especially in the context of its high-quality asset base and strong contracts."

- Gibson Energy Inc. (GEI-T) with a "buy" rating and $22 target. Consensus is $19.54.

The analyst said: "We rate Gibson 'buy–above-average risk,' in part owing to our view of an oil price recovery through 2018. We believe the company is best positioned to capitalize on a meaningful rebound in oil prices (owing to its exposure to tight oil and liquids-rich basins, as well as meaningful margin exposure), while still offering some downside protection — it generates 70 per cent of its operating profits from take-or-pay and fee-based contracts. While we do not disagree with the prevailing consensus that the company's risk profile is elevated relative to its midstream peers (as evidenced by our above-average risk qualifier), we believe the risk profile is not as high as its current valuation implies. Consequently, we believe the company offers an attractive risk-adjusted investment opportunity at current levels."

- Inter Pipeline Ltd. (IPL-T) with a "hold" rating and $28 target. Consensus is $26.90.

The analyst said: "Inter Pipeline is enviably positioned and benefits from high-quality cash flows, largely driven by its Oil Sands Transportation segment (which features long-term contracts and cost-of-service/take-or-pay provisions with investment-grade counterparties). It also has a pathway for growth stemming from acquisition opportunities in its Bulk Liquid Storage segment. However, based on our view that oil sands volume growth is slowing considerably in the medium term, we believe incremental growth opportunities for the company have necessarily slowed as well. Given our view of Inter Pipeline's growth profile, we believe the stock is trading near levels reflective of fair value."

- Keyera Corp. (KEY-T) with a "hold" rating and $43 target. Consensus is $45.

The analyst said: "We believe Keyera offers investors a unique asset base, a sustainable and growing dividend (driven in part by a low payout ratio), a balanced risk profile and continued growth in distributable cash flow. Keyera has been an integral player in providing diluent solutions to oil sands producers, and we believe the condensate handling and liquids terminalling business will continue to deliver growth through to 2018. Thus, as expected growth in oil sands volumes slows post-2017, we believe Keyera will also experience slowing distributable cash flow growth. From our perspective, the push-back is one of valuation; we view the company as fairly valued given its distributable cash flow profile and our long-term growth assumption."

- Pembina Pipeline Corp. (PPL-T) with a "top pick" rating and $46 target. Consensus is $40.08.

The analyst said: "Pembina is our Top Pick among the eight midstream companies. We like the company's strong asset base and good contracts, and believe its ambitious growth program is poised to drive significant distributable cash flow growth through to at least the end of 2018. Further out, we like the company's positioning, which features strong exposure to northeast B.C. and northwest Alberta through its Conventional Pipelines, Gas Services and Midstream segments, along with the beginnings of a solid foothold in the condensate market."

- Tidewater Midstream and Infrastructure Ltd. (TWM-X) with a "buy" rating and $2 target. Consensus is $2.24.

The analyst said: "Tidewater has the potential to be a high-growth story, the success of which lies with management's ability to string together a collection of midstream assets that are more valuable as an interconnected network than as individual islands. Our initial interactions with the management team have been favourable and the company has executed on some interesting transactions. We are cautiously optimistic as we watch the story unfold; as Tidewater delivers on its strategy, conviction around the story should improve. From our perspective, the push-back is largely one of risk around the business plan and execution; the bet is that Tidewater is able to execute on its high-growth strategy."

- Veresen Inc. (VSN-T) with a "buy" rating and $11 target. Consensus is $10.98.

The analyst said: "Veresen generates high-quality cash flows with a solid foundation of midstream, power and pipeline assets. The company also has an avenue for growth as oil prices recover via its ownership in Veresen Midstream, which is building a gathering and processing network in the Montney. However, the perceived risks around the sustainability of the dividend, the adverse impacts of a highly dilutive DRIP [dividend reinvestment program] and management's decision to continue funding Jordan Cove in a difficult macroeconomic environment loom large. Our price target indicates an attractive potential return, but we are also cognizant of the risks."

In summarizing the sector, Mr. Bouchard said: "Our approach integrates a bottom-up analysis based on the microeconomics of the Canadian E&P sector with our top-down outlook for a recovery in oil prices. As a result, we gravitate to names more exposed to an oil price recovery (GEI, PPL, TWM and VSN) and to those with exposure to northwest Alberta and northeast British Columbia (ALA, PPL and VSN)."

He added: "It is not all doom and gloom, though — we believe there are some bright spots despite the pullback in oil sands spending. The drive to develop high-deliverability and liquids-rich gas plays continues marching ahead and with it so does the requisite infrastructure. The bottom line, however, is that each midstream company is impacted to varying degrees by what is happening in the WCSB — some positively and some negatively."

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Canadian National Railway Co. (CNR-T, CNI-N) remains "a best-in-class rail franchise and long-term core holding," said Raymond James analyst Steve Hansen.

However, following the release of first-quarter financial results, Mr. Hansen trimmed his target price for the stock, citing "near-term concerns over mounting volume and FX headwinds (as reflected in CN's revised 2016 guidance." He said both factors are likely to affect the company's "premium" sector valuation.

CN reported earnings per share of $1, an increase of 16 per cent year over year and "handily" topping the projections of both Mr. Hansen and the Street of 94 cents. He attributed the beat to "better-than-expected operating efficiency/expense control, a situation likely aided by the continent's atypically warm winter weather."

Though he said a traffic slowdown hurt the top line, he noted CN reported an "impressive" operating ratio of 58.9 per cent. OR is a measure of a railway's efficiency, with a lower figure considered more optimal. CN's result was an improvement of 6.75 per cent year over year.

"Despite a robust start to the year, CN management issued revised 2016 guidance that now calls for in-line/flat EPS growth (versus mid-single-digit growth prior), citing familiar headwinds in Coal, Crude, and Frac Sand, coupled with mounting new headwinds in: 1) Intermodal (down 7.4 per cent in the quarter to date), an issue common to all west coast ports, but one being more acutely felt in Prince Rupert; and, (2) Canadian Grain, with farmer bins rapidly emptying on strong first-half movements. The sharp bounce in fuel prices and the Canadian dollar has also introduced additional headwinds relative to prior expectations."

In reaction to the results and lower guidance, Mr. Hansen lowered his EPS projections for both 2016 and 2017 to $4.45 and $4.95 from $4.70 and $5.15, respectively. His revenue estimates dropped to $12.047-billion and $12.642-billion from $12.567-billion and $13.128-billion.

Maintaining his "market perform" rating for the stock, his target price fell to $82 from $85. The analyst average price target is $81.19, according to Bloomberg.

Elsewhere, CIBC World Markets analyst Kevin Chiang downgraded the stock to "sector perform" from "sector outperform."

"There is no doubt CN is the best-in-class operator and this was again highlighted with Q1 results," said Mr. Chiang. "That said .... we are downgrading CN from SO to SP to reflect its relative valuation. Note, CN's lowered guidance was not a driver of the downgrade. Instead, CN's total return to our $86 price target (down from $87 prior) is 6 per cent and so we view it as more fairly valued at current levels. Also, when we look at CN's relative valuation on a forward P/E [price to earnings], it is the only major Class 1 trading above the market (both the S&P 500 and the S&P/TSX) and its relative valuation to its Class 1 peers is close to the upper end of its range. On 2017E P/E, the multiple spread of CN versus the average of the other major rails is approaching two points.

"We continue to like CN's long-term story and do believe it should trade at a premium to its peers. We believe its network reach and commodity mix are a structural advantage, especially when considering the growth opportunities across CN's intermodal franchise. In addition, coal, crude and frac sand are just a combined 8 per cent of CN's revenue today, which means any further downside to these commodities will have a less relative impact versus the other Class 1s. That said, this network advantage is being reflected in CN's current valuation. We believe that the upside to CN's current multiple is capped until we see improved volume visibility from the whole rail sector. "

TD Securities analyst Cherilyn Radbourne moved CN to "hold" from "buy" with a target of $86, down from $89.

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The near-term risk-reward for Open Text Corp. (OTEX-Q, OTC-T) looks attractive, though longer-term challenges linger, according to BMO Nesbitt Burns analyst Thanos Moschopoulos.
 
Ahead of the release of the Waterloo, Ont.-based tech company's third-quarter 2016 results on Wednesday after the market close, Mr. Moschopoulos said he remains neutral on the stock given his long-term concerns.

"History has shown that Open Text's quarters are exceedingly difficult to predict, and we don't claim that our crystal ball has improved in that respect," said Mr. Moschopoulos. "That said, we think that adjusted EPS for the quarter should be in line (with potential room for upside) as the Street's margin assumptions seem too conservative. Further, even if Open Text were to miss, we think that the impact to the stock should be mitigated by investor optimism related to the recent releases of Suite 16 and Cloud 16, and the fact that Street estimates haven't yet been updated to reflect the recent acquisition of the HP assets.

Mr. Moschopoulos is projecting quarterly revenue of $450.8-million (U.S.) and adjusted EPS of 84 cents, "roughly" in line with the consensus estimates.

"Looking past the quarter, we'll note that Open Text delivered a very strong quarter following its last major product release in 2014 (with 22-per-cent year-over-year organic license growth in the June 2014 quarter)," he said. "The Street doesn't seem to be baking in an uplift related to the recent Suite 16 and Cloud 16 releases (Street estimates imply low single-digit year-over-year organic license growth in the June quarter, by our math), and, in our view, this also provides some potential room for upside. Longer term, we remain apprehensive about Open Text's relatively modest level of R&D spending relative to its revenue base, its slow organic growth, and its high exposure to on-premise software versus cloud/SaaS [Software as a Service]."

After raising his financial estimates to reflect the $170-million purchase of customer experience (CX) assets from HP Inc., Mr. Moschopoulos bumped his target price for the U.S. issue of Open Text stock to $57 (U.S.) from $50. Consensus is $53.47.

He did not change his "market perform" rating.

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Citing an improved valuation and "attractive" relative returns to his target, RBC Dominion Securities analyst Stephen Walker upgraded Newmont Mining Corp. (NEM-N) to "outperform" from "sector perform."

"Our valuation multiples are in line with those used for Newmont's Tier I peers (Barrick and Goldcorp), and Newmont is trading at a discount to its peers," said Mr. Walker. "Our forward adjusted cash flow estimate has been rolled into the first half of 2017 and captures the third-quarter 2016 contribution from NEM's 75-per-cent stake in the Merian mine in Suriname and initial Q1/17 production from the Long Canyon heap leach mine in Nevada."

He added: "Our production profile for Newmont is relatively stable over the 2016 to 2020 period … similar to production profiles for ABX, GG, and KGC. In comparison to its North American Tier I peers, at our estimates Newmont is trading at a discount on the basis of net asset value (NAV), 2016 and 2017 price to cash flow (P/CF), price to adjusted CF, and price to earnings, and provides the strongest estimated free cash flow (FCF) yield over the next two years."

Mr. Walker said Newmont is in a position to generate "significant" FCF upon the completion of its scheduled 2016 capital programs. He added there should be adequate capital to fund "significant" debt repayment as well as new development projects.

"The company has stated that it is in discussions with parties interested in buying its stake in Batu Hijau," the analyst said. "While there is no certainty of a sale, Batu Hijau proceeds could be as much as $0.9-billion). We believe a sale would be a positive outcome for Newmont given the ongoing geopolitical risk and future capital commitments for its share of the 3-year, $1-billion Phase 7 waste-stripping program. With proceeds from a Batu sale, we could envision NEM buying the 50-per-cent stake in the KCGM [Kalgoorlie Consolidated Gold Mines ] from ABX [Barrick] for an estimated value of $634-million (at $1,250/oz gold and a 5-per-cent discount rate), replacing the 270,000 oz/year lost with the Batu Hijau sale."

Mr. Walker raised his price target for the stock to $40 (U.S.) from $34. Consensus is $32.28.

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Retail performance remains the focus for Agrium Inc. (AGU-N, AGU-T), said RBC Dominion Securities analyst Andrew Wong in a first-quarter 2016 preview.

"The U.S. spring planting season got off to an early start, which we view as supportive for first-half 2016 retail segment performance," the analyst said. "However, this is offset by wholesale segment weakness driven by declining nutrient prices. We estimate 1Q/16 EPS loss at (3 cents), in line with consensus and management guidance for 'a slight loss' – note that 1Q is historically a seasonally weaker quarter."

Ahead of the release of its quarterly results on May 3, Mr. Wong said strong U.S. corn acreage and crop prices appear to be a "near-term positive."

"The USDA is forecasting 93.6 million acres of corn will be planted in 2016, up 6 per cent year over year," he said. "We believe this is a tailwind for retail segment performance as corn input requirements are higher than soybean/wheat. We also note that crop prices have held relatively stable despite high global production – year-over-year prices corn up 4 per cent, soybean up 2 per cent, wheat down 1 per cent. However, strong 2016 crop production may lead to a pull back in 2017 plantings and, barring an unexpected weather catalyst, crop prices and challenging [agriculture] fundamentals will remain largely unchanged."

Mr. Wong lowered his 2016 and 2017 EPS estimates to $6.17 and $6.83 from $6.25 and $7.50, respectively. He did say he expects a "modest" dividend increase in the next 12 months

"Although we remain in a challenging [agriculture] environment, we expect Agrium's FCF will gradually improve due to stable retail cash generation and declining capex," said Mr. Wong. "We think management is taking a cautious and prudent approach to dividend increases due to the macro backdrop, and will likely wait until late-2016 or early-2017 before making a decision on further dividend increases."

Maintaining his "outperform" rating, he lowered his price target for the stock to $95 (U.S.) from $100. Consensus is $95.26.

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In other analyst actions:

AMC Networks Inc. (AMCX-Q) was raised to "outperform" from "neutral" at Macquarie by equity analyst Amy Yong. The 12-month target price is $82 (U.S,) per share.

Badger Daylighting Ltd. (BAD-T) was rated new "market perform" at BMO Capital Markets by equity analyst Bert Powell. The target price is $24 (Canadian) per share.

3D Systems Corp. (DDD-N) was downgraded to "hold" from "buy" at Needham & Co. by equity analyst James Ricchiuti.

Discovery Communications Inc. (DISCA-Q) was downgraded to "underperform" from "neutral" at Macquarie by equity analyst Amy Yong. The 12-month target price is $25 (U.S.) per share.

Denbury Resources Inc. (DNR-N) was downgraded to "sector weight" from "overweight" at KeyBanc by equity analyst David Deckelbaum.

Oasis Petroleum Inc. (OAS-N) was downgraded to "hold" from "buy" at Cantor Fitzgerald by equity analyst Brad Carpenter. The target price is $9 (U.S.) per share.

Palo Alto Networks Inc. (PANW-N) was raised to "buy" from "hold" at Wunderlich by equity analyst Robert Breza. The 12-month target price is $190 (U.S.) per share.

Perrigo Co PLC (PRGO-N) was downgraded to "hold" from "buy" at Stifel by equity analyst Annabel Samimy. It was downgraded to "hold" from "buy" at Jefferies by equity analyst David Steinberg with a 12-month target price of $112 (U.S.) per share.

Range Resources Corp. (RRC-N) was downgraded to "sector weight" from "overweight" at KeyBanc by equity analyst David Deckelbaum.

West Fraser Timber Co. Ltd. (WFT-T) was raised to "buy" from "neutral" at Dundee by equity analyst Stephen Atkinson. The 12-month target price is $52 (Canadian) per share.

Whiting Petroleum Corp. (WLL-N) was downgraded to "hold" from "buy" at Cantor Fitzgerald by equity analyst Brad Carpenter. The target price is $11 (U.S.) per share.

With files from Bloomberg News