Tuesday’s analyst upgrades and downgrades

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

Calling Pure Multi-Family REIT LP (RUF.U-X, RUF.UN-X), "a great place to live," RBC Dominion Securities analyst Michael Smith initiated coverage of the stock with an "outperform" rating.

"In our view, the REIT checks a lot of the right boxes with above-average organic growth potential, an aligned management team, favorable industry fundamentals and a well-located, Class A portfolio in the U.S. Sunbelt. In addition, the REIT has a significant growth through acquisitions opportunity and we expect this will enhance both liquidity and the trading price of RUF units."

Vancouver-based Pure invests in family real estate properties in the United States, possessing a portfolio of 19 communities primarily in Texas (which generates 88 per cent of its net operating income).

"In our view, there are two primary growth drivers for the business," said Mr. Smith. "These include supply and demand dynamics for local markets, together with job growth and higher wages. In addition, we see the lease-up of recently acquired properties and value-add initiatives as incremental growth drivers. On the demand side, above-average population growth in Texas, as well as the broader Sunbelt continues without abate. On top of this, the employment picture continues to improve with professional job growth of about 3.7 per cent year over year in April 2017, based on the pro forma weighted average of the REIT's five markets. While new supply is set to tick-up in 2017, we believe the overall level remains manageable at 3.0 per cent of existing inventory compared with the long-term average of 2.4 per cent."

Mr. Smith said Pure presents investors with "an alluring combination of both organic and acquisition growth" with the U.S. Sunbelt "benefitting" from above-average rent growth driven by a robust population, job and wage growth as well as an elevated propensity to rent, despite some near-term supply headwinds."

"Over the next twelve months, we see several potential catalysts for RUF units, including: 1) the full internalization of property management (and related cost savings); 2) a TSX listing; and, 3) JVs with other institutional investors (e.g., domestic pension funds)," he said. "With the internalization of property management underway, we believe this may open the door for new relationships with Canadian investors seeking exposure to U.S. multi-family assets. In addition to the potential fee stream from managed properties, we see ancillary benefits such as increased size and scale, as well as, possible reputational benefits depending on the calibre of joint-venture partners. We also see increased visibility and demand for RUF units should the REIT 'graduate' to the TSX from its TSX Venture listing. Either cumulatively or on their own, we believe these events may help improve valuation multiples as new investors are drawn to the name or as existing investors increase positions."

Mr. Smith set a price target for the REIT of $7.75. The analyst consensus price target is $7.41 per unit, according to Thomson Reuters data.

"Our target multiple is in line with the REIT's closest peer, Milestone Apartments REIT ("Milestone" or "MST"), which was recently privatized and represents a modest premium to the broader Canadian apartment peer group, which we value at a 2-per-cent discount," the analyst said. "We believe our target valuation multiple reflects the REIT's attractive growth prospects stemming from its presence in high growth metropolitan areas, internalized asset management, transition to internal property management and successful track record of key management personnel. These factors are mildly tempered by the REIT's small market cap, near-term supply headwinds and TSX Venture listing."

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The outlook for Canadian oil and gas companies remains strong despite price volatility, according to Credit Suisse analyst Jason Frew.

"On the back of an OPEC cut extension and continuing drawdown on global oil, the upside on equity within our coverage continues to screen favourably given the market has not priced in the positive fundamental picture in our view," he said. "At [Credit Suisse] deck (which remains above strip pricing), we see 25 per cent upside on average across our coverage, while returns are largely flat at strip."

In a research note on the sector, Mr. Frew compared Canadian energy majors, noting: "Following the transformation of CVE's business post COP deal, we provide a holistic view on the Canadian large cap producers within our coverage (CNQ, CVE, HSE, IMO, and SU) with some key charts in our note. SU and CNQ continue to screen favourably and CVE longer term looks very compelling on growth and valuation, however there are some near term headwinds in our view. An important observation is that quality oil sands assets are now largely consolidated by few Canadian majors. With that perspective, any future oil sands growth for the Canadian majors will have to come organically. We continue to view IMO and CVE's progress in in-situ solvent technologies as a key differentiator among the Canadian oil sands producers given the use of solvent that provide comparable advantages on project economics and lower emissions intensity."

He reinstated coverage of Cenovus Energy Inc. (CVE-T) with an "outperform" rating and $20 target price, both unchanged, following its deal to buy $17.7-billion worth of oil-sands assets from ConocoPhillips.

"In our view, the transaction with COP addresses key strategic weaknesses in the existing portfolio that have become more apparent in the oil price downturn: 1) core assets in a 50/50 JV, 2) lack of balance in capital projects, and; 3) lack of scale and product diversity," said Mr. Frew. "However, leverage rises materially, from underlevered to overlevered relative to peers. In addition, CVE needs to execute on a series of asset sales in order to fully fund the transaction which the market has viewed as pricey. Our $20 target price offers 55-per-cent total return upside to the current price versus 20 per cent for peers. CVE's IR day in June should reinforce the company's commitment to oil sands development and innovation while providing further detail of plans to capitalize on the Deep Basin assets. The IR day should help but progress on asset sales over the next year or so may ultimately provide stronger catalysts."

Mr. Frew made the following target price changes to stocks in his coverage universe:

• ARC Resources Ltd. (ARX-T, “outperform” rating) to $26 from $28. Consensus: $25.27.
  
  Mr. Frew: “ARX continued to make solid progress on the development plan and longer term opportunities in the quarter. We continue to find ARX attractive given its exposure to the prolific Montney play, thoughtful funded growth, balanced commodity exposure, and careful management of underlying portfolio decline.”
   
• Crescent Point Energy Corp. (CPG-T, “neutral”) to $18 from $20. Consensus: $20.59.
  
  Mr. Frew: “The business strategy remains focused on assets with large oil-inplace and low recovery factors to date, with complementary secondary waterflood development. At $55 (U.S.) WTI, the company's five year growth plan delivers a 7-per-cent production CAGR [compound annual growth rate], maintains the current dividend, and provides modestly declining net debt to cash flow through 2021. With the business moving in the right direction, we believe the market will revisit the stock over time given its solid profile and discounted valuation.”
   
• Enerplus Corp. (ERF-T, “outperform”) to $18 from $16. Consensus: $15.70.
  
  Mr. Frew: “ERF remains a top pick within our coverage universe and Q1 results strongly reinforced our view. With the majority of ERF's completed Williston Basin wells brought on stream in the latter half of Q1, core Bakken production should have momentum into Q2..”
   
• Imperial Oil Ltd. (IMO-T, “outperform”) to $49 from $50. Consensus: $45.
  
  Mr. Frew: “Our positive view is founded on improving FCF generation, strong balance sheet, and technology leadership in the oil sands which is rapidly becoming a differentiating factor given the need for improved project economics and lower GHG emissions intensity. Q1 reinforces our view on these fronts but we acknowledge upstream asset performance is a work in progress.”
   
• Pengrowth Energy Corp. (PGF-T, “underperform”) to $1.75 from $2. Consensus: $1.57.
  
  Mr. Frew: “The company continues to track well operationally; however, we remain on the sideline until further debt reduction through asset sales or relaxation of covenants before taking a more constructive view.”
   
• Suncor Energy Inc. (SU-T, “outperform”) to $50 from $48. Consensus: $48.50.
  
  Mr. Frew: “Overall, SU continues to operate well with high levels of utilization at fully owned facilities. Despite the issues at Syncrude there is a compelling value proposition from further asset optimization initiatives over time. Meanwhile FCF [free cash flow] expansion is differentiated versus many global peers as growth capex ramps down into 2018 and new longer duration projects ramp up.”

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RBC Dominion Securities analyst Paul Quinn said he's "increasingly optimistic" about the growth prospects for Rayonier Advanced Materials Inc. (RYAM-N) following its $807-million (U.S.) acquisition of Tembec Inc. (TMB-T).

"We view the acquisition as a strong strategic fit, with opportunities for further synergies and an opportunity for RYAM to establish itself a leader in growing specialty cellulose markets," said Mr. Quinn.

Under the deal, announced Thursday prior to market open, Montreal-based Tembec is selling to Florida-based Rayonier for $4.05 a share in cash or the equivalent in Rayonier shares. The $320-million offer, which includes the assumption of $487-million in debt, represented a 37-per-cent premium to Tembec's share price at the close of trading on May 24.

"Management is currently targeting $50-million in cost within 3 years that will come from S&GA ($10-million), sales & marketing ($7.5-million), supply chain optimization ($17.5-million), and operational improvements ($15-million)," the analyst said.

"While we view these projections as optimistic, we do see opportunities for significant revenue synergies in realized pricing. As the most established and highest quality specialty cellulose provider, RYAM receives a significant premium (greater-than 30 per cent, or $350/MT) for its product. If the company were able to transfer this premium to Tembec's specialty pulp sales, it would represent incremental EBITDA in the $20-million-$25-million range. There is also synergy potential from sharing customer lists, which could lead to new sales opportunities. Unlike market pulp, specialty cellulose purchasers tend to favor long-term, value-add relationships with suppliers. There are much higher quality standards when supplying to end-markets such as pharmaceuticals relative to traditional pulp end-markets (i.e. tissues and diapers), which increases the negotiating power of suppliers."

Adding the diversification stemming from the deal de-risks its portfolio, Mr. Quinn raised his target for Rayonier stock to $20 (U.S.) from $16. Consensus is $18.75.

He maintained his "market perform" rating.

"Following the acquisition, we expect a return to EBITDA growth at RYAM, supported largely by Tembec's growth, but also aided incrementally through announced cost synergy opportunities," he said. "Although we see opportunities for further revenue synergies and growth at Tembec, we prefer to remain conservative pending further updates from management. Although it remains below EBITDA, we expect savings on interest payments to be material (greater than $15-million annually).

"Due to the uncertainty associated with the acquisition (i.e. regulatory risk, integration risk, etc.) we are slightly decreasing our target multiple to 6.5 times (from 6.75 times). Although these risks exist in the short-term, future multiple expansion is likely as the company returns to growth and investors gain clarity surrounding the company's strategy."

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Boyd Group Income Fund's (BYD.UN-T) acquisition of Assured Automotive Inc. bolsters both its growth and margin outlook, according to Raymond James analyst Steve Hansen.

"We believe this deal looks solid on all accounts, offering Boyd not only enhanced scale and geographic diversity, but also attractive financial accretion and future growth opportunities," said Mr. Hansen.

On Monday, the Winnipeg-based trust announced a definitive agreement to acquire Assured, Canada's largest non-franchise collision repair company, for a purchase price of $193.6-million in a combination of $146.1-million in cash and $47.5-million in stock.

Mr. Hansen called the terms "attractive" and the deal "immediately" accretive.

"With normalized TTM [trailing 12 month] EBITDA pegged at $20.2-million (including $2-million of assumed synergies), the standalone purchase multiple equates to 9.6 times," he said. "That said, net of $25.5-million in future tax benefits associated with a tax-efficient transaction (asset-purchase), the effective purchase price consideration drops to $168.1-million, lowering the purchase multiple to 8.3 times. In this context, management expects the deal to be immediately accretive to both earnings per unit and cash flow per unit. The deal is expected to close within 30–60 days, or in 3Q17."

The analyst said Assured brings much more than just incremental locations, emphasizing its emphasizing its "unique" attributes that point toward enhanced margins and growth. Those included an "accomplished team keen to grow" and a "unique" high-margin 'dealership in-take' model.

"On a pro-forma basis, BYD's net debt/EBITDA is expected to be 1.5 times, leaving the firm with plenty of dry powder to fund further growth opportunities," said Mr. Hansen. "In this context, management noted that its M&A pipeline still remains solid, and expects that with the bandwidth of its corporate development team now freed up (the Assured deal reportedly bogged them down in 1Q17), they can return to a more brisk pace of M&A (following a quiet 1Q17)."

"While it may still be too early to revise its plans, we highlight that Boyd's acquisition of Assured has clearly vaulted the company forward in terms of its 2020 strategic plan to double in size vs. 2015 levels — a target that is looking increasingly conservative in our view, particularly if one were to look at EBITDA as the target metric (versus revenue as stated)."

With an "outperform" rating (unchanged), Mr. Hansen raised his target price for Boyd to $110 from $100. Consensus is $101.92.

Elsewhere, BMO Nesbitt Burns analyst Jonathan Lamers boosted his target to $111 from $98 with an "outperform" rating.

"The Assured acquisition improves visibility to near-term earnings growth after the pace of acquisitions had slowed materially year to date and confirms continued prospects for strategic multi-shop platform acquisitions at reasonable purchase valuations," said Mr. Lamers. "Strategically, the acquisition also provides a new platform for tuck-in acquisition growth and may provide opportunities to leverage Assured's higher-margin model."

CIBC World Markets analyst Mark Petrie bumped his target by $6 to $112 with an "outperformer" rating.

Mr. Petrie said: "With this deal Boyd is slightly ahead of pace to double the size of its business by 2020. Much work remains but Boyd has proven over the past 18 months it can execute deals large and small while continuing to organically gain share and improve operational performance."

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CIBC World Markets analyst Todd Coupland downgraded DragonWave Inc. (DRWI-T) in response to lower-than-expected fourth-quarter financial results.

"Lower sales have put pressure on balance sheet liquidity," he said." Given these new concerns about the balance sheet constraining the company's ability to execute its plan … we have downgraded our rating to Underperformer - Speculative (prior Outperformer - Speculative)."

The Ottawa-based tech company's shares dropped 22.5 per cent on Monday in response to the earnings, released Friday.

DragonWave reported quarterly sales of $8-million, well below Mr. Coupland's expectation of $13.5-million. Adjusted earnings per share came in at a 97-cent loss, versus a 23-cent loss projection.

"Downside was due to order deferrals, customer timing for deployment changes and supply chain constraint," he said.

"Assuming Dragonwave can gain support from its lenders, it could allow the company to execute against customer orders later in 2017. We will re-evaluate whether this assumption is supported by backlog and known network densification orders from Sprint later in the year."

His target dropped to $1.15 from $14. Consensus is $14.37.

"Our view is that the enterprise value (EV) to sales multiple of 0.5 times (from 1.0x) is justified given the Company's balance sheet and cash burn," said Mr. Coupland. "At this valuation, Dragonwave's value per share in CAD is $1.15 based on an estimated cash burn of $3-million in Q1 of 2018, using debt of $17-million. Dragonwave's peer group is now trading in a range of 0.6 times up to 3.7 times. The overall average is 1.8x. The lower EV/S [enterprise value to sales] versus peers is due to the company's small size and recent execution issues that have been well documented.

"While the recent award with Sprint was encouraging, we have yet to see follow through on costs and working capital management. We would need to see a credible restructuring plan and/or consistent customer orders and backlog to re-evaluate our view. While the Sprint deal could yield this, we will re-evaluate whether it supports a positive thesis once the balance sheet concerns have been addressed. Dragonwave currently has few followers and those that do don't believe it can successfully transition the company. For that to change the company will have to earn it one step at a time."

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In other analyst actions:

Eight Capital analyst Tal Woolley initiated coverage of Canadian Tire Corp. Ltd. (CTC.A-T) with a "neutral" rating and $165 target. The analyst average target price is $177.08, according to Bloomberg data.

Paradigm Capital analyst David Davidson initiated coverage of Critical Elements Corp. (CRE-X) with a "speculative buy." Mr. Davidson set a target of $2 per share.

Independent Research GmbH analyst Sven Diermeier initiated coverage of Tesla Inc. (TSLA-Q) with a "hold" rating and $350 (U.S.) target. The average is $279.56.

MoffettNathanson analyst Craig Moffett upgraded AT&T Inc. (T-N) to "neutral" from "sell" with a target of $36 (U.S.), down from $37. The average is $42.50.