Wednesday's analyst upgrades and downgrades

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Inside the Market's roundup of some of today's key analyst actions. This file will be updated often during the trading day so check back for new details.

Canadian Energy Services & Technology Corp. (CEU-T) should be a core holding in any energy portfolio, said Raymond James analyst Andrew Bradford.

Noting "a key investment feature of CES's business is its structurally low maintenance capital requirements and the correspondingly high free cash flow yields this implies," Mr. Bradford initiated coverage of the stock with an "outperform" rating.

"Just about every dividend-paying energy company has either cut its dividend, or its stock is struggling with the unspoken overhang of a potential dividend cut," he said. "On Dec. 10, CES reduced its dividend by 35 per cent – $25-million annually – which at the time appeared to simultaneously bring its 2016 payout ratios back in line with its historical norms and remove the divided-cut overhang as an obstacle to performance. However, given the continued downward trend in drilling activity, we foresee the potential for a second dividend reduction before too long. From a tactical perspective, this could be viewed as an obstacle for near term performance, but the over-arching feature in our view is that the current price is a very attractive level at which to buy CES given its potential for multi-year growth.

"Also tactically, energy investing has been very difficult through the now 20-month-old bear market: the traditional institutional investor base has become conspicuous by its absence in the day-to-day energy market, with the predictable result of severe volatility. But the severity of the decline only bolsters our confidence that under capitalization and ultimately reduced supply will motivate a general commodity correction and will drive E&P spending, CES revenues, and its stock higher."

Mr. Bradford noted the company's transformation from a company centred around drilling fluids to a "full-service speciality oilfield chemical company, with reach into every major basin in North America."

"Investors should expect that CES will grow market share via a combination of product innovation and a customer-oriented service culture," he said. "And while the drilling market is cyclically very weak, we think it's noteworthy that CES's U.S. market share has been on a growing trend, even after correcting for acquisitions. That is, CES has leveraged organic growth through its acquired businesses."

He added: "CES has demonstrated a willingness to branch into new specialty chemicals verticals. This is most apparent with its fracturing chemicals product lines. But we think the acquisition of Sialco Materials provided evidence of a strategy to extend beyond its traditional markets. In the longer-term, we wouldn't be surprised if CES were more frequently characterized as a diversified specialty chemicals provider."

Mr. Bradford set a target price of $4.75 for the stock. The analyst consensus target price is $5.43, according to Thomson Reuters.

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Following Fortis Inc.'s (FTS-T) $6.9-billion (U.S.) deal for Michigan-based transmission company ITC Holdings Corp., BMO Nesbitt Burns analyst Ben Pham said he now sees "attractive risk/reward" for the Canadian electric and gas utility company's stock.

Mr. Pham upgraded his rating for Fortis to "outperform" from "market perform."

"We believe the ITC acquisition is highly strategic for FTS," he said. "Other than increased scale and geographic and regulatory diversification, the acquisition provides access to a future low-risk growing regulated earnings stream and a significant entry into electric transmission (from distribution and to a lesser extent generation). We believe this increased footprint and scale provides FTS a nice platform to source additional growth opportunities over the long term not only in its traditional hunting ground in North America, but also possibly on a global basis. It also supports the 6-per-cent dividend growth target through 2020. Pro forma, about 60 per cent of earnings will be generated in the U.S. versus 45 per cent previously."

He added: "We believe the acquisition maps out to 1.8 times rate base and 20 times forward price to earnings. While those acquisition metrics are rich, they are consistent with recent transactions and the deal is expected to be accretive to FTS (an increase of 5 per cent in 2017). Further, the premium reflects the above-average growth prospects at ITC, the scarcity of transmission assets that come up for sale, and the strategic benefits."

Mr. Pham said he does not expect "material" regulatory hurdles for the deal, though he noted "multiple state commission and Federal Energy Regulatory Commission approval does increase regulatory approval complexity and risk."

"However, FTS has a proven U.S. acquisition track record and thus we see a late 2016 close as reasonable," he said.

The analyst raised his target price to $44 from $43, emphasizing a potential total return of 23 per cent. The analyst average target price is $45.07.

Elsewhere, Credit Suisse analyst Andrew Kuske downgraded the stock to "neutral" from "outperform" and lowered his target to $42 from $46.

Mr. Kuske said: "Following the Fortis and ITC Holdings deal announcement, the Canadian stock sold off more than 10 per cent - which is an extreme move for a deal that received prior media speculation. In our view, the deal structure creates an uncomfortable amount of uncertainty on three major issues: (a) funding; (b) foreign exchange; and, (c) flow back risks. We view a major area of disappointment is the lack of clarity regarding the sale of up to 19.9 per cent of ITC. From our perspective, a larger component of the deal for long-dated capital would have lessened the share exchange and flowback concerns. Accordingly, with the closing timeline and these reasons, we lower our Fortis rating."

He added: "For the next 12 months or so, we view the FTS shares as being tied to the ITC deal fortunes. With our view of structural issues, we view the shares are being largely rangebound until closing."

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Ahead of the release of fourth-quarter 2015 results, Canaccord Genuity analyst Peter Bures said he would recommend adding to positions on HudBay Minerals Inc. (HMB-T).

In a research note previewing quarterly earnings for base metal companies, Mr. Bures upgraded his rating for HudBay to "buy" from "hold," noting the stock's 53-per-cent decline in price thus far in 2016 presents a "relatively cheap valuation."

Expecting the company's debt renegotiations to end favourably, he emphasized the stock is trading at 7 times 2016 enterprise value to EBITDA, compared to a  peer average of 9.1.

He maintained his target price of $4. Consensus is $6.78.

In previewing the sector's earnings, Mr. Bures said: "To say the first month of 2016 has been volatile for base metals and the equities would be an understatement and, in our opinion, justifies maintaining focus on those companies with the strongest balance sheets. We have yet to see announced production curtailments of meaningful size (400-800,000t) that would make us look more favorably upon the prospects for higher copper prices in the near term. We believe the key themes for this earnings season will be debt reduction options (i.e., asset sales/streams), capital spending programs/savings opportunities, negotiations with creditors (term extensions and covenant relief) and strategic options should $2.00 (U.S.)/lb copper persist for an extended period of time. Secondary themes, for those companies with better balance sheets, may be M&A or asset purchase opportunities."

He made the following target price changes:

• Imperial Metals Corp. (III-T, buy) to $10 from $10.50. Consensus: $7.50.
  
  He said: “Continued recovery from Mount Polley tailings dam failure, and long-term growth from Red Chris. High financial leverage, but strong shareholder support.”
  
  
• Lundin Mining Corp. (LUN-T, buy) to $4.50 from $4. Consensus: $5.31.
  
  He said: “A strong balance sheet, with operating leverage from a relatively high cash cost base.”
   
• Teck Resources Ltd. (TCK.B-T, sell) to $2 from $1. Consensus: $6.35.
  
  He said: “Teck shares are up 3 per cent year to date (YTD), while spot copper, coal and oil prices have declined 5 per cent, 3 per cent and 23 per cent, respectively, and the Canadian dollar is flat, each a headwind for Teck. Zinc prices, however, are up 5 per cent YTD and have supported Teck’s performance in 2016. Though fundamentals for zinc prices remain relatively strong, we would note that past supply/demand deficit estimates have been met with increased Chinese zinc mine output which has always been a key forecasting risk. TCK is relatively expensive, currently trading at 10.9 times 2016 EV/EBITDA versus peer average of 9.1x.”
  

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A strong fourth quarter for Cimco Refrigeration, a segment of Toromont Industries Ltd. (TIH-T), "took the chill out" of otherwise disappointing results, said Raymond James analyst Ben Cherniavsky.

He noted the earnings miss featured "lower than expected revenues, competitive margin pressure, and a year-over-year decline in consolidated bookings."

"The Equipment Group (EG) was the sole source of the revenue and EBIT miss, but this was not terribly surprising in the context of what other machinery bellwethers have recently reported," the analyst said. "Similarly, we were unsurprised to see EG bookings fall 18 per cent year over year and competitive pressures depress margins 30 basis points despite a more favourable mix. Again, this is all consistent with—in fact, it is rather benign compared to—what we have seen elsewhere in the sector thus far. Furthermore, although EG aftermarket revenues also missed our forecast, they still registered a double-digit year over year (10 per cent) growth rate."

He added: "In contrast to the difficulties in Toromont's EG, Cimco registered good 4Q15 results, with revenues, margins and EBIT all exceeding our estimates and increasing year over year. The unit also reported particularly strong 4Q15 aftermarket sales (up 22 per cent) and robust bookings (up 20 per cent). Cimco, however, represents a relatively small (approximately 9 per cent) portion Toromont's consolidated profits."

In reaction to the results, Mr. Cherniavsky reduced his 2016 earnings per share and revenue projections to $1.83 and $1.791-billion from $2.04 and $1.94-billion, respectively.

He lowered his target price for the stock to $32 from $37.50. The average is $34.94.

"Given the universal challenges plaguing the equipment markets at present, we continue to view our Outperform rating on Toromont as akin to 'picking the best house in a bad neighbourhood,'" he said. "With a robust aftermarkets business, exceptionally strong balance sheet, and proven management track record, we expect Toromont will continue to outperform its peers through this downturn and be in an enviable position for an eventual market recovery over the long-term."

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Before the release of its third-quarter 2016 financial results on Thursday morning, CIBC World Markets analyst Paul Holden downgraded his rating for Canaccord Genuity Group Inc. (CF-T), saying "the light at the end of the tunnel has moved further away."

Dropping the stock to "sector performer" from "sector outperformer," Mr. Holden lowered his estimates for the quarter given "weak" deal volumes. His operating earnings per share projection fell from 7 cents to a loss of 3 cents.

"The earnings outlook has gone from bad to worse," he said. "The Canadian equity market has reached bear market territory and it feels like other developed markets are on the path to joining us. 2016 earnings expectations for global bulge bracket investment dealers have come down by 14 per cent on average since the end of November and the average estimate for small/mid-cap brokers in the U.S. is down 8 per cent. Given that forward price-to-earnings multiples for both have fallen even further, the market is signaling further downside risk for earnings expectations. Geographic diversification will not help Canaccord in this type of environment.

"2016 is off to a terrible start. The value of equity financings in January was down 68% in the U.K., down 44 per cent in the U.S. and down 74 per cent in Canada. Our revised estimates imply that the current quarter is likely to be even worse than the quarter the company is about to report. We are estimating an operating EPS loss of 3 cents for FQ3 and a loss of 6 cents for FQ4. As we have seen in the past, the financing market can turn quickly, but we just don't see that turn happening in the near term.

He lowered his price target for the stock to $5.50 from $10. Consensus is $6.75.

"While we continue to see significant potential upside for the stock under more normal capital markets conditions, it seems that we have moved further away from normal conditions, not closer," he said. "Also, value opportunities within the diversified financials are now easier to find than even six months ago. We prefer to recommend the asset management firms over the broker dealers given that the asset managers are expected to remain profitable, offer a higher dividend yield with lower risk and offer significant potential upside when equity markets recover."

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The "tide has turned" for Constellation Software Inc. (CSU-T), according to CIBC World Markets analyst Stephanie Price, who upgraded her rating for the stock to "sector performer" from "sector underperformer."

"The recent sell-off in the NASDAQ has turned the tide for valuation of many tech stocks," she said. "As a result, CSU is now trading closer towards its five-year average and relatively in line with peers versus significant premium in the past."

She added: "Our upgrade is more than just a valuation call. We believe the current volatility provides opportunities for CSU's acquisition strategy as valuations become more reasonable and competition for deals lessens. In this type of environment, we believe that Constellation is better positioned to win larger deals, a key concern previously."

On Wednesday, Constellation announced the acquisition of SIV.AG, a provider of utility billing, financial, and customer care outsourcing solutions for over 300 utilities and energy service providers throughout Europe, through its subsidiary N. Harris Computer Corp.

"We believe this acquisition had margins slightly lower than typical and expect Constellation to work to improve profitability post-acquisition," said Ms. Price.

She added: "We believe that Constellation, as a value-buyer, has had difficulty competing for acquisitions over the past several years, spending $122-million in 2014 and [approximately] $250-million in 2015. Given current market volatility, we believe the acquisition environment becomes more attractive, with fewer competitors on deals and lowered valuation expectations."

Noting the stock is down 18 per cent in 2016 and underperforming its peers (down 12 per cent) and the market (down 6 per cent), Ms. Price raised her target price to $505 from $425. Consensus is $594.98.

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In other analyst actions:

Akamai Technologies Inc (AKAM-Q) was raised to "buy" from "hold" at Craig-Hallum by equity analyst Jeff Van Rhee. The 12-month target price is $53 (U.S.) per share. It was raised to "buy" from "neutral" at B. Riley by equity analyst Sameet Sinha with a 12-month target price of $60 per share.

Dean Foods Co (DF-N) was raised to "outperform" from "market perform" at Bernstein by equity analyst Alexia Howard. The 12-month target price is $25 (U.S.) per share. It was raised to "buy" from "hold" at BB&T Capital by equity analyst Brett Hundley with a 12-month target price of $22 per share.

Coca-Cola Co (KO-N) was raised to "hold" from "sell" at Société Générale by equity analyst Andrew Holland. The 12-month target price is $44 (U.S.) per share.

Pandora Media Inc (P-N) was downgraded to "market perform" from "outperform" at Cowen by equity analyst John Blackledge. The 12-month target price is $9 (U.S.) per share.

SolarCity Corp (SCTY-Q) was raised to "strong buy" from "outperform" at Raymond James by equity analyst Pavel Molchanov. The 12-month target price is $60 (U.S.) per share.

Shire PLC (SHPG-Q) was raised to "outperform" from "sector perform" at RBC Capital by equity analyst Douglas Miehm. The 12-month target price is $240 (U.S.) per share.

Tahoe Resources Inc (THO-T) was downgraded to "sector perform" from "outperform" at RBC Capital by equity analyst Stephen Walker. The 12-month target price is $13 (Canadian) per share.

US Bancorp (USB-N) was raised to "outperform" from "market perform" at Wells Fargo by equity analyst Matthew Burnell.

With files from Bloomberg News