Wednesday's analyst upgrades and downgrades

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

Redknee Solutions Inc. (RKN-T) is likely to see the financial benefits of restructuring in the second half of 2016, said Raymond James analyst Steven Li.

Coupled with further improvement in cash flow, Mr. Li said he likes the Mississauga-based tech company's risk-reward profile. Accordingly, he upgraded the stock to "outperform" from "market perform."

Noting the price of Redknee shares has fallen almost 40 per cent in the year to date versus an 8-per-cent rise in the TSX, the analyst said the decline, following "weak" earnings reports, is due largely to "substantial" capex/opex pressures faced by its telco customers.

"While the telco market remains tough, we note that contract awards have significantly picked up and importantly, support/maintenance revenues look to have bottomed," said Mr. Li.

He pointed to Redknee announcing six major contracts worth over $50-million in total over the past few months. He called them "sizeable" with "significant" license components that should ramp up in late 2016 or early 2017.

Mr. Li said the company's support and maintenance revenues of $22.7-million in the second quarter, a decline of 9 per cent from the previous quarter, are at a "low-water mark."

"That [result] led to some concerns as declining support would imply some customer churn," he said. "There are several moving parts that muddy the waters a little … we show how Core support excluding acquisitions and NSN [Nokia Siemens Network] planned roll-off is trending. The perceived pressure on Core support is much more muted (we estimated 2 per cent quarter over quarter in 2Q) and all of that is attributable to a handful of Tier2 customers opting for a lower tier of support (management called out $0.5-million impact on the earnings call). Looking ahead, we believe 2Q was the low-water mark and expect support to start increasing especially as recent customer wins go live."

He added the planned restructuring is almost complete and should save $25-million in costs, or $6-million in incremental EBITDA. He also projects an improvement in cash flow.

"We like the chances of RKN starting to surprise positively," said Mr. Li.

He maintained a price target of $2.50 for the stock. The analyst consensus price target is $2.98, according to Thomson Reuters.

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The uncertainty surrounding the resolution of its Kumtor mine dispute with the government of Kyrgyzstan has prompted BMO Nesbitt Burns analyst Andrew Breichmanas to downgrade his rating for Centerra Gold Inc. (CG-T) to "market perform" from "outperform."

The Toronto-based miner has announced it has delivered a notice of arbitration to the country's government in connection to its lucrative facility. Last week, Centerra was fined almost $99-million (U.S.) for handling of mine waste. Its subsidiary, Kumtor Operating Co., has also been fined in response to a lawsuit from an environmental safety regulator.

Centerra is seeking to resolve the claims about the alleged environmental breaches. It is also seeking to unwind a $200-million inter-corporate dividend paid by Kumtor Gold Company and resolve the withholding of environmental approvals of Kumtor's 2016 annual mine plan.

"Centerra previously initiated arbitration proceedings in 2008 while attempting to complete a restructuring of the project ownership," said Mr. Breichmanas. "Ultimately, the move prompted discussions with a government working group and arbitration was postponed until a negotiated agreement was reached in April 2009. These proceedings may move more quickly given a notice from the State Agency for Geology and Mineral Resources that if environmental approvals are not received by June 30, mining operations will be required to cease."

Mr. Breichmanas noted the previous arbitration caused Centerra stock to underperformer peer indexes "significantly" through 2018. .

"While this process may move more quickly, similar potential appears to exist," the analyst said. "We had been of the view that the company's strong balance sheet and shift towards more attractive jurisdictions through project development would limit downside risk given the stock's attractive valuation. However, the more aggressive stance taken by management greatly increases headline risk surrounding Kumtor and is likely to affect performance in the near term."

He also reduced his target price to $7.50 from $10. The analyst average is $8.22, according to Bloomberg.

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Raymond James analyst Frederic Bastien raised his target price for Brookfield Infrastructure Partners LP (BIP-N, BIP.UN-T) following a marketing trip with the company's chief financial officer, Bahir Manios.

Mr. Bastien said Brookfield is currently working on five exclusive deals in Brazil.

"This should come as little surprise given the country's current state of affairs and BIP's long operating history therein," he said. "The risk-adjusted returns for Brazilian transmission assets with availability-based revenue frameworks and revenue indexation are reportedly off the charts. BIP notably pointed to real returns of 13 per cent — implying an overly punishing country risk premium of 700 basis points over comparable utilities elsewhere in the world. Management knows it must strike while the iron is hot, however, as the opportunity window will likely shut the moment Brazil starts showing signs of stabilization. To this end, it seeks to deploy $500-million to $1-billion on potential acquisitions by year-end."

The analyst also said Brookfield's UK-regulated distribution business is "growing gangbusters" and expects it to become the company's largest by next year, contributing 21 per cent of funds from operations. He added it is poised to grow at an annual rate of 10-15 per cent through 2025.

"BIP's 70-per-cent market share on all new 'last-mile' electricity and natural gas connections in the U.K. positions the business for strong gains through 2017, as does the country's £10-£12-billion smart meter rollout beyond our forecast horizon," said Mr. Bastien. "BIP already secured a $220-million contract for 700,000 accredited smart meters, and is now bidding on agreements that could see it invest another $600-million in the medium term. This program is only one of many organic growth initiatives along with NGPL's Chicago Market Expansion Project leading us to believe that a period of outperformance for BIP may be just around the corner."

Maintaining his "strong buy" rating, Mr. Bastien raised his target price for the stock to $54 (U.S.) from $50. Consensus is $47.75.

"We believe it continues to offer the biggest potential for organic growth and M&A upside among the stocks we cover," he said.

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With the merger of Waste Connections Inc. and Progressive Waste Solutions Ltd. complete, CIBC World Markets analyst Kevin Chiang initiated coverage of Waste Connections (WCN-N, WCN-T) with a "sector outperformer" rating.

"We view the merger positively as the combined company should benefit from improved FCF [free cash flow] conversion, greater diversification, and the creation of a large-cap liquid Canadian industrial name investors can play," said Mr. Chiang. "It has the qualities of a core holding, which we define as a company with the following above-average attributes: quality, value, and growth."

Mr. Chiang said the company presents investors with an alternative in the Canadian industrial landscape.

"The biggest criticism from investors looking at the Canadian industrial investment universe is that it is dominated by the two rails," he said. "CN and CP combined currently constitute 60 per cent of the S&P/TSX Industrials Index. With the addition of WCN to the S&P/TSX, this adds another large-cap industrial name with best-in-class operating metrics, adding to our view that this is a core holding. While we have made the case that WCN's multiple versus its waste peers is justified, compared to the larger-cap Canadian industrial names, we also see a compelling valuation narrative. Directly compared to the two Canadian Class 1s, WCN has a higher FCF yield (or lower FCF multiple) despite having a better near-term EBITDA growth profile and better top-line visibility. And broadly speaking, looking at the top 10 Canadian industrial names by market cap, a number of them are exposed to the energy/commodity markets, which have had recent challenges, and/or there is a significant step down in liquidity."

Mr. Chiang said investors should not "fear" the company's current multiple, trading a 1- to 2-point premium to its peers – Waste Management Inc. (WM-N) and Republic Services Inc. (RSG-N). He calls it "more than justified."

"First, the higher EBITDA multiple is supported by a higher FCF conversion," he said. "WCN's FCF as a percentage of revenue is about five points above its peers resulting in all three names trading at a similar FCF yield of 5.5 per cent. Second, WCN's earnings stream is growing at a faster clip. Based on consensus estimates, WM's and RSG's EBITDA CAGR [compound annual growth rate] between 2015 and 2018 EBITDA are 5 per cent and 4 per cent, respectively. This compares to our expectations of WCN's EBITDA growing by a CAGR of [about] 8 per cent over the same period. This above-average growth rate reflects WCN's better organic growth profile (i.e., WCN's services are in more exclusive markets than its peers resulting in higher margins) and the tailwind from the BIN synergies.

"Lastly, we make the case …  that there is still upside to WCN's multiple. We see an opportunity for WCN's normalized FCF conversion rate to increase by 100 bps [basis points] as it reaps the benefits from the BIN synergies and lower effective tax rate. This would infer another one-plus point bump in WCN's multiple. More importantly, we think it supports our view that WCN offers investors a steady return story. Looking at WCN's top-line growth opportunities and FCF conversion, we see a path to an annual 10-plus--per-cent equity pickup in addition to its returning cash to shareholder strategy."

He set a price target of $76 (U.S.). Consensus is $73.60.

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Whole Foods Market Inc. (WFM-Q) is "on the offensive," said Credit Suisse analyst Edward Kelly.

Calling the U.S. retailer's recently launched 365 chain "impressive," Mr. Kelly upgraded his rating for the stock to "outperform" from "neutral."

"We see a unique opportunity to own this leading specialty food player while still in the early stages of a repositioning that should reinvigorate growth," he said. "A 50-per-cent drop in the stock from its peak provides an attractive entry point."

Mr. Kelly said the company has finally found a "credible" strategy to reposition itself in a growing corner of the grocery sector.

"The competitive landscape in natural/organic retailing is evolving at a rapid pace," he said. "Growth at smaller specialty players has been robust as capital chases the higher returns of healthy living. Traditional players like Kroger and Costco have aggressively expanded their natural/organic offerings at lower prices to drive basket growth. The middle-income and millennial customer accounts for more of the industry growth today than in the past, as healthy living goes mainstream. The days of charging upper-income consumers, the ultra-health conscious, and environmentalists high prices for organic product appear to be over. WFM has been slow to react to the heightened competitive landscape, but is now in the early stages of an aggressive repositioning that we believe will reinvigorate growth."

He called the launch of 365 in California "an upside surprise" and provides "significant credibility to the idea that the runway remains large."

"The format allows WFM to reach markets where demographic constraints make its core stores uneconomical," said Mr. Kelly. "While we still have questions around the 1,200-store target, 365 could dramatically expand the new store opportunity."

Though he said the company's earnings are likely to remain "choppy," noting investment stories in retail "are not pretty," Mr. Kelly did raise his target price for the stock to $40 (U.S.) from $30. He said the downside seems limited by poor sentiment.

Consensus is $29.71.

"We view the risk/reward in WFM positively, as its large valuation discount to other growth players suggests upside could be large, while negative sentiment and the recent take-out multiple of TFM provides some floor," he said. "WFM trades at a sizable discount to other consumer growth names based on EV [enterprise value]/EBITDA."

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In other analyst actions:

Briggs & Stratton Corp (BGG-N) was downgraded to "market perform" from "strong buy" at Raymond James by equity analyst Samuel Darkatsh.

Bank of Nova Scotia (BNS-T) was raised to "buy" from "market perform" at Cormark Securities by equity analyst Meny Grauman. The 12-month target price is $69 (Canadian) per share.

Centerra Gold Inc  was downgraded to "market perform" from "speculative outperform" at BMO Capital Markets by equity analyst Andrew Breichmanas. The target price is $7.50 (Canadian) per share.

EMC Corp (EMC-N) was downgraded to "neutral" from "buy" at UBS by equity analyst Steven Milunovich. The 12-month target price is $30 (U.S.) per share.

Gilead Sciences Inc (GILD-Q) was rated new "buy" at Gabelli & Co. by equity analyst Jing He.

Helmerich & Payne Inc (HP-N) was downgraded to "underperform" from "neutral" at Credit Suisse by equity analyst James Wicklund. The target price is $48 (U.S.) per share.

Krispy Kreme Doughnuts Inc (KKD-N) was downgraded to "neutral" from "buy" at CL King by equity analyst Michael Gallo.

Precision Drilling Corp (PDS-N) was downgraded to "underperform" from "neutral" at Credit Suisse by equity analyst James Wicklund. The target price is $3 (U.S.) per share.

PrairieSky Royalty Ltd (PSK-T) was raised to "buy" from "neutral" at Dundee by equity analyst Chad Ellison. The target price is $27 (Canadian) per share.

Patterson-UTI Energy Inc (PTEN-Q) was downgraded to "underperform" from "neutral" at Credit Suisse by equity analyst James Wicklund. The target price is $15 (U.S.) per share.

Rock Energy Inc (RE-T) was downgraded to "hold" from "speculative buy" at Canaccord Genuity by equity analyst Sam Roach. The 12-month target price is 95 cents (Canadian) per share.

TORC Oil & Gas Ltd (TOG-T) was raised to "buy" from "neutral" at Dundee by equity analyst Brian Kristjansen. The target price is $10 (Canadian) per share.

Westar Energy Inc (WR-N) was downgraded to "neutral" from "buy" at Mizuho Securities USA by equity analyst Jim Von Riesemann. The 12-month target price is $60 (U.S.) per share.

With files from Bloomberg News