Wednesday's analyst upgrades and downgrades

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

Canadian banks should continue to deliver "solid" returns to shareholders, said CIBC World Markets analyst Robert Sedran in a research note previewing the fourth-quarter earnings season, which begins on Nov. 29.

"Though our crystal ball is never quite as clear when we stretch our horizon to add another year to our published forecasts, there is something enjoyable about working with a clean year that is untouched by some of the near-term issues that can bring volatility to the quarterly results," said Mr. Sedran. "As we contemplate fiscal 2018, we see mid-to-late-cycle type growth, which is to say landing in the mid-single digits ... about right for this point in the cycle.

"The most difficult items to forecast when we add a new year are the more cyclical ones: the net interest margin, which is sensitive to the level and shape of the yield curve, and loan losses. On the latter, we have a small decline in loan loss ratios built into fiscal 2018 from what we assume will be a near-term plateau in fiscal 2017. On the former, though the rate environment does seem to have shifted since the U.S. election, we still assume that changes to the front end of the yield curve will be slow in coming and so forecast a stable margin that sees the slow leak we have been witnessing in recent years stop but not yet reverse (more hawkish monetary policy on either or both sides of the border could provide some upside to our revenue forecasts)."

Mr. Sedran said the fourth quarter will end a better-than-expected year for the sector.

"We forecast a sequential decline of 2 per cent for the large banks in Q4/2016, which implies 3 per cent year over year earnings growth," he said. "The sequential decline is a product of moderately rising loan losses, seasonally higher expenses, and lower capital markets related revenues (CMRR) from a strong FQ3 (some of the indicators we track point to less activity in the period and FQ3 saw a benefit to trading revenues from Brexit-related volatility). For revenues, we look for moderate growth in lending NII and average earning assets, but anticipate some margin compression following generally modest progress on margins in Q3/F16. We also forecast a decline in fee-based income given strong growth in fee-based income last quarter. On loan losses, we look for an increase on average generally driven by higher Q/Q loan losses on oil & gas portfolios. The banks showed better credit quality in Q3 and we look for provisions to fall somewhere between Q3/F16 levels and elevated Q2/F16 levels, with a bias towards the former."

In the report, Mr. Sedran raised his target price for stocks in the sector. His changes were:

- Bank of Montreal (BMO-T, sector performer) to $94 from $90. Consensus is $87.60.
- Bank of Nova Scotia (BNS-T, sector performer) to $79 from $74. Consensus is $74.71.
- National Bank of Canada (NA-T, sector performer) to $52 from $48. Consensus is $51.54.
- Royal Bank of Canada (RY-T, sector outperformer) to $95 from $87. Consensus is $86.45.
- Toronto-Dominion Bank (TD-T, sector performer) to $67 from $61. Consensus is $62.65.
- Canadian Western Bank (CWB-T, sector underperformer) to $29 from $27. Consensus is $26.73.
- Laurentian Bank of Canada (LB-T, sector performer) to $56 from $53. Consensus is $52.91.

"With bank shares having entered the year weighed down by oil concerns, the better-than-expected earnings performance led to still better share price performance as multiples expanded to reflect the fact that – who knew? – these are strong and diversified banks that were not going to be taken down by a commodity correction," said Mr. Sedran. "With the expansion achieved so far this year, bank multiples sit at roughly post-crisis averages and below longer-term averages. Moreover, the seven multiple point discount to the S&P/TSX P/E [price-to-earnings] multiple is much wider than the four point long-term average. With solid dividend yields (and dividend growth forecast), we expect the sector to continue to generate good total returns from here. Our price targets are now based on F2018 earnings estimates."

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The markdown intensity at Lululemon Athletica Inc. (LULU-Q) has increased noticeably this quarter and now sits at its highest level since 2012, according to Credit Suisse analyst Christian Buss.

"With an increase in discounting in women's tops particularly, we have less conviction in the company being able to sustain recent top-line momentum, which we view as crucial in supporting earnings recapture," said Mr. Buss. "As a result, we lower our fiscal 2016 comp assumption to 5.1 per cent from 6.2 per cent and reduce our forward multiple to 25 times from 30 times as the benefits from restructuring and margin recapture moderate."

Accordingly, he downgraded his rating to "neutral" from "outperform" and dropped his target price for the stock to $53 (U.S.) from $76. The analyst average price target is currently $68.56, according to Bloomberg.

Based on proprietary data research, Mr. Buss said the retailer's markdown rate is 2.7 per cent for the quarter, which is higher than both the same quarter in 2015 (2.5 per cent) and previous quarter (2.0 per cent). He said the rise in discounting is seen across all core categories for both men and women.

"This is the highest markdown intensity rate we have observed in our data set for the company in 14 quarters, or since 4Q12," he said. "On a 2-year basis, the average markdown intensity rate has been 1.8 per cent. We note that the increased markdown intensity was driven by both women's apparel (rate of 2.9 per cent) and men's apparel (rate of 2.1 per cent)."

"There was a marked increase in the percentage of apparel on sale this quarter, with 13.9 per cent of all apparel on sale (compared to 8.6 per cent of apparel last year and 10.6 per cent of apparel last quarter). Historically, we have found the percentage of apparel on sale tends to average between 8-10 per cent of total SKUs [stock keeping units], suggesting elevated levels of discounting could be occurring this quarter. Discounting in women's apparel drove much of the outsized markdown activity, with 15.4 per cent of apparel on sale."

Mr. Buss emphasized the markdown intensity rate for women's tops of 2.0 per cent, an increase from 1.7 per cent in the second quarter. He said the rise in sale price for tops was increased "significantly" through the quarter from 7 per cent in August to 16 per cent in October. The historical average is 8 to 10 per cent.

"This is particularly concerning in light of new top introductions for fall that we had hoped would support productivity recapture from lapsed customers," the analyst said.

"Our analysis of women's tops suggests there may be difficulties in full-price selling, as the average original price for the category has fallen from $73 in June to $57 in October, a 28-per-cent decline. With new product arriving in stores through the late-summer and initial indications for higher category AURs [average unit retails], the data now shows a reversal of trends over the last three months. This suggests that lululemon product is not resonating with consumers, with AUR degradation likely pressuring comps going forwards."

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H&R Real Estate Investment Trust (HR.UN-T) currently provides investors with a solid entry point, according to Raymond James analyst Ken Avalos.

However, despite emphasizing that opportunity in the wake of a recent sell-off, Mr. Avalos lowered his target price for the REIT in reaction to the release of its third-quarter financial results.

On Monday, Toronto-based H&R reported diluted funds from operations of 45 cents per unit, a penny lower than the projections of both the analyst and the Street. Cash same-asset property net operating income rose 0.3 per cent from the previous quarter, while portfolio occupancy fell 0.1 per cent year over year.

"Post-quarter, H&R sold a 50-per-cent non-managing interest in the TransCanada Tower in Calgary for $257-million (5.15-per-cent cap rate)," said Mr. Avalos. "The REIT also agreed to sell a 50-per-cent non-managing interest in two enclosed shopping malls for $213-million. Once the aforementioned transactions close, H&R will have sold $1-billion of assets this year against $255-million of acquisitions. Though it dilutes FFO, we are always in favour of management teams taking chips off the table in a low cap rate environment in an effort to grow NAV [net asset value]."

The REIT also announced it was raising its distribution by 3 cents annually to $1.38. It was the first increase since January of 2013.

"H&R continues to make steps towards proving it's a NAV-focused REIT, with sizable asset sales and a growing development pipeline," said Mr. Avalos. "FFO will obviously take a hit but we like the trade the company is making. The distribution hike and a 'Say on Pay' vote at their next AGM are additional steps towards making H&R more shareholder friendly."

Mr. Avalos maintained his "outperform" rating for the stock and lowered his target price by a loonie to $24 per unit. The analyst consensus price target is $24.85, according to Thomson Reuters.

Elsewhere, Canaccord Genuity analyst Jenny Ma maintained a "buy" rating and $25 target.

Ms. Ma said: "We believe that H&R REIT should trade at a premium to NAV to reflect the size and scale of its portfolio, exposure to the more robust U.S. economy which should support cash flow growth, low leverage ratio, and reasonable 2017 estimated AFFO [adjusted funds from opeations] payout ratio. We are maintaining our $25 target price, which is based on a 5-per-cent premium to NAV. Combined with the updated annual distribution of $1.38 per unit (6.6-per-cent distribution yield), our target price implies a 25.6-per-cent forecast total return."

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Canaccord Genuity analyst Sam Roach downgraded his rating for Traverse Energy Ltd. (TVL-X) based on larger-than-expected production declines and a dry well at its Coyote property in Alberta in the third-quarter.

He moved the Calgary-based exploration company to "hold" from "speculative buy."

"While well tie-ins in Q4 could provide a production bump in the coming months, Traverse likely lacks the financial capacity to drive material value accretion through the drill bit, in our view," said Mr. Roach.

On Monday, Traverse reported third-quarter production of 632 barrels of oil equivalent per day, down 34 per cent year over year. Mr. Roach cited a lack of new drilling and poor exploration results as the chief reasons for the decline.

"We expect production to recover in December when recent drills and recompletions are tied-in," the analyst said. "Maintaining production over 1,000 boe/d would require new horizontal drilling in 2017, in our view.

"Traverse drilled two wells in the quarter, with one successful Banff oil well at Watts and one dry and abandoned well at West Coyote. No IP rates were provided, but at least one follow-up well at Watts is planned in Q1/17. We expect Traverse will stick to drilling vertical wells for now, as current commodity prices would not warrant drilling horizontals."

Mr. Roach lowered his target price for the stock to 45 cents from 65 cents. Consensus is 63 cents.

"We would become more positive on TVL if the company could demonstrate its ability to meaningfully grow reserves and production per share at current commodity prices," he said. "Specifically, higher commodity prices could warrant higher-impact horizontal drilling and new pool discoveries could add to Traverse's reserves estimates."

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Though HNZ Group Inc. (HNZ-T) reported disappointing third-quarter results, Desjardins Securities analyst Benoit Poirier said he remains positive on the stock, citing an "attractive" potential for returns given its "positive" free cash flow expectations for 2017 and "pristine" balance sheet.

On Nov. 13, HNZ, a Quebec-based provider of helicopter transportation and related support services, reported revenue of $56-million, missing the projections of both Mr. Poirier ($60-million) and the consensus ($61-million) and representing a 5.3-per-cent drop year over year. Adjusted earnings per share of 13 cents also missed estimates (57 cents and 49 cents, respectively).

"EBITDA margin [16.4 per cent, versus a consensus of 21.7 per cent] was disappointing and reflects a challenging market, competitive pressure and the company's strategy to rent aircraft instead of purchasing them (resulting in lower D&A but higher operating expenses)," said Mr. Poirier.

"In the short term, HNZ will focus on reducing its cost structure in the segment in order to protect margins. The company is maintaining its focus on growing offshore operations and leveraging its strong financial position for opportunities to expand its business. In our view, the solid balance sheet supports the potential for business diversification."

Mr. Poirier lowered his target for HNZ stock to $15 from $16 with a "buy" rating (unchanged). Consensus is $14.13.

"While ongoing softness in the industry will likely continue until there is a sustainable rebound in commodity prices, we remain positive on HNZ as we expect the company to generate positive FCF in 2017 (we expect $21-million)," he said. "In our view, positive FCF, combined with the solid balance sheet, provides plenty of opportunity for cash deployment (M&A, partnerships and share buybacks) and reinforces HNZ's credibility versus peers when bidding on long-term contracts. In the meantime, the fleet appraisal value of $14 per share should provide downside support, especially at the current valuation."

He added: "We note that HNZ has been outperforming its primary competitors in the year to date, falling only 7 per cent compared with an average of 41 per cent for peers, reflecting the challenging market conditions for the industry. Of note, CHC Group, one of HNZ's main competitors, filed for Chapter 11 on May 5, 2016, sending the stock into an abyss (down 98 per cent year to date)."

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In other analyst actions:

Silver Wheaton Corp. (SLW-T, SLW-N) was raised to "outperform" from "sector perform" at National Bank by analyst Shane Nagle. He maintained a target of $37 per share. The analyst average is $43.70.

Timbercreek Financial Corp. (TF-T) was rated a new "outperform" by National Bank analyst Jaeme Gloyn with a target price of $9 per share. Consensus is $8.88.

Questor Technology Inc. (QST-X) was raised to "outperform" from "sector perform" at Alta Corp Capital by analyst Mark Westby. He kept his target of 90 cents per share. The average is $1.20.

Deutsche Bank analyst Bryan Kraft upgraded Walt Disney Co. (DIS-N) to "buy" from "hold," saying subscriber declines have improved and citing clarity on cost growth with its cable networks. He maintained a target price of $112 (U.S.), compared to the average of $107.12.

Canyon Services Group Inc. (FRC-T) was rated a new "buy" by Alta Corp analyst Aaron MacNeil with a $6.75 target. The average is $7.04.

Pacific Crest Securities analyst Brad Erickson upgraded Fitbit Inc. (FIT-N) to "sector weight" from "underweight." He did not specify a target price. The consensus is $10.87 (U.S.)

Sysco Corp. (SYY-N) was cut to "neutral" from "outperform" by Credit Suisse analyst Edward Kelly with a target of $55 (U.S.), down from $59. The average is $53.71.