Wednesday's analyst upgrades and downgrades

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

NAPEC Inc. (NPC-T) currently provides an "excellent" entry point for investors, said Raymond James analyst Frederic Bastien.

He initiated coverage of the Drummondville, Que.-based company with an "outperform" rating.

"In our years following Canada's publicly-traded contractors, we were presented with many opportunities to add to our coverage list," said Mr. Bastien. "We passed on several of them as we couldn't get comfortable with these firms' managements, strategies, service offerings or geographic footprints. It proved the right decision, in hindsight, as the stocks we contemplated failed to create meaningful value for investors. While the same can be said of NAPEC up to now, we argue the proverbial stars are beginning to align for this specialized utility contractor. Our analysis shows that NAPEC carries little downside risk at current levels and solid upside potential as the company capitalizes on the growing and consolidating market for electric and gas utility construction."

Mr. Bastien sees visibility for double-digit organic growth for NAPEC, which provides construction and maintenance services to the public utility and heavy industrial markets, through 2018.

"NAPEC derives over 80 per cent of its revenues from the Northeast U.S., where factors are converging to form an exceptionally supportive operating environment," the analyst said. "Sitting atop the list are reliability and safety. U.S. regulators won't allow the electric grid to reach the breaking point again after Hurricane Sandy left 8.5 million people without power and paralyzed Manhattan. As a result they are now granting operators rate base increases to reinvest in aging infrastructure. In addition, publicly-listed utilities are playing catch-up after years of underinvestment in the wake of the global financial crisis. With a stronger American economy and continued access to low-cost capital, they are more open to invest for the long-run. Lastly, a rapidly changing energy mix in favour of natural gas and renewables is driving major investments in the infrastructure to bring this new power to market. All of this is effecting record capital spending plans for some of NAPEC's major customers—including Exelon and Con Edison."

"More and more utilities are turning to acquisitions to combat the adverse effect of reduced consumer demand, steeper regulatory costs and increased competitive options for power. As they get bigger and oversee larger capex programs, we believe utilities will expect increasingly more from their suppliers. Therein lies the opportunity for NAPEC, which has ambitions and the wherewithal to grow with them. With CEO Pierre Gauthier's industry know-how and sound forward thinking, support from Quebec's two largest pension funds (Caisse de depot et placement du Quebec (la Caisse), the Fonds de solidarite des travailleurs du Quebec (FTQ)) and access to capital markets, we see NAPEC particularly well positioned to consolidate small electrical and gas utility contractors across the U.S. Northeast. Longer-term, we believe the stock represents an ideal takeover target for a large utility contractor with subscale presence in the region, or a diversified firm lacking capacity in NAPEC's service areas."

Mr. Bastien touted Mr. Gauthier's three-year strategic plan, which includes a repositioning of its operations on both sides of the border as well as the sale of non-core businesses and an emphasizes on "more profitable" activities. He called the impact, thus far, on margins "impressive" and expects further profitability from the recent acquisition of PCT Contracting, which he said "commands a leading position in New York's lucrative natural gas market.

"There is potential for further improvements next year, as NAPEC's restructuring efforts yield additional savings and scale drives operating leverage," he said. This, at least, is what is implicit in our sector-leading EBITDA margin target of 8.7 per cent for 2018."

Mr. Bastien set a target price for the stock of $1.40, which is the consensus price target.

"The stock notably trades at an EV/EBITDA [enterprise value to earnings before interest, taxes, depreciation and amortization] multiple of 5.0 times our 2017 estimates, versus average multiples of 6.2 times for the three Canadian contractors we cover and 8.2 times for a better representative group of U.S. specialty contractors," he said. "Assuming NAPEC delivers on its well-laid out strategic plan and the market rewards the company appropriately, we believe investors could be staring at a $2.00 stock price in two years' time."

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Touting a "a Tr(i)ump-ant return for Keystone XL," Credit Suisse analyst Andrew Kuske raised his target price for stock of TransCanada Corp. (TRP-T).

On Tuesday, U.S. president Donald Trump signed two executive orders to proceed with construction of the controversial Keystone XL and Dakota Access oil pipelines. TransCanada stock jumped 2.7 per cent following the move.

"From a TRP perspective, there are many positives from the Executive Order relating to KXL," said Mr. Kuske. "Yet, there are many questions that also exist in relation to the project that are unresolved. An obvious window is open to develop this type of infrastructure that possesses a long asset life well beyond most political terms. In the weeks and months ahead, clarity is likely on many issues. With renewed confidence on KXL, we include the project in our numbers and believe a favourable bias looks to exist for a lot of energy infrastructure in the near-term which looks to favour TRP's large footprint and capital allocation activities."

He added: "From our perspective, the headline economics of KXL are very compelling and, will clearly be subject to change given some of the "known unknowns". At TRP's most recent Investor day more than a year ago on Nov.  17 2015, KXL's cost estimate was $8-billion (U.S.). At that time, TRP invested $2.4-billion and had an additional $0.4-billion of capitalized interest. In the past, TRP expected KXL to generate roughly $1-billion of annual EBITDA. Given the President's actions and the likely course of action for TRP, we believe a variety of updated project data will be provided in due course."

With an "outperform" rating, his target rose "modestly" to $74 from $70. Consensus is $67.72.

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In a research note on the energy sector, CIBC World Markets analysts introduced their 2018 estimates and made "modest" tweaks to their price deck.

"While we remain constructive on the medium-term crude outlook, driven by the impact that even partial OPEC compliance will have on near-term global supply/demand balances, market skepticism about cheating is high and we believe any data points suggesting that OPEC is producing above its collective quota will likely keep a lid on near-term pricing," they said. "As such, we are tweaking our 2017 WTI price assumptions slightly lower to $57.50 (U.S.) per barrel from $60, with the bulk of the price reduction being applied to our H1/17 numbers to handicap some of the above-mentioned risks."

They maintained their Henry Hub natural gas assumption for 2017 of $3.35 (U.S.) per  thousand cubic feet and kept their 2018 assumption of $3.50/Mcf.

"We are constructive on 2018 strip improving given the strong demand growth driven by U.S. LNG export ramp-up and continued pipeline additions to Mexico," the analyst said. "While near-term price action will be a derivative of the weather outlook, we believe that if inventories end heating season near the five-year average, there will be a very bullish inventory build over the summer which will drive up prices over winter 2017/18 and summer 2018 as supply catches up to demand."

On 2018, the analysts said: "Given our view that the "high beta" energy trade has largely played out over the course of 2016, we believe 2017 and 2018 will see a return to more traditional stock picking fundamentals. With that in mind, our top picks in the Integrateds/OilSands space are CNRL and Suncor. In the Canadian E&P sector, we currently see the best value in "blue chip" Canadian SMID caps, including Raging River, Spartan, Whitecap and NuVista. Within the oilfield services sector, our top picks are Canyon, Precision, Western and Enerflex; each of which have slightly different rationale, risk weightings and expected upside potential."

They made several target price alterations in the note. Their changes to large cap stocks in CIBC's coverage universe were:

Cenovus Energy Inc. (CVE-T, neutral) to $24 from $25. Consensus: $22.91.
Suncor Energy Inc. (SU-T, outperformer) to $50 from $45. Consensus: $47.46.
Crescent Point Energy Corp. (CPG-T, neutral) to $20 from $22. Consensus: $23.48.
PrairieSky Royalty Ltd. (PSK-T, outperformer) to $38 from $35. Consensus: $32.96.

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Though he warned of potential volatility going forward, Canaccord Genuity analyst David Galison initiated coverage of Alterra Power Corp. (AXY-T) with a "speculative buy" rating.

"There has been a significant growth in installed capacity for renewable energy (wind, solar, hydro, geothermal.) over the past several years," said Mr. Galison. "Government subsidies have been a major contributor to supporting this development; however, these incentives are temporary. In the U.S, the recently extended federal production tax credit (PTC) for wind and the federal investment tax credit (ITC) for solar are expected to continue to support near-term renewable demand for companies such as Alterra. However … these incentives are scheduled to be phased out by 2020.

"While renewable generation as a proportion of total electricity generation was [approximately] 63 per cent in Canada in 2015, renewable generation in the U.S. only accounted for 13.8 per cent (also in 2015) suggesting the U.S. will likely be a focus area for Canadian Independent Power Producers (IPP) over the next several years."

Mr. Galison expressed concern over U.S. President Donald Trump's commitment to the coal industry and lack of enthusiasm for the push to develop renewable energy sources.

"On the surface this could be viewed as a potential reduction in the number of growth opportunities for new renewable and gas-fired plants," he said. "However, the cost of renewables has declined significantly over the past several years. This, combined with gains in efficiency, is allowing renewables to reach a more competitive environment with traditional power-generating technologies. … The U.S. Energy Information Association (EIA) estimates that the levelized cost of electricity (LCOE) for certain renewables (based on 2015 dollars without tax credits) such as onshore wind and solar PV (which are focus technologies for Alterra) entering service in 2022 should compare favorably to existing technologies. The competitiveness is even better when tax credits are incorporated. The year 2022 is used as it is the first year that all technologies are available, given the long lead time and licensing requirements for some technologies. Additionally, due to new regulations (CAA 111b), conventional coal plants cannot be built without carbon captor and storage (CCS) technologies because they are required to meet specific CO2 emission standards."

Mr. Galison said he sees "good" earnings visibility for Vancouver-based Alterra based on its asset base as "the majority of Alterra's electricity generation is currently sold under long-term contracts or power hedges with a remaining weighted-average contract life of 18 years (22 years in North America)." He projects 70 to 80 per cent of its cash flow in 2018 will be covered by power purchase agreements or power hedges.

"We are currently forecasting a 15-per-cent compound annual growth rate (CAGR) in the company's proportionate share of adjusted EBITDA over the next couple of years (2016-2018 ) as generation issues are resolved and new power generating assets enter commercial operation," he said. "This EBITDA growth should also support increases to the company's annual dividend."

He set a price target of $7 for the stock. The analyst consensus is $6.88.

"Our valuation of 12.3 times our 2018 estimated adjusted EBITDA (Alterra's share) outlook is lower than Alterra's historical trading range of 13.0 times, as the company currently does not have any sanctioned growth projects post-2018," the analyst said. "Based on our 2018 outlook, Alterra is expected to grow its share of EBITDA at 14.1-per-cent compound annual growth rate (CAGR) from the 2013 level of $28.8-million. With no additional growth projects sanctioned, we expect EBITDA growth (Alterra's share) to decline closer to the 1-2-per-cent range. However, should Alterra continue to sanction additional growth projects at favourable returns or complete accretive acquisitions we could revisit our valuation."

"It is important to note that while the shares of Alterra are listed in Canadian dollars, the company's financials and dividend payments are all in USD, suggesting the potential for volatility in the company's valuation. Additional volatility is introduced due to various currency translations as well as some Power Purchase Agreements (PPAs) and debt levels are tied to the price of aluminum (discussed in more detail in segments). Further complexity is introduced in evaluating the shares as a significant portion of the company's earnings and cash flow are generated through equity-accounted investments."

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Calling its fourth-quarter results "mixed" under a "challenging fundamental backdrop" based on industry competition, RBC Dominion Securities analyst Jonathan Atkin downgraded his rating Verizon Communications Inc. (VZ-N).

On Tuesday, Verizon reported quarterly consolidated revenues of $32.3-billion (U.S.), a drop of 5.6 per cent year over year. The result topped both Mr. Atkin's projection of $31.9-billion and the consensus of $32.1-billion. Earnings before interest, taxes, depreciation and amortization of $10.4-billion represented a 4.7-per-cent drop, and they were lower than both the analyst's estimate ($10.5-billion) and the Street's expectation ($10.8-billion).

"We are marginally increasing our 2017 revenue forecast to account for inorganic growth in ancillary businesses (including an approximately $1-billion top-line impact from the pending XO acquisition)," said Mr. Atkin. "However, we expect margin performance to be muted in the near-term. Given a more difficult fundamental backdrop in 2017 as a result of increased competition and the threat of margin erosion from the iPhone refresh, we are reducing our 2017 consolidated EBITDA estimate."

Mr. Atkin's 2017 projection fell to $45.1-billion from $45.5-billion. His earnings per share estimate fell to $3.88 from $4.02.

His rating for the stock moved to "sector perform" from "outperform" and his target fell to $51 from $54. Consensus is $53.57.

"We are shifting our rating to Sector Perform as we see more attractive carriers in other large-cap carrier sectors (e.g., cable)," said Mr. Atkin. "Risks to our more cautious stance include: 1) tax reform, which could provide offsetting financial benefits to counter fundamental/operating pressures; 2) wireless consolidation (e.g., Sprint/T-Mobile), which could change the competitive dynamic over time; however, we view regulatory approval as challenging."

Meanwhile, the stock was also downgraded to "market perform" from "outperform" by FBR Capital Markets analyst David Dixon with a target of $52 (U.S.), down from $57.

Raymond James analyst Frank Louthan lowered his rating to "market perform" from "outperform." He did not specify a target.

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Citi analyst Alexander Hacking upgraded Alcoa Corp. (AA-N) following "strong" fourth-quarter results and better-than-expected guidance.

Citing improved earnings growth and upside risk if Chinese supply-side reform materializes, Mr. Hacking moved his rating to "buy" from "neutral."

On Tuesday, the New York-based company reported quarterly earnings before interest, taxes, depreciation and amortization of $335-million (U.S.), topping Mr. Hacking's projection of $294-million and the consensus of $303-million. He cited higher-than-estimated results from its alumina, cast products, energy and corporate segments.

"Alcoa is projecting $2.1-2.3-billion of EBITDA in 2017 at 81 cents per pound aluminum and $335 per tonne alumina," the analyst said. "This is higher than our spot price outlook and we raise our 2017 EBITDA estimate to $1,350-million (using Citi's house view of 76 cents per pound aluminum and $285 per tonne alumina). AA is targeting $50-million of improvement in net performance (adjusted for pricing & FX). Alcoa plans to start 11 of the 18 potential projects it outlined in 2017. All 18 projects are expected to contribute $300-million of EBITDA with $370-million of capital expenditure."

His target for the stock rose to $45 (U.S.) from $32. Consensus is $32.44.

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The expectations for Sysco Corp. (SYY-N) have gotten ahead of themselves, said RBC Dominion Securities analyst William Kirk.

He initiated coverage of the stock with a "sector perform" rating.

"Despite a softening category and an unsustainable gross margin trajectory, Sysco trades at an all-time high and with the smallest post-recession gap to restaurant valuations," he said. "While we think the $500-million three-year EBIT growth goal is achievable/raisable, we believe this is already factored into consensus numbers."

Mr. Kirk said Sysco's performance is diverging from its peers, while, at the same time, its valuation is "at a high and has converged to the industry."

"We do not think Sysco's gross margin should be expanding while the industry is slowing," he said. "We believe there is a lag between input cost volatility and 'out-the-door' pricing to consumers. This manifests itself most with customers who aren't under contract and purchase at market rates. Nearly 50 per cent of Sysco's customers are at market rate. Margin expansion in an environment that features: 1) softer restaurant volumes, 2) softer restaurant EBIT margin expansion, 3) greater customer wage pressure, and 4) wholesaler competition willing to compress gross margins, is unsustainable. Despite this, consensus is forecasting gross margin expansion of nearly 40 basis points for each of the next two quarters. Sysco is disadvantaged relative to peers on: 1) e-commerce capabilities, 2) value-added products, and 3) private label sales."

"Sysco should be able to meet its three-year EBIT growth goal, but this would not be a surprise. A key tenet of the bullish thesis is upside to Sysco's three-year EBIT growth plan of $500-million. However, after removing estimated EBIT contribution from the Brakes acquisition, we believe consensus estimates are already modeling $537-million in EBIT growth by FY18. Sysco is nearly halfway through the program, and appears to be ahead of plan. Sysco will continue to benefit from selling fuel (surcharge) for more than they are paying (favorable hedging). The plan appears achievable and even has upside, but we do not think the stock will react much to such an announcement. We question SYY's SYGMA capital spend (more than the division's annual EBIT). We believe this will have negative ROIC [return on invested capital] and margin implications."

He set a target of $47 for the stock. Consensus is $53.81.

"Restaurant volumes have slowed and Sysco's topline results have diverged from the industry. Despite this, Sysco trades at an all-time high and closer to restaurant valuation than at any time post-recession. We believe this implies a sense of acceleration that we don't share. Sysco, despite worse growth and less sustainable gross margin profile, trades at a two-turn EV/NTM EBITDA [enterprise value to next 12 month earnings before interest, taxes, depreciation and amortization] premium to US Foods and Performance Food Group."

At the same time, Mr. Kirk initiated coverage of Performance Food Group Co. (PFGC-N) with a "sector perform" rating and $24 (U.S.) target. Consensus is $27.38.

"While PFGC is gaining wholesale share, we expect those gains to slow. Deflation presented an opportunity for unsustainable gross margin expansion at PFGC," he said. "We believe others, who have shown a willingness to share in end-market pain, by allowing gross margins to contract, will have the best topline acceleration."

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In other analyst actions:

Husky Energy Inc. (HSE-T) was downgraded to "sector perform" from "outperform" at RBC Capital by analyst Greg Pardy. His target remains $18, while the analyst average price target is $19.39, according to Bloomberg.

Dundee initiated coverage of Lundin Gold Inc. (LUG-T) with a "buy" rating and $7.75 target. The average is $8.45.

The firm also gave Continental Gold Inc. (CNL-T) a "buy" rating and $7 target. The average is $6.21.

As well, Osisko Mining Inc. (OSK-T) was started with a "buy" rating and $4.30 target. The average is $4.06.