Friday's analyst upgrades and downgrades

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

Calling it "a flotilla trying to raft up in stormy seas," Credit Suisse analyst Christian Buss lowered his rating for Hudson's Bay Co. (HBC-T).

"In light of underlying demand weakness across the department store landscape, concerns about integration risk, and questions about the square footage expansion and acquisition strategy going forwards, we are downgrading shares," said Mr. Buss, moving the stock to "neutral" from "outperform."

Mr. Buss said the retailer's fourth-quarter financial results, released on April 4, accentuated the challenges it faces across all banners. The company reported normalized earnings per share of a penny, in comparison to 79 cents for the same period a year earlier.

"While we view the comprehensive review of each banner to improve productivity as well as the announced $75-million annualized cost savings as positives, we remain worried about the company's ability to drive revenue absent capital intensive square footage growth or acquisitions," he said. "By banner, the DSG [Department Store Group] continues to suffer from both cyclical and secular challenges facing the North America industry with comps for the quarter up a modest 0.6 per cent. Saks remains weak, with comps flat and down 3 per cent for the year. Within off-price, the company is experiencing delays in improving the business with comps down 5.9 per cent for the quarter. Its European business posted worse than expected results with comps down 2 per cent and we continue to expect delayed leverage as the company expands its footprint."

Mr. Buss added the "challenging" environment faced by malls is also troubling.

"Given our concerns about the underlying growth potential of the North American and European department store environment, we take a cautious stance with respect to revenue growth potential across banners," he said. "Our long-term model is predicated on comps at DSG up 0.5 per cent, at Saks down 0.5 per cent, at Off 5th up 1.5 per cent and in Europe up 0.5 per cent with benefit from ramping operations in the Netherlands. This drives total comps up for HBC up 0 per cent to 1 per cent over the long-term challenging leverage of fixed expense given a continued focus on square footage expansion and acquisitions. Absent a meaningful driver of merchandise margin from improved negotiations with suppliers on increasing scale, or a more meaningful cost restructuring we view EBITDA growth potential as limited."

"We view execution risk associated with integration of disparate global operations combined with continued focus on expansion and acquisitions as substantial. In short, we think Hudson's Bay may have bitten off more than it can operationally chew, limiting the ability to recognize revenue, sourcing, and SG&A synergies that could come from consolidation of the department store landscape. We note the recently identified $75-million in cost savings represent a modest 50 basis points benefit to operating margins. Our long-term model has operating margins remaining negative over the next five years, with a five-year adjusted EBITDA growth CAGR of 3 per cent."

Though he called the company's real estate assets "compelling," he said it's unclear "how to untangle from operating company."

Mr. Buss lowered his fiscal 2017 revenue projection to $14.693-billion from $15.098-billion. His EBITDA estimate dropped to $688-million from $859-million, while his earnings per share expectation fell to a 96-cent loss from a 16-cent profit.

For 2018, his estimates fell to revenue of $15.149-billion (from $15.616-billion), EBITDA of $662-million (from $920-million) and EPS of an 89-cent loss (from a 44-cent gain).

His target fell to $12 from $23. The analyst average price target is $14.67, according to Bloomberg.

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McDonald's Corp. (MCD-N) is beginning to reap the rewards of changes to its brand and market position as well as business model alterations, according to BMO Nesbitt Burns analyst Andrew Strelzik.

Initiating coverage of several U.S. fast food companies, Mr. Strelzik gave McDonald's an "outperform" rating.

"The company's layered initiatives should work together over time to drive a more attractive customer proposition, including a pipeline of menu news, marketing scale to leverage the menu news, and greater brand access to facilitate stronger demand," he said. "McDonald's is approaching an inflection in its business model with the refranchising of China/Hong Kong that should enable accelerated margin expansion over the next 24 months. The company is also on the verge of returning a material amount of cash to shareholders, including the repurchase of stock equivalent to an estimated 10-15 per cent of its market cap.

"McDonald's has a well-established long-term financial plan that should drive its stock higher, but we believe there are several opportunities for MCD to exceed guidance/targets. Opportunities include: 1) food costs based on our proprietary food basket analysis (94-per-cent correlation); 2) G&A (metrics at the high end or well above peers); and 3) additional cash returns to shareholders (greater capex efficiency and a more flexible approach to balance sheet leverage)."

Mr. Strelzik said the company finds itself in a potential "sweet spot" in its ability to capitalize on the current state of the U.S. industry. Emphasizing its ability to leverage its "reinforced value positioning" and menu changes, he sees benefits being reaped in the second half of the year.

"We expect MCD to continue realizing low-single-digit same store sales growth in the U.S. over at least the next 12-18 months, reflecting a host of sales drivers that build on its recent successes against a backdrop of easing compares," he said. "After lapping 5.4-per-cent U.S. same-store sales growth in 1Q, MCD's comparisons ease by 350-700 basis points over the subsequent three quarters."

He added: "We expect MCD to realize same-store sales growth modestly ahead of consensus in 2017, with EPS largely in-line with expectations. We believe there is upside potential to consensus same store sales expectations in 1Q17 and for the full year largely driven by continued momentum in the US segment. In addition, US same store sales trends should accelerate throughout the year as MCD leverages a progression of menu news, marketing scale, and benefits from remodels and technology rollout against easier year-ago compares throughout the year. Our 2017 EPS estimates are more in line with expectations owing to a prudent approach to the margin outlook, although our regression analysis implies greater food cost favorability than MCD has indicated. Our 2017 comp estimate of 2.3 per cent is 20 basis points ahead of consensus and does not include the benefits from potentially stronger industry trends in 2H17 that we believe could materialize, while our EPS estimate of $6.15 is at the mid-point of an admittedly wide consensus range ($5.99-$6.30; consensus of $6.16)."

The analyst set a price target of $153 (U.S.) for the stock. The analyst consensus price target is $135.70, according to Thomson Reuters.

"We believe MCD is well positioned to achieve its long-term growth targets and see opportunities for upside in some areas," the analyst said. "MCD has taken steps to strengthen its operating model and revitalize the brand behind greater alignment with core customers and focus on competitive advantages. We believe MCD currently is in only the early stages of leveraging its stronger positioning, particularly in the US, reflecting a well-developed pipeline of menu news to continue to support customer engagement (e.g., more focused value efforts, renovations around core menu items, new product innovation) and initiatives that leverage the top-line momentum by easing access to the brand. As a result, we believe MCD is well positioned to deliver on its 2019 targets and also see upside potential in some areas."

At the same time, Mr. Strelzik also initiated coverage of Wendys Co. (WEN-Q) with an "outperform" rating and a target of $17 (U.S.) per share. Consensus is $14.24.

"Wendy's positioning in the mature hamburger fast food segment is somewhat unique and more defensible than that of its value-driven peers," he said. "Its positioning creates advantages across menu platforms, innovation opportunities, and a slightly different customer base that historically drove comps above peer average levels with less volatility. Moreover, we view Wendy's as a longer-term share gainer in the category as it can more easily move down the price/value chain by leveraging quality advantages than peers can move up the value chain given quality perception headwinds.

"More confidence in Wendy's ability to grow U.S. units than for peers seeking to do the same, while zero-based budgeting approach to G&A affords visibility into EBITDA margin progression. Nearly half of the unit growth at Wendy's over the next several years already is committed to, while a slower closure pace should facilitate the return to net growth. Our work suggests G&A targets are not overly aggressive, and CPG performance implies a high likelihood of at least achieving targets with ZBB."

He gave Yum! Brands Inc. (YUM-N) a "market perform" rating and $66 (U.S.) target. Consensus is $69.76.

"We expect the company to make steady progress toward its long-term targets, reflecting the stability created by its brand and geographic diversity, participation in attractive categories within the restaurant industry, leading international exposure with additional growth opportunities across brands, and the benefits to its business model from the shift to a more highly franchised model," he said. "We view Taco Bell as the crown jewel of YUM's portfolio and KFC has experienced a resurgence in the U.S. as stronger marketing/innovation has driven a broad change in consumer perception of the brand and an expansion of its typical customer base. These positives are balanced by several ongoing concerns that we expect to limit the upside to the stock over the medium term. First, YUM appears less well positioned to benefit from the potential for stronger industry trends in 2H17 outside of Taco Bell – implying decelerating performance vs the industry – as KFC trends tend not to correlate with the industry or changes in food costs and Pizza Hut may be left behind if peers benefit from the stronger industry (zero-sum game). Second, our proprietary franchisee work suggests the ability to return KFC to unit growth in the U.S. by 2019 may be no better than 50/50, a lower probability than some peers seeking to achieve a return to new unit growth in the U.S. (e.g., WEN). Third, we are not overly optimistic that Pizza Hut U.S. performance can make inroads against peers in the medium term, in part as franchisees seem noncommittal to asset base changes the brand needs. Fourth, China remains a significant wild card given the lack of meaningful recovery following supplier issues and slowing economic trends create further headwinds."

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Canaccord Genuity analysts Mark Rothschild and Jenny Ma raised their target prices for a quartet of real estate investment trusts in response to Commercial Real Estate Services Ltd.'s recently released quarterly Cap Rate Survey.

"Not surprisingly, the Q1/17 Cap Rate Survey indicated that demand for real estate remains strong across most asset classes and geographies," the analysts said. "According to CBRE, stronger than expected economic growth in Canada and ongoing geopolitical and economic uncertainty (particularly in the U.S. and Europe) have led to elevated demand to acquire income-producing real estate in a comparatively stable country like Canada. Consequently, cap rates were flat or declined in most markets and asset classes. Overall, the national average cap rate was 5.76 per cent as at quarter-end Q1/17, representing a 14 basis points year-over-year decline. The most significant declines in cap rates in Q1/17 were reported for rental apartment and industrial assets in Toronto, retail assets in Alberta, and Class AA office assets in Ottawa, whereas the only significant upward move in cap rates was for office assets in Edmonton."

They added: "In our view, the continued strong demand for real estate at even higher prices can be attributed to the substantial spread between cap rates and the cost of debt and investor demand for yield. Long-term bond yields had jumped in late 2016. However, modest economic growth and inflation expectations in Canada along with uncertainty around the implementation of potentially inflationary economic policies under President Trump's administration have resulted in downward pressure on bond yields. Thus far in 2017, the yield on the 10-year government bond yield is down 23 basis points in Canada and down 21 basis points in the US. Currently, the spread between the national average cap rate and the yield on the 10-year Government of Canada bond is 428 basis points, above the long-term average of 389 basis points."

Based on the report, the pair made the following target price changes:

- Canadian Apartment Real Estate Investment Trust (CAR.UN-T, "hold" rating) to $36 from $32.50. The analyst consensus price target is $34.

The analysts said: "Properties in the GTA account for 45 per cent of CAP REIT's net operating income and the REIT is the most exposed residential REIT to the strong housing market in Toronto. The strong Toronto housing market and increased demand from investors to own stable properties in the GTA has had an impact on rental apartment cap rates. While the recent actions taken by the provincial government (detailed later) may have some impact on cooling rent increases, demand is exceptionally strong and the values placed on rental properties in the GTA have increased materially. Consequently, we are lowering our utilized cap rate for CAP REIT to 4.50 per cent (from 4.75 per cent). This compares to the cap rate range of 3.50-4.00 per cent for rental apartments in Toronto and a range of 4.42-5.05 per cent for rental apartment cap rates nationwide. As a result of the lower utilized cap rate, our NAV [net asset value] estimate increases to $33.34 (from $30.19)."

- InterRent Real Estate Investment Trust (IIP.UN-T, "buy" rating) to $9.25 from $8.50. Consensus is $8.49.

They said: "InterRent REIT's portfolio is almost entirely located in Ontario, with the province accounting for 85 per cent of the REIT's annual rental revenue, with the remainder derived from Montreal and Gatineau. We highlight that approximately 20 per cent of InterRent's rental revenue is derived from its properties located in the GTA. Fundamentals in the REIT's core markets are sound and should support solid internal growth over the coming years. Our weighted average utilized cap rate declines from 5.00 per cent to 4.75 per cent primarily as a result of the cap rate compression witnessed in the GTA rental apartment market. This compares to the cap rate range of 3.50-4.00 per cent for rental apartments in Toronto and a range of 4.42- 5.05 per cent for rental apartment cap rates nationwide. Consequently, our NAV per unit estimate increases to $8.39 (from $7.68)."

- Killam Apartment REIT (KMP.UN-T, "buy" rating) to $14 from $13.50. Consensus is $13.66.

They said: "Killam Apartment REIT's primary market is Halifax which accounts for 42 per cent of the REIT's NOI. In addition, the REIT derives 19% of NOI from properties in Ontario, primarily in Ottawa, London, Windsor, and Cambridge. Fundamentals are healthy in Killam's most important markets, although we do have some concern about increased supply in Halifax. Having said that, cap rates have compressed and we are therefore lowering our utilized cap rate to 5.40 per cent from 5.50 per cent."

- Canadian Real Estate Investment Trust (REF.UN-T, "buy" rating) to $53 from $51. Consensus is $51.43.

They said: "CREIT has one of the most diversified portfolios in our coverage universe both by asset class and geography. While our cap rate assumptions for the REIT's Calgary portfolio (specifically the office and industrial assets) have increased, the REIT's NAV has benefitted from declining cap rates in its retail portfolio (54 per cent of NOI) and its office and industrial assets located in Toronto and Vancouver, the latter which account for 14 per cent of NOI. As a result, our overall weighted average utilized cap rate for CREIT's portfolio declines to 5.85 per cent from 6.00 per cent. Consequently, our NAV per unit estimate increases to $48.21 (from $46.46)."

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Citing its higher growth portfolio and margin expansion potential, Raymond James analyst Kenric Tyghe raised his target price for shares of Winpak Ltd. (WPK-T) ahead of the release of its first-quarter financial results on April 27.

Mr. Tyghe is projecting revenue growth of 8.8 per cent to $215.7-million for the Winnipeg-based company, slightly below the consensus estimate of $218-million. He said the result is driven by volume growth as well as "positive mix impact."

"Additional business wins at major U.S. protein customers, and acceleration of growth in the tray business, underpin our revenue growth estimate," he said.

Expecting a decline in gross margins (by 0.84 per cent) due to higher resin prices and "modest" manufacturing inefficiencies, which he said are "largely behind" them, Mr. Tyghe is projecting earnings before interest, taxes, depreciation and amortization of $50.7-million and an EBITDA margin of 23.5 per cent (down 0.68 per cent).

"The margin decrease is driven by gross margin compression, partially offset by expense leverage (SG&A margin is expected to improve 10 bp to 11.6 per cent)," he said.

With an "outperform" rating (unchanged), his target jumped to $56 from $51. Consensus is $43.55.

"Our new target price is based on Winpak's last 12 month price-to-earnings and enterprise value-to-EBITDA multiples of 22.0 times and 11.0 times, respectively, which are in line with the LTM averages (versus the 3-year averages of 20.0 times and 9.8 times applied previously)," the analyst said.

"We believe applying the LTM multiples more appropriately captures both the current U.S. macro backdrop and market risk appetite (the 3-year averages were also negatively skewed by the perceived risks associated with JAB's acquisition of Keurig). We expect a solid 8.8-per-cent increase in revenue in 1Q17, reflecting continued volume growth momentum in key product groups (on new business wins) and improving mix impact. We forecast gross margin compression of 84 basis points to 33.4 per cent given higher raw material costs and manufacturing inefficiencies, on a tough 1Q16 comparison (1Q16 gross margins increased 263 basis points). We believe the new account wins, rising resin prices and expected margin expansion through 2017 are supportive of our constructive thesis on Winpak."

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In other analyst actions:

Canadian Pacific Railway Ltd. (CP-T) was downgraded to "hold" from "buy" at Loop Capital Markets by analyst Rick Paterson. He raised his target to $215 from $210. The average is $222.44.

Cormark Securities Inc. analyst Jeff Fenwick upgraded Home Capital Group Inc. (HCG-T) to "speculative buy" from "market perform." He lowered his target to $25 from $30, while the average is $25.64.

MTY Food Group Inc. (MTY-T) was rated new "hold" at TD Securities by analyst Derek Lessard with a $48 target. The average is $51.90.

AcuityAds Holding Inc. (AT-X) was rated new "speculative buy" at Cormark Securities by analyst Hubert Mak with a $6 target. The average is $6.06.

Brookfield Canada Office Properties (BOX.UN-T) was downgraded to "tender" from "hold" at TD Securities by analyst Sam Damiani with a target of $32.50, up from $32. The average is $31.75.

CSX Corp. (CSX-Q) was raised to "outperform" from "market perform" at Raymond James by analyst Patrick Brown. His target is $55 (U.S.), while the average is $56.96.

It was raised to "buy" from "hold" by Aegis Capital analyst Jeffrey Kauffman, who increased his target to $64 from $50.