Friday's analyst upgrades and downgrades

Share

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

The underperformance of Goldcorp Inc. (G-T, GG-N) shares is coming to an end with operational improvements, according to Canaccord Genuity analyst Tony Lesiak.

In a research report on precious metals producers released Friday in which the firm raised its forward curve pricing assumptions in reaction to recent commodity price increases, Mr. Lesiak upgraded his rating for the Vancouver-based company to "buy" from "hold."

"We expect both Cerro Negro and Eleonore to hit nameplate production rates in less than 12 months and also expect the completion of the pyrite leach circuit at Penasquito within a year (earlier than first expected)," said Mr. Lesiak. "Despite the expected 36-per-cent decline in gold grades at Penasquito in 2H17, we expect gold production to be relatively consistent sequentially with grade improvement expected from all the Canadian operations and PV [Pueblo Viejo]. While 2018 and especially 1H18 are expected to be weak at Penasquito (another 30-per-cent decline in gold grades forecast) given the processing of stockpiles, the pre-stripping program is ahead of schedule and grades may be better than planned later in the year."

Mr. Lesiak also stressed the importance of the company's "strong" exposure to zinc, noting it represents approximately 15 per cent of its revenues.

"We forecast Penasquito to produce more zinc metal than Lundin Mining, with strong zinc pricing helping the mine generate over 50 per cent of Goldcorp's forecast FCF between 2019 and 2021 at prevailing zinc prices," he said. "Goldcorp's current relatively weak balance sheet could improve quickly (net cash by late 2020 on the forward curve)."

'The mid-year reserve update is expected to be released with 3Q results and we expect reserves and resources to be largely replaced at the existing mines. Longer term, our financial model assumes 55 per cent (or 22.4Mozs) conversion of the resource base which we believe may seem aggressive but is supported by the company's 20 per cent five-year reserve growth plan excluding acquisitions. Many of G's mines are underground and have a strong conversion history and have shown improved geological potential (Cerro Negro, Musselwhite) of late with some 4.5Mozs expected to be unlocked from the Century project at Porcupine and the Eco Tails dewatering process (co-mingling tailings and waste) potentially unlocking a large portion of the 10Moz of resources at PV and Penasquito (and helping drive throughput rates higher given water availability). The key areas of disappointment may come from Red Lake (only small starter mine reserves of 200kozs expected in 2017) and Eleonore (dilution increase)."

Believing a "turning point approaching," Mr. Lesiak raised his 2017, 2018 and 2019 earnings per share projections to 38 cents, 45 cents and 82 cents, respectively, from 23 cents, 30 cents and 69 cents.

His target price for the stock rose to $21 from $19.50. The analyst average price target is $21.35, according to Bloomberg data.

"Our target remains predicated on a sector average 0.95 times multiple (unchanged) to NAV [net asset value] but we see potential for an upward bias," the analyst said. "We see a potential return to a premium valuation (was up 20 per cent historically), assuming rapid FCF [free cash flow] growth in 2019, an improved balance sheet, and an end to value eroding M&A. On that note, the divestiture and acquisition process appears done for now. The sequence of Coffee, Dome Century, Nueva Union and Casale should keep management suitably occupied for the next 8 years. Given the changes to our estimates), driven by operational improvements, we are revising our rating … Goldcorp currently trades broadly in line with most of its peers on NAV (0.75 times) and at a 6-per-cent discount on 2019 estimated CF (5.2x)."

Mr. Lesiak downgraded IAMGOLD Corp. (IMG-T, IAG-N) to "hold" from "buy" with a target of $9.50 from $11. The average is $9.61.

"While we continue to appreciate the strong growth profile, declining cost structure, the progress being made at each of its key assets and the upside from the generative exploration program, we see upward momentum fading in the near term," he said. "IAMGOLD is the best performer again year-to-date among the larger gold companies and was the best performer in 2016.

"IAMGOLD's valuation is now at a modest premium to the group average compared to the historical heavy discount and we believe concerns surrounding Westwood could act as a headwind for further re-rating. We believe the recent seismic event at Westwood that injured three employees should have been press released. While the event occurred in a non-producing stope, any notable injury-related seismic event at a core asset with a history of seismicity is material in our opinion. The lack of disclosure could result in a step back in the management re-rating progress that has occurred through operational execution and the re-rating of its core assets through successful partnership and exploration."

=====

At the same time, Mr. Lesiak's colleague Rahul Paul lowered his rating for Primero Mining Corp. (P-T, PPP-N) to "speculative buy" from "buy," despite still seeing "value and a path forward."

"While current share price levels appear to imply a high likelihood of insolvency, we see value in San Dimas and a path forward that avoids bankruptcy," he said. "We believe a potential bankruptcy process could be long and painful, with significant downside risks to all stakeholders including Wheaton Precious Metals (WPM-T), debt-holders, unions, local communities and the Mexican government. We believe a likely solution could involve a potential restructuring of the stream (reducing the burden to the operator) and a sale of Primero to a larger producer with the resources to turn around San Dimas.

"We acknowledge this to be a high-risk call since we do not believe the status quo (i.e., Primero as a standalone entity with an unchanged stream on San Dimas) is viable. We believe the current silver stream severely encumbers San Dimas' ability to be viable longer term (even if liquidity constraints, labour issues, and the tax dispute were to be resolved). In addition, we believe Primero may not be able to secure the additional funds required to catch-up on exploration and development to drive sustained profitability. Moreover, any delay in finding a solution to Primero's woes may increase the risk, since the operation may fall further behind, making it increasingly difficult and expensive to ramp-up the mine to profitable levels, in turn reducing the attractiveness of the asset to a third party. If the stream is not restructured, downside risks to equity holders may be very high, justifying the downgrade."

Mr. Paul said a sale of Primero "appears to be the best solution." However, he warned that potential buyers may "require a substantial reduction in the stream."

"In light of significant cuts to spending over the last two years and the recent operational disruptions, we believe San Dimas has fallen significantly behind on the exploration and development that we believe is essential to ramp-up to and sustain profitable production levels," he said. "Even if the stream is reduced and Primero's debt refinanced, San Dimas will likely require substantial investments in exploration and development over the next two years in order to ramp-up up to sustainably profitable levels (we estimate, potentially up to $50-million per year, at least for the next year or so) and to replace depleted reserves/resources. In light of the current share price, we believe it would be difficult for Primero to raise the additional funds required (we estimate $50-million) as a standalone entity. A better capitalized mid-cap producer may be in a better position to make the investments needed to turn around San Dimas. However, we believe that in order to generate interest from a buyer, the stream may have to be restructured so as to leave more than 50 per cent of the economics with the operator, in addition to providing flexibility / funding over the next two years to get the operation back on track. This could be achieved through a number of means including participation by WPM in capital spending and / or a temporary respite from required silver stream deliveries for a period of time. We note that the last time a stream was restructured in order to facilitate a transaction (Centerra's acquisition of Thomson Creek), the operator was left with 51 per cent of the FCF (first 5 years) / 47 per cent of the FCF (LOM). Considering the operational challenges and the higher geopolitical risk profile, we expect that the stream may have to be restructured more favourably. Currently (prior to assuming any restructuring), we estimate that only 15 per cent of 2019E FCF from San Dimas goes to the operator (31 per cent over our modeled LOM)."

"The timing of a transaction remains very uncertain and involves finding a solution that is agreeable to a number of stakeholders (including equity/debt holders, WPM, unions and the Mexican government/tax authorities). The key risk to Primero equity holders remains prolonged delays with the process, which could continue to cause P shares to drift even lower from current depressed levels. While we agree that even a sizeable premium to equity holders in the event of such a transaction may fail to cover losses associated with the 92-per-cent year-to-date decline in the share price, we expect that the re-rating may be in the acquiring company share price (a share-based transaction is most likely) over time as San Dimas is turned around. Overall, we see a reasonable likelihood of a transaction before the RCF expiry date (Nov 23, 2017), but it is difficult to rule out an extension to the deadline at the eleventh hour (with a guarantee from WPM)."

Mr. Paul dropped his target for the stock to 40 cents from 90 cents. The average is currently 21 cents.

=====

In Canaccord's report, the analysts also made numerous price target changes for stocks in their coverage universe

"Gold equities on average continue to underperform expectations in 2017 with gold outperforming the larger gold miners by 16 per cent," they said. "While frustration among the specialty funds is rising (weak ROIC, inability to meet cost of capital, management comp, value destructive M&A, index rebalancing, aggressive currency swings), we believe the key reason the sector is trading near the bottom of historical valuation trading ranges remains the absence of the generalist investor. Further compounding the situation has been the numerous company-specific events and exogenous shocks (ELD, THO, ACA, WPM, P, AKG) that have plagued the sector of late and have made stock selection more relevant.

"The quest for safety has seen a widening of the valuation spreads between the perceived higher quality names (royalty companies and RGLD and AEM) and the higher risk or lower quality names. Strong operating performance and organic value accretion is being rewarded (IAMGOLD and Kinross) while mid cap consolidation driven by index relevance has not. While growth remains less important, declining production profiles remain a concern. Strong management and the ability to deliver on guidance remains paramount. Overall, the valuation divergence may persist until we see the return of the generalist investor. While weakness in the broader markets could bring in new money, the need for liquidity should persist given the poorly rooted gold price which has been more driven by geopolitical factors of late. Similar to late 2015 and early 2016 it may take time for any gold rally to work its way down market cap. In the interim, with many of the premier quality names relatively overbought, we could see flows move down the quality ladder, to a certain degree. This theme could favour the likes of Goldcorp which may be finally emerging from its underperformance or Wheaton Precious which has lagged in the royalty sector."

They raised their targets for the following stocks:

Agnico Eagle Mines Ltd. (AEM-T, "buy) to $76 from $73. Consensus: $68.64.
Asanko Gold Inc. (AKG-T, "buy") to $2.50 from $2.25. Consensus: $2.68.
Argonaut Gold Inc. (AR-T, "buy") to $3.50 from $3.25. Consensus: $3.59.
B2Gold Corp. (BTO-T, "buy") to $5.50 from $5. Consensus: $5.10.
Centerra Gold Inc. (CG-T, "hold") to $10 from $7. Consensus: $10.21.
Detour Gold Corp. (DGC-T, "buy") to $22.50 from $21. Consensus: $21.69.
Endeavour Mining Corp. (EDV-T, "buy") to $36 from $33. Consensus: $32.19.
Franco Nevada Corp. (FNV-T, "buy") to $118 from $114. Consensus: $98.34.
Kinross Gold Corp. (K-T, "buy") to $7.75 from $7. Consensus: $7.10.
Klondex Mines Ltd. (KDX-T, "buy") to $6 from $5.50. Consensus: $6.48.
New Gold Inc. (NGD-T, "hold") to $4.75 from $4.25. Consensus: $5.02.
Osisko Gold Royalties Ltd. (OR-T, "buy") to $21.50 from $20. Consensus: $19.58.
Royal Gold Inc. (RGLD-Q, "buy") to $113 (U.S.) from $105. Consensus: $90.45.
Sandstorm Gold Ltd. (SSL-T, "buy") to $10 from $9.50. Consensus: $7.48.
SSR Mining Inc. (SSRM-T, "buy") to $21 from $20. Consensus: $17.15.

Their targets fell for:

Barrick Gold Corp. (ABX-T, "buy") to $27.50 from $30. Consensus: $25.21.
Brio Gold Inc. (BRIO-T, "buy") to $3.75 from $4. Consensus: $4.57.

=====

"Riding the gold swing," Desjardins Securities analyst Raj Ray initiated coverage of five intermediate and junior gold producers," believing the "recipe for a 'higher for longer' gold price appears to be in place."

He made the claim based on "heightened" geopolitical tensions and weakness in the U.S. greenback due to "continuing policy uncertainty."

"However, we do expect some short-term retracement, driven by the possibility of another interest rate hike before year-end and the start of balance sheet reduction by the U.S. Federal Reserve," said Mr. Ray.

"From a gold price perspective, 2017 has been a decent year, with the spot gold price up 12 per cent year-to-date although with some volatility. However, gold equities have markedly underperformed their leverage except for cases where companies have significantly outperformed market expectations. In general, after a lacklustre 1H17 for most gold equities, we are positive on 3Q17 with the gold price headed toward the second-highest quarterly average (after 3Q16) since 2014 although foreign currency appreciation relative to the US dollar might temper some of the excitement. Our preferred names within our coverage are Oceana and Golden Star, with SEMAFO being a notable mention. Beyond absolute returns, in selecting these companies we have looked at the potential for relatively better operational performance in 2H17, low or positive FX exposure, stable balance sheet with strong FCF yield and, finally, discounted valuation relative to peers. In addition, from a longer-term perspective, we have also taken into consideration management and asset quality as well as exploration potential."

Mr. Ray initiated coverage of the following companies:

- OceanaGold Corp. (OGC-T) with a "buy" rating and $5.75 target. Consensus is $5.17.

Mr. Ray: "Oceana is one of the lowest-cost intermediate producers, with a well-diversified asset portfolio and strong cash generation potential from 2018 onwards. Notwithstanding the recent challenges with the Haile ramp-up, Oceana's management has a strong track record of delivering results and optimizing operations. Over the last four years, Oceana has consistently met or exceeded guidance. After a lacklustre 1H17, we believe Oceana shares could be poised for a relatively stronger finish to the year. We currently expect announcement of commercial production at Haile in 4Q17, and the company remains on track to meet its 2017 operational guidance. Oceana continues to trade at a significant discount to peers on cash flow metrics. However, on P/NAV, it trades at a premium at 1.13 times versus peers at 1.04 times."

- Golden Star Resources Ltd. (GSC-T) with a "buy" rating and $1.75 target. Consensus is $1.22.

Mr. Ray: "Golden Star's gradual transition to a low-cost producer is starting to show results, with a marked decline in operating costs over the last few years. With the start of the Wassa underground and Prestea underground operations in 2017, cash costs are expected to decline further. Given the outlook for improving operations, stabilized balance sheet, capex spend nearing completion and potential further upside to be uncovered through additional exploration, we believe Golden Star shares are well-positioned for a re-rating. The company has one of the best FCF yields among junior peer producers and continues to trade at a significant discount to peers on all metrics."

- SEMAFO Inc. (SMF-T) with a "buy" rating and $4.75 target. Consensus is $4.97..

Mr. Ray: "SEMAFO is an intermediate producer with significant production growth expected over the next two years. The pullback in the share price following a weaker 1H17 has, in our opinion, provided a nice entry point for investors who are willing to accept some near-term volatility for strong potential FCF generation starting in 2H18, assuming timely completion and smooth ramp of the Boungou mine. Although every project is different and execution risk remains, SEMAFO management's expertise in operating a high-grade, open pit mine in Burkina Faso should come to good use during the commissioning of Boungou."

- Kirkland Lake Gold Ltd. (KL-T) with a "buy" rating and $19 target. Consensus is $16.73.

Mr. Ray: "Although our target price represents a potential return of only 20 per cent, we believe there could be additional upside to our estimates given the outlook for continuing strong operational performance from Fosterville and potential for visibility on growth opportunities at both the Canadian and Australian operations. Note that although KL Gold trades at a premium on NAV and CFPS [cash flow per share] metrics compared with its intermediate producer peer group, the peer average is currently skewed to the downside given recent operational and/or jurisdictional issues with a number of intermediate producers. Given KL Gold's attributes of steady operations, a solid balance sheet and significant growth potential, we believe its shares could trade closer to 1.3–1.4x on P/NAV and 10–12x on P/CFPS. Despite KL Gold's impressive year-to-date stock performance, we currently do not see any potential downside to the stock. In our opinion, KL Gold could continue to surprise market expectations to the upside in the near term, driven by operational results from Fosterville."

- Wesdome Gold Mines Ltd. (WDO-T) with a "buy" rating and $3.15 target. Consensus is $4.72.

Mr. Ray: "It has been a year of crests and troughs for Wesdome shares, with the stock price reaching a high of $4.40 (the highest level since at least 2003) and then pulling back by almost 47 per cent as of the last close. Part of the euphoria in late 2016 and early 2017 was excitement about the drill results from its brownfield Kiena asset, which raised expectations of a restart. However, Wesdome was also affected by the GDXJ rebalancing, first positively due to its inclusion in March 2017 which led to a surge in the stock price, and then negatively due to a reduction in its weighting with the extensive rebalancing in June 2017. We believe there could be substantial exploration upside to its assets given Wesdome has historically been capital-starved."

=====

In other analyst actions:

Clarus Securities analyst Joseph Mackay downgraded DHX Media Ltd. (DHX.B-T) to "speculative buy" from "buy" and dropped his target by a loonie to $7.

National Bank Financial analyst Adam Shine also downgraded the stock to "sector perform" from "outperform" with a target of $5.75, down from $8.25. The average target is $6.18.

BMO Nesbitt Burns analyst Ketan Mamtora downgraded Norbord Inc. (OSB-N, OSB-T) to "underperform" from "market perform" with a target of $32 (U.S.), rising from $31. The analyst average is $39.95.

"2017 is proving a banner year for Norbord," said Mr. Mamtora. "High industry operating rate (91 per cent) and two major hurricanes have driven OSB prices to peak levels. Norbord's balance sheet has improved dramatically. However, 2.7Bsf of OSB supply additions (11-12 per cent of North American capacity) over the next 6-9 months seem destined to pressure OSB prices. With Norbord's stock approaching a decade high and consensus estimate for 2018 relatively flat, risks are skewed to the downside."

BMO Nesbitt Burns analyst Mark Wilde downgraded Louisiana-Pacific Corp. (LPX-N) to "underperform" from "market perform" while raising his target to $24 (U.S.) from $22. The average is $27.67.

"Current OSB fundamentals are healthy," said Mr. Wilde. "LPX has also done a solid job of growing the siding business. Siding offers a higher growth rate and greater cross-cycle earnings stability. The balance sheet is strong. The key issue is that 2.7Bsf of OSB supply additions over the next 6-9 months are almost certain to pressure OSB prices in 2018."

RBC Dominion Securities analyst Shelby Tucker raised Atlanta-based Southern Co. (SO-N) to "outperform" from "sector perform" with an unchanged target of $53 (U.S.). Consensus is $51.41.

Mr. Tucker said: "We believe SO's current valuation (a 10-per-cent discount to peers), coupled with its 4.6-per-cent dividend yield, is pricing in too great a discount for construction risk at Vogtle [Electric Generating Plant]. Our meetings with four Georgia commissioners reinforced our belief that the [Georgia Public Service Commission] is committed to completing Vogtle. While questions remain surrounding monetization and a hard cap, we left our meetings incrementally more positive."