Monday’s analyst upgrades and downgrades

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Inside the Market's roundup of some of today's key analyst actions. This file will be updated during the trading day so check back for new details.

Upside in Canada's airline stocks will "remain limited" until capacity is "adequately adjusted" and the economy improves, said Raymond James analyst Ben Cherniavsky.

In a third-quarter sector preview, he said both WestJet Airlines Ltd. (WJA-T;WJA.A-T) and Air Canada (AC-T) are poised to report "fuel-induced 'record' results for the seasonally strong" quarter. Accordingly, he did "tweak" his earnings forecasts for both. However, he expects investors will be focused on revenue per available seat mile (RASM) and "capacity discipline" going forward.

The analyst noted WestJet and Air Canada shares have dropped 10 per cent and 19 per cent, respectively, in the quarter, compared to a 9-per-cent drop for the TSX. The U.S. ARCA airline index (XAL-N) lost 9 per cent, versus a 7-per-cent decline in the S&P 500.

"With the market unwilling to pay-up for the one-time windfall from lower fuel costs, investors continue to send airline managers a strong message that pricing power still matters," said Mr. Cherniavsky. "Indeed, it is no coincidence, we think, that the aforementioned pressure on airline stocks corresponded to declining RASM trends in the U.S. (where carriers update RASM monthly) and falling load factors in Canada. Nor do we think it is a coincidence that Delta's stock rallied last week when, along with in-line third quarter 2015 results, the company reported that it will cut 2016 ASM growth to 0 to 2 per cent."

He added: "Air Canada's most recent monthly traffic report indicated a full 10.5-per-cent increase in its ASMs for the third quarter of 2015; meanwhile WestJet reported 6.3-per-cent growth in its third quarter ASMs. Notably, the latter was less than the 7.0 to 7.5-per-cent third quarter ASM growth guidance that the company provided in late July, but this was purely related to the delays that WestJet has experienced getting its new 767s certified and off the ground (i.e. this is a deferred, not structural, capacity adjustment)."

Mr. Cherniavsky raised his third-quarter earnings per share estimate to 74 cents from 71 cents with his 2015 estimate going to $2.88 from $2.85. His price target for the stock was unchanged at $26. Consensus is $30.20.

For Air Canada, he raised his third-quarter EPS projection to $2.05 from $1.99. His 2015 full-year EPS went to $3.63 from $3.48. He did lower his price target to $11 from $14, compared to a $17.75 consensus.

He maintained his "market perform" ratings for both.

"In the pending third quarter earnings reports, Air Canada and WestJet are expected to provide guidance on their capacity plans for 2016," he said. "Our models assume that there will be some moderation of ASM growth next year, but not enough to bring the market into balance (unless the economy surprisingly rebounds). Given the aircraft purchases to which both carriers are committed, the new route announcements that have already been made, and the planned expansion of their respective airlines-within-airlines (Rouge and Encore), we believe it will be difficult for either company to demonstrate serious 'capacity discipline' (à la Delta) without compromising their strategic plans and market share ambitions. The show-down continues!"

He added: "Longer-term, we still see compelling growth potential for WestJet as it exploits its cost and balance sheet advantage over Air Canada. Shorter-term, however, we believe Air Canada's competitive response will continue to suppress both carriers' results and valuation."

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The demand for potash in 2015 will turn out to be "far weaker than the current thinking," said CIBC World Markets analyst Jacob Bout.

Despite projecting prices to drop by $50 per tonne over the next two years based on continuous oversupply and moderate demand growth, he upgraded Potash Corp. of Saskatchewan Inc. (POT-T;POT-N) to "sector outperformer" from "sector performer" following its decision to withdraw its $8.7-billion (U.S.) proposal for K+S AG and given a 27-per-cent return on target.

"We regard this outcome as the right one for Potash: It made little sense, in our view, for a low-cost producer (Potash) to buy a high-cost producer (K+S) in a surplus market," he said. "Preservation of the balance sheet and perhaps a stock buyback are more prudent measures for Potash Corp."

"For a sustained Potash Corp. rally, there must be an increased focus on a price-over-volume strategy."

The analyst lowered his estimates for the second half of the 2015 in the wake of reductions to his nitrogen price assumptions. His third-quarter earnings per share estimate dropped by a cent to 39 cents with his 2015 EPS estimate falling by two cents to $1.80. His 2016 EPS estimate fell to $1.74 from $1.98 on lower potash prices.

He also reduced his price target for the stock to $28 (U.S.) from $34. Consensus is $28.77.

Mr. Bout also lowered his price target for Agrium Inc. (AGU-T;AGU-N) to $117 from $125 (consensus is $111.83) based on his lower potash and nitrogen assumptions. He maintained his "sector outperformer" rating.

"We maintain that Precision Ag is the future of farming and that AGU is well positioned to provide yield solutions through its retail platform," he said. "While we have lowered our wholesale fertilizer pricing projections, we have made no changes to our AGU retail division expectations."

He also lowered his target on Methanex Corp. (MX-T;MEOH-Q) to $46 from $53 (consensus is $55) and The Mosaic Company (MOS-N) to $40 from $46 (consensus is $44.27) . His "sector performer" rating did not change for either.

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Though shares of Itron Inc. (ITRI-Q) have underperformed the broader market in recent years, Canaccord Genuity analyst John Quealy now sees a "much more attractive risk/reward longer-term at current prices).

Seeing a more 'favourable' environment from which it can boost earnings power, he upgraded his rating for the technology and service company to "buy" from "hold."

"Several developments over the past couple of months support this upgrade, including our expectation of restructuring savings beginning to show in the [third-quarter 2015] report, an improvement in Smart Grid market tone and opportunity after several years of malaise, M&A valuation support from the metering group (Elster deal and speculated pending deal of another major metering vendor), along with recent activist interest working to push valuation creation in the nearer term," said Mr. Quealy.

"In our view, the recent activist investor stake may serve to amplify (not necessarily over-ride) the actions of new COO Thomas Deitrich ... For example, as we've noted several times previously, R&D budgets (approximately 8 per cent of revenues) will need to be re-examined and justified, especially as the smart electric 'design-win' cycle enters its later stages."

Calling the balance sheet "very clean" and adding smart grid market "appears to more opportunistic," he also raised his price target to $45 (U.S.) from $35. Consensus is $36.43.

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Credit Suisse analyst Dan Galves lowered his third and fourth quarter earnings per share estimates for Magna International Inc. (MGA-N, MG-T) to "reflect a slow-down in share repurchase activity."

Mr. Galves now projects the company to use $400-million (U.S.) for buybacks in the third quarter with no cash allocated in the fourth quarter, as it will be closing its acquisitions, including the $2.5-billion takeover of German transmission–maker Getrag. He said that deal with boost its 2016 consolidated revenues by nearly $2-billion and increase segment income by $150-million.

His 2015 EPS estimate fell by two cents to $4.66 with his 2016 projection dropping a dime to $5.55.

Mr. Galves maintained his "outperform" rating for Magna, but he lowered his target price for the stock to $60 from $65. Consensus is $65.41.

"[Magna is a] cheap stock at [about 9 times 2016 price to earnings]," he said. "Even under more conservative assumptions, MGA can generate organic growth of [approximately] 6 per cent a year in'16 and '17 (versus industry production of 2-3 per cent), enough to drive [about] 30-40 basis points to annual margin expansion. Should also support $1.1-$1.4-billion of [free cash flow per year], which MGA will return to shareholders through buybacks (management  was constrained on repurchases in 2015 due to acquisition/divestiture activity). Beyond '16, the company has a strong backlog of new business across the company, augmented by Getrag's strong new business profile in China (particularly with local brands); while every supplier in China should benefit in 2016 with new government stimulus, MGA is in a good position to continue growing at [greater than] 10 per cent in 2017-2019 (including unconsolidated joint ventures), even as the market slows to low single digits."

He added: "With the North American market not expected to grow meaningfully and [approximately] 80 per cent of MGA's [earnings before interest and taxes] coming from the region, the stock is simply not worth owning at this point in the cycle. And as long as the company is perceived to be a commodity supplier, we believe it will continue to fall out of favour with investors, especially given expectations of increasing [original equipment manufacturer] pricing pressure."

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General Electric Co (GE-N) is executing well in the near term while continuing its transformation for the longer term, said RBC Dominion Securities analyst Deane Dray.

"GE is in the throes of more change today than at any other time in its 123-year history, managing a breakneck pace on its transformative portfolio moves, including its acquisition of Alstom, the exit of GE Capital (including the Synchrony share exchange), and long-term cost reduction, gross margin improvement, and Simplification goals to reach higher-tier profitability," said Mr. Dray. "We expect the portfolio pivot to [greater than] 90 per cent industrial and [less than] 10 per cent finance by 2018 will be a game-changer, both in how investors perceive GE and its expected boost to valuation.

"We have been impressed with the cadence of GE's earnings quality and this solid near-term performance should further boost investor confidence. We believe GE's catalyst-rich story can fuel sustained multiple expansion."

Maintaining his "sector outperform" rating, he raised his price target to $32 (U.S.) from $30. Consensus is $30.

"Given GE's near-term moving pieces, we are basing our price target on our initial 2018 EPS [estimate of approximately] $2.08," he said. "We apply a 16.5 times [price-to-earnings]  based on a sum-of-the-parts, and discount the future valuation to year-end 2016, driving our $32 price target. We believe many investors, such as Trian, are also taking this longer-term valuation approach."

He also noted that "underweight" investors are likely to be converted into incremental buyers,  and added:

"We are mindful of how GE stock has languished among the most under-owned names in the S&P 500, largely due to its legacy of underperformance over the last decade and complexity surrounding its financial assets. But the targeted pivot to a [greater-than-90-percent industrial/less-than-10-per-cent finance] earnings mix should be a game-changer in how investors perceive GE. The Trian activist endorsement is also reinvigorating interest in the story, and we expect conversion of new investors currently on the sidelines to buoy the stock longer-term. GE has a history of being a strong performer in 4Q and we like the set-up this year."

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In other analyst actions:

ALLETE Inc (ALE-N) was downgraded to "hold" from "buy" at Wunderlich by equity analyst James Dobson. The 12-month target price is $54 (U.S.) per share.

Abercrombie & Fitch Co (ANF-N) was raised to "hold" from "sell" at Wunderlich by equity analyst Eric Beder. The 12-month target price is $21 (U.S.) per share.

CalAtlantic Group Inc (CAA-N) was raised to "buy" from "neutral" at Compass Point by equity analyst Wilkes Graham. The target price is $48.50 (U.S.) per share.

Cameron International Corp (CAM-N) was downgraded to "neutral" from "positive" at Susquehanna by equity analyst Charles Minervino. The 12-month target price is $70 (U.S.) per share.

Diamond Foods Inc (DMND-Q) was downgraded to "hold" from "buy" at BB&T Capital by equity analyst Brett Hundley.

Darden Restaurants Inc (DRI-N) was raised to "buy" from "hold" at Maxim Group by equity analyst Stephen Anderson. The 12-month target price is $80 (U.S.) per share.

Garmin Ltd (GRMN-Q) was raised to "neutral" from "underweight" at JPMorgan by equity analyst Paul Coster. The 18-month target price is $34 (U.S.) per share.

Joy Global Inc (JOY-N) was downgraded to "underweight" from "hold" at BB&T Capital by equity analyst Mark Levin.

NIKE Inc (NKE-N) was raised to "buy" from "hold" at BB&T Capital by equity analyst Corinna Freedman. The 12-month target price is $148 (U.S.) per share.

PHX Energy Services Corp (PHX-T) was downgraded to "sell" from "hold" at Paradigm Capital by equity analyst Jason Tucker. The 12-month target price is $2.25 (Canadian) per share.

SolarCity Corp (SCTY-Q) was rated new "sell" at Axiom Capital by equity analyst Gordon Johnson. The target price is $24 (U.S.) per share.

Seagate Technology PLC (STX-Q) was downgraded to "neutral" from "positive" at Susquehanna by equity analyst Mehdi Hosseini. The 12-month target price is $45 (U.S.) per share.

Ubiquiti Networks Inc (UBNT-Q) was downgraded to "market underperform" from "market perform" at JMP Securities by equity analyst Erik Suppiger. The 12- month target price is $26 (U.S.) per share.

Urban Outfitters Inc (URBN-Q) was downgraded to "hold" from "buy" at Wunderlich by equity analyst Eric Beder. The 12-month target price is $30 (U.S.) per share.

With files from Bloomberg News