Monday's analyst upgrades and downgrades

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

The risk-reward for Hydro One Ltd. (H-T) stock is "attractive again," according to Raymond James analyst Frederic Bastien.

Following the third-quarter financial results that exceeded his expectations, Mr. Bastien upgraded his rating to "outperform" from "market perform."

On Friday, Hydro One reported quarterly earnings per share of 39 cents, ahead of both the consensus projection (31 cents) and the forecast of Mr. Bastien (a Street-high 34 cents). He pointed to greater-than-expected peak transmission demand and cost savings as the chief reason for the beat.

"Revenues rose 6 per cent year-over-year reflecting the changes in the Ontario Energy Board's (OEB) approved distribution rates and the unusually hot weather conditions across the province, which boosted peak transmission demand," said Mr. Bastien. "On the expense side, Hydro One continues to improve efficiency, lowering costs relating to support services, equipment refurbishments and station maintenance."

Mr. Bastien noted the utility now has its management largely in place, adding: "Mayo Schmidt rounded out his executive team with two more hires since we last commented on Hydro One. Joining the firm as COO is Greg Kiraly, who previously held senior roles with US investor-owned utilities such as PG&E, Commonwealth Edison and PSE&G. Paul Barry signed up as EVP Strategy and Corporate Development after having held financial and business development roles with various electric power, natural gas and water utilities (including Duke Energy, Pepco Holdings and General Electric). While more i's must be dotted and t's crossed before Hydro One can execute on large cross-border M&A opportunities, we feel the bench strength to act on such deals is now in place."

In analyzing Hydro One's $41-million deal to purchase Orillia Power Corp., Mr. Bastien said he "welcomes" the transaction, but he said distribution "upside" is in regulation and not consolidation.

"Significantly more value can be unlocked in the existing Distribution business, which has consistently unperformed under a cost-of-service structure, as it transitions to a performance-based one starting in 2018," the analyst said.

"With the OEB lowering subsequent to quarter-end the allowable ROE for electric and gas utilities operating in Ontario to 8.78 per cent from 9.19 per cent, we felt it prudent to bring our 2017 estimates down modestly. Still embedded in our forecasts, however, are strong results from Transmission and productivity gains that will bring Distribution above its allowed ROE—netting over-earnings of 123 basis points from a consolidated standpoint."

He maintained a $25 target price for the stock, seeing "more upside as the utility transitions to an incentive based framework in 2018." The analyst consensus price target is $25.19, according to Thomson Reuters.

"We apply a target yield of 3.5 per cent on our 2017 dividend estimate to derive our valuation," he said. "This is in-line with the stock's trading average since its IPO and higher than Fortis' current yield of 3.9 per cent, in view of Hydro One's monopoly-like status in regulation-friendly Ontario."

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BMO Nesbitt Burns analyst Gerrick Johnson downgraded Spin Master Corp. (TOY-T) based on its current valuation.

Moving his rating for the stock to "market perform" from "outperform," Mr. Johnson said: "Spin Master is a great toy company, with a strong portfolio of toys and exceptional growth potential. We have confidence in the company's ability to achieve its long-term goals owing to a track record of creativity and innovation supported by solid execution and deep relationships with inventors, suppliers, licensors, and distribution partners. However, with the stock appreciating 94 per cent since its July 30, 2015 IPO, it has achieved our price target of $34. Now trading at 18.5 times our 2017 EPS estimate of $1.40 (U.S.), we think shares are fully valued in relation to our 12-month time horizon and may need time to grow into its premium P/E multiple."

On Nov. 8, the Toronto-based company reported third-quarter adjusted earnings per share of 86 cents, below the projections of Mr. Johnson (97 cents) and the Street (90 cents). However, it was an increase of 3.5 per cent from the previous year.

Net revenue of $475-million exceeded the estimates of the analyst ($464-million) and the consensus ($447-million), and it represented a rise of 23 per cent (from $387-million) at the same point in 2015.

"From an industry standpoint, we believe toy stocks and the toy industry can perform well in any economic environment, and still have confidence in a 3-4-per-cent growth rate for the U.S. industry in 2016, its third consecutive year of strong growth," said Mr. Johnson. "But in a post-Trump world, the market has seen a shift out of defensive, divided-paying stocks (toy and video games) to more stocks of cyclical and economically sensitive industries (powersports, leisure). Should this market trend persist, it may put more pressure on the company for earnings growth with contracting of industry multiples

Mr. Johnson kept his $34 target price for shares. Consensus is $41.39.

"We are confident in TOY's ability to achieve top-line growth and gain market share through its consistent creativity, use of entertainment licensors, and solid execution," he said. "Furthermore, TOY has the potential to expand margins from scale and efficiency gains and development of international presence. However, we believe shares are currently fairly valued."

"We recommend holding shares and waiting for better opportunities to accumulate more."

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Following a site visit to its Oyu Tolgoi mine in Mongolia, Canaccord Genuity analyst Dalton Baretto raised his rating for Turquoise Hill Resources Ltd. (TRQ-T, TRQ-Q).

"We were very impressed by the asset, and have had a chance to better understand the country, the improving political situation, and the people who make up the bulk of the workforce," said Mr. Baretto, who upgraded the stock to "buy" from "hold."

Explaining the "country risk [is] significantly improving," he added: "We believe the geopolitical risk surrounding the asset has significantly improved due to the clarification of the conflicting interpretations in the ARSHA [amended and restated shareholders' agreement], the involvement of international lenders following the draw-down of project financing, the evolution of the political structure (particularly the Mongolian Democratic Party) and the renewed commitment to foreign investment, natural resource development, economic diversification, job creation and education. The previous practice of promising cash handouts as part of the electoral platform has been outlawed."

Mr. Baretto said underground development at the facility is on track for mid-2020, but he noted management said the schedule, for both development and ramp-up, is conservative. He also said he believes elements of the $5.1-billion capex budget "that have limited transparency contain significant contingencies."

"Given the incremental disclosure regarding the expansion scenario(s) in the 2016 technical report as well as our recent site visit to the (very impressive) asset, we are now comfortable in modelling in a 25-per-cent expansion scenario on the Reserve base (a scenario we now feel is highly probable)," the analyst said.

He raised his target price for the stock to $6.25 from $4.50. Consensus is $5.43.

"Despite the increase to our NAV, our valuation may as yet be viewed as conservative," he noted.

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In reaction to an "upgraded" growth outlook, CIBC World Markets analyst Paul Holden raised his rating for Onex Corp. (ONEX-T) to "sector outperformer" from "sector performer."

On Friday, the Toronto-based company reported third-quarter net asset value of $57.37 per share, up 3 per cent from the previous quarter and 5 per cent year over year.

Mr. Holden noted NAV growth has failed to reach management's 15-per-cent goal for the past two years, but he said there are reasons for optimism going forward.

"First off, the company has been able to deploy a good amount of capital this year," he said. "Four private equity investments have been made/announced since August this year, three of which have closed. Pro forma the closing of those three transactions, cash has been reduced to 25 per cent of total capital. The last time cash represented 25 per cent or less of capital was Q3/13. Cash should be less of a drag on NAV growth going forward. Second, we think that the maturity of investments suggests that the company could be approaching a disposition cycle. We would typically expect Onex to hold an investment for 4-5 years. By the end of 2017, eight of Onex's operating companies would have been made more than four years ago ... Dispositions could accelerate late 2017 and into 2018.

"Third, we believe that the implied value of Onex's private investments have increased materially following the U.S. election results. Onex is predominately a portfolio of levered equity investments where the cost of leverage has not changed (94 per cent of financing is locked in through end of 2018) and underlying equity value has increased as implied by the S&P 500. The value of a levered portfolio of U.S. companies has gone up while the stock has not."

Mr. Holden raised his target for the stock to $100 from $81 to reflect higher growth projections, a strong greenback and the company's current price-to-NAV multiple. Consensus is $85.70.

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Questerre Energy Corp. (QEC-T) remains the best way to gain meaningful exposure to the Utica Shale in Quebec, said Canaccord Genuity analyst Sam Roach, who called the company's rise in share price "understandable."

The company, based in Calgary, holds a 25-per-cent working interest in Utica prospective lands, about 1 million acres, in the St. Lawrence region.

"QEC shares tripled after the Quebec Government gave the initial nod to oil and gas development in the province [in mid-October]," he said. "With an improved valuation in the stock, Questerre tapped the equity market, issuing 15 million shares for proceeds of [approximately] $7-million to fund ongoing development in the Montney. At current trading levels, we estimate QEC is pricing in 15 cents per share for the Quebec Utica."

"However, there remains a number of significant milestones before development can begin. First, the Quebec Government has to pass Bill 106, then the regulatory body needs to provide framework for development practices and after that JV partner and operator Repsol would make the final call on investment."

Though he raised his target price for the stock to 40 cents from 30 cents to reflect "a heavily risked valuation for Quebec," Mr. Roach downgraded his rating to "sell from "hold" given a negative implied return. The analyst consensus is 30 cents.

"We believe there is deep value in Questerre's Quebec assets. Based on an aggressive development schedule, we estimate the unrisked value for Questerre's 25-per-cent working interest in 1.0 million acres of land could be north of $280-million (about $1.00 per share)," the analyst said. "Going forward, we expect further steps toward firm oil and gas regulatory framework in Quebec and any indication of a development plan from Repsol could provide catalysts for the stock, but we are cautious that QEC is pricing in significant value for Quebec at this stage."

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Citing a "Trump Bump," Citi analyst Paul Lejuex said it's time to get more bullish on U.S. specialty retail and department stores.

"We cannot ignore the likelihood that tax reform (both personal and corporate) provides a bump that many of our retailers need," said Mr. Lejuex. "Whether on the right side of the Trump win or not, with tax reform consumers are likely to find more money in their pockets (creating a rising tide)."

He upgraded the following stocks to "buy" from "neutral" to reflect his more optimistic view:

Boot Barn Holdings Inc. (BOOT-N) with a target of $19 from $12. Consensus is $13.60.
Chico's FAS Inc. (CHS-N) with a target of $16 from $13. Consensus is $13.47.
L Brands Inc. (LB-N) with a target of $84 from $74. Consensus is $74.
Kohls Corp. (KSS-N) with a target of $64 from $50. Consensus is $51.

"The one thing that really stands out to us in the bull case for our group (that we keep coming back to as we think about both the bull and bear case) is the likelihood of tax cuts," he said. "Obviously we don't know for sure what we will happen, and there is substantial uncertainty about the magnitude of the cuts, but judging by comments made during the campaign and Trump's desire to spur growth, we believe chances are high we see some tax cuts. We strongly suggest reading the mote by Citi's Specialty Pharmaceuticals Analyst Liav Abraham titled "Trump and Taxes: Comprehensive US Corporate Tax Reform Around the Corner," which describes (based on due diligence with tax experts) that 'Comprehensive US tax reform Is likely around the corner. Much of the groundwork has already been laid by the house Ways and Means Committee.' Much of the focus is on corporate tax relief but personal cuts are mentioned as well. If Trump in fact follows through, it would be the first large tax cut since the Bush tax cuts of 2001 and 2003. And we believe most everyone will benefit."

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In other analyst actions:

Rogers Communications Inc. (RCI.B-T) was raised to "action list buy" from "buy" by TD Securities analyst Vince Valentini with a $62 target (unchanged). The analyst average is $57.75, according to Bloomberg.

Parkland Fuel Corp. (PKI-T) was upgraded to "outperform" from "sector perform" by Alta Corp analyst Dirk Lever with a target of $32.50 (unchanged). The average is $32.03.

Semafo Inc. (SMF-T) was raised to "buy" from "hold" by Laurentian Bank Securities analyst Pierre Vaillancourt with a target price of $6.50, down from $7.25. The average is $7.32.

Constellation Software Inc. (CSU-T) was cut to "sector perform" from "sector outperform" by Scotia analyst Paul Steep with a target of $630 (unchanged). The average is $603.50.

Canadian Energy Services & Technology Corp. (CEU-T) was raised to "Hold" from "Sell" at Industrial Alliance by analyst Elias Foscolos. His target price rose to $6 from $4, compared to the average of $7.40.

Just Energy Group Inc. (JE-T) was rated a new "buy" at Canaccord Genuity by equity analyst Raveel Afzaal with a $9.50 target. The average is $10.03.