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Monday’s analyst upgrades and downgrades

An Apple iPhone 7 in Bordeaux, France, February 1, 2017.


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

The federal government's proposed legislation to legalize marijuana represents "modest de-risking event," said Canaccord Genuity analyst Neil Maruoka.

In a research report on the Canadian cannabis industry, Mr. Maruoka said the draft bill "fit largely" within the parameters of his expectations and contained "no significant downside surprises." Accordingly, he increased the probability of the recreational market becoming legalized in his valuation models.

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"While we view this to be a watershed moment for the industry, we were not surprised that stocks sold off broadly given the lack of details provided on important issues like distribution and product offerings," he said. "On the whole, many of the factors and considerations included in the bill were largely in line with our expectations, with an overarching emphasis on restricting access to youth, while limiting the influence of organized crime and ensuring profits do not flow to illicit markets. As the debate over this legislation progresses, we believe there could be a lack of macro or industry catalysts in the coming months, and we would therefore recommend investors look for companies with differentiated strategies and stock-specific catalysts.

"Because the broad strokes of the legislation were generally in line with our expectations, we have made only small changes to our valuations for cannabis stocks in our coverage universe. We have increased our expected probability of a legal rec market from 75 per cent to 80 per cent in all our models, resulting in target price increases for most stocks except WEED [Canopy Growth Corp.], which we believe could see greater headwinds to its industry-leading brand strategy; we have therefore increased our recreational WACC [weighted average cost of capital] for WEED from 16 per cent to 18 per cent (bringing this in line with peers)."

Mr. Maruoka lowered his target price for Canopy Growth Corp. (WEED-T) to $11.50 from $12 with a "hold" rating (unchanged). The analyst consensus price target is $14.05.

"Canopy has one of the most comprehensive branding strategies amongst Canadian LPs; however, because regulations around marketing and branding could be restrictive in the proposed regulated framework, we have removed the 2-per-cent discount previously applied to Canopy's recreational WACC (versus its peers)," he said. "We believe it is uncertain how much Canopy will be able to leverage its brands given the restrictions in the proposed legislation. We have also included the cash and 2.5 million shares from Canopy's recent $24.3-million private placement financing, which is modestly dilutive to our target price. The higher recreational market discount rate of 18 per cent more than offsets the small valuation increase stemming from the higher probability of the recreational market coming on line."

Mr. Maruoka raised his target price for the following stocks:

- Aphria Inc. (APH-T, "hold") to $7 from $6.50. Consensus: $7.30.

"We have updated our [net present value] analysis to incorporate an 80-per-cent likelihood (increased from 75 per cent) of recreational legalization," he said. "In addition, following Aphria's Q3 results, we have included modest incremental upside from the company's recently announced minority investment in Florida based dispensary Chestnut Hill Tree Farm."

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- OrganiGram Holdings Inc. (OGI-X, "speculative buy") to $3.40 from $3.25. Consensus: $3.99.

- Supreme Pharmaceuticals Inc. (SL-CN, "speculative buy") to $2.25 from $2.15. Consensus: $2.28.

- Emblem Corp. (EMC-X, "speculative buy") to $3.80 from $3.75. Consensus: $4.15.

"Because the medical opportunity largely underpins our valuation for Emblem, changes to our recreational assumptions therefore have a limited impact on our overall valuation for the company," he said.


Yangarra Resources Ltd. (YGR-T) is "pushing the Cardium to its limits," according to Canaccord Genuity analyst Sam Roach.

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He initiated coverage of the Calgary-based exploration focused oil and natural gas company with a "speculative buy" rating.

"Yangarra pushed the envelope of efficiency gains in the Cardium this past winter, when it drilled 10 extended-reach horizontal wells, some with over 100 frac stages," said Mr. Roach. "Initial rates from six of the 10 wells have been announced, with five of six exceeding type curves by a wide margin. Four of the first six wells made the top-10 list in 2016, alongside Whitecap and PennWest. IP rates from the remaining four wells are expected in May, potentially providing further tailwinds for the stock."

Touting its "outsized" drilling inventory, Mr. Roach said Yangarra's "significant" land position supports its growth targets, and may also prove attractive to potential acquirers.

"At Willesden Green Yangarra holds 108 gross (78 net) sections of Cardium rights, with an average working interest of 72 per cent," he said. "Management believes it has a drilling inventory of [approximately] 700 gross (472 net) one-mile Cardium horizontal wells, which is more than 10 years of inventory at the current pace of drilling."

"Yangarra plans to drill 15 extended-reach horizontal Cardium wells and spend a total of $50-million in 2017. The company forecasts average Q4/17 production of up to 5,500 barrels of oil equivalent per day (versus Q4/16 production of 3,200 boe/d), implying greater-than 60-per-cent per share growth this year, while spending 105 per cent of cash flow. We think Yangarra should meet guidance provided Cardium results continue to impress and oil prices hold above $45/bbl."

Mr. Roach noted Yangarra currently trades at 5.3 times its 2018 estimated enterprise value to debt-adjusted cash flow, which is a premium to its small-cap peers. He said it is warranted based on the company's peer-leading growth, however he is "cautious that multiple compression is possible."

He set a target price for the stock of $4. Consensus is $3.89.

"Yangarra caught investors' attention by posting some impressive Cardium results and forecasting peer-leading growth in 2017," said Mr. Roach. "We are confident the company can deliver on its stated growth targets, but we see risk in the stock due to increasing decline rates and possible multiple compression, thus the Speculative qualifier in our rating."


Ahead of the scheduled release of its quarterly financial results on May 2, RBC Dominion Securities analyst Amit Daryanani raised his target price for Apple Inc. (AAPL-Q) to reflect improved iPhone expectations.

"We think iPhone units have been stable to modestly better than expected and mix continues to remain positive (more 'plus' models)," said Mr. Daryanani. "The wild card into the print will be gross margin, where we see two dynamics: better mix from iPhones offset by higher commodity costs (NAND, DRAM [dynamic random-access memory)."

"Fundamentally, we remain positive on AAPL based on: 1) iPhone 8 cycle tailwinds; 2) capital allocation increase and repatriation benefits; 3) services growth/acceleration; and 4) potential upside from Trump-onomics (taxes, cash repatriation)."

He increased his second-quarter revenue and EPS estimates to $53.5-billion (U.S.) and $2.04, respectively, from $52.6-billion and $1.99. The Street's expectations are $52.9-billion and $2.02.

For the third quarter, his projections rose to $45.8-billion and $1.63 from $44.5-billion and $1.59, versus the consensus of $45.6-billion and $1.62. His full-year 2017 estimates are now $228.1-billion and $8.95 from $226-billion and $8.85. The consensus sit at $228.5-billion and $8.94.

He pointed to six items for investors to focus on from the quarterly report: "1) iPhone: Investors will focus on units, ASP, and sales mix during the quarter. 2) Gross margins: Puts and takes from mix shift toward the flagship iPhone 7 device, 7+ mix, services growth, and NAND pricing. 3) Capital allocation program: Increase in the company's share buyback program and dividend. 4) Services mix: Contribution of services to total revenues and any data points on revenue/profitability of Apple Music, AppStore, and ApplePay. 5) iPhone 8: Any comments regarding iPhone 8 timing or features. 6) OPEX dynamics: How opex will trend vs. revenue trajectory; opex has been trending as a higher percentage of revenue in recent years."

With an "outperform" rating (unchanged), his target rose to $157 (U.S.) from $155. Consensus is $147.03.

"We believe AAPL's current stock price creates an attractive entry point for investors to benefit from its ability to return to revenue and EPS growth in FY17," he said. "We believe multiple catalysts remain as the company benefits from: (1) iPhone ramps; (2) Mac/iPad refresh cycle; (3) potential iTV launch or other major product lines; and (4) improvements in capital allocation policy. We believe the fundamental reality remains that AAPL's valuation is materially sub-par to what we anticipate is its long-term revenue and EPS potential."

"We believe AAPL's true differentiation is its unique computing ecosystem: iOS. iOS provides users with an integrated, scalable, and seamless experience across multiple devices, which we believe will be difficult for competitors to replicate in scale. Simplistically, the scale of users attracts application developers, which in turn bolsters the number of users. We believe this cycle results in a captive consumer base that transitions more data and usage via iOS on Apple device."


Adopting a more cautious view on its growth and level of acquisitions going forward, AutoCanada Inc. (ACQ-T) was cut to "hold" from "buy" by Accountability Research analyst Harriet Li.

"While we continue to believe that the company is uniquely positioned to take advantage of consolidation opportunities in the Canadian auto dealer market, recent acquisitions have not kept pace with the company's growth over the last couple of years and has fallen short of our expectations," she said. "Moreover, AutoCanada's concentration of dealerships located in the troubled Alberta market will continue to weigh on the company's performance this year. Lastly, it remains to be seen whether the current senior management team can replicate Pat Priestner's success in growing the company following his retirement."

Citing continued weakness in Alberta auto sales, Ms. Li lowered our 2017 earnings estimate to $1.67 per share from $1.97. She introduced her 2018 projection of $2.00 per share based on an improved outlook in the province.

Ms. Li's target for the stock declined to $25 from $27. The average is $24.22.


A potential partnership with Glasgow's city council could prove to be a catalyst for stock of CGI Group Inc. (GIB.A-T, GIB-N), said Raymond James analyst Steven Li.

Ahead of the release of its second-quarter financial results, scheduled for May 2, Mr. Li noted the Montreal-based company's shares have underperformed peers recently. He suggested either a strong quarterly report or movement toward a deal to work with the Scottish city on the privatization of its IT services could bring a bounce.

"Last Thursday, the Herald Scotland reported that a report is to go before councilors at Glasgow City Council (GCC) this week recommending a partnership with CGI," he said. "Recall this has been controversial as Serco (incumbent) in February announced that it would take legal action to prevent Glasgow from pursuing this contract with CGI. The privatization of the Scottish councils' IT services is a very large opportunity for CGI, and all organic. Importantly, if CGI can win the Glasgow contract, they will have the No. 1 and No. 2 (Edinburgh) largest councils on board which makes it more likely other Scottish councils and public sector bodies will also join CGI's contract vehicle. Stay tuned."

Mr. Li is projected quarterly revenue and earnings per share of $2.76-billion and 93 cents, respectively, which is in line with the consensus of $2.74-billion and 93 cents. He cited foreign exchange as a 6-per-cent headwind for the quarter, weighing on both revenue and EPS.

He has an "outperform" rating and $72 target. Consensus is $71.64.

"With a strong FX headwind this 2Q, we are not looking for any headline heroics (inline rev/eps more than satisfactory)," the analyst said. "We are expecting another strong organic growth/cash flow quarter. We also just picked up some potentially positive developments in Glasgow. Longer term, we expect CGI to astutely redeploy its strong cash flow (growth, M&A, buyback) which should maintain a strong EPS growth outlook (last 5-yr EPS CAGR [compound annual growth rate] 21 per cent, last 10-yr EPS CAGR 21 per cent)."


Citing an unfavorable risk-reward following the U.S. Food and Drug Administration rejection of its drug to treat rheumatoid arthritis, BMO Nesbitt Burns analyst Alex Arfaei downgraded his rating for Eli Lilly and Co. (LLY-N).

On Friday, the Indianapolis-based pharmaceutical giant said the FDA ruled it need additional clinical data to "determine the most appropriate doses" for its baricitinib drug.

"Bari's CRL [complete response letter] is a surprising, and significant setback," said Mr. Arfaei. "In the U.S., Bari's launch will now be 7-8 years behind Pfizer Inc.'s Xeljanz, and much closer to biosimilars. We are pushing back our Bari U.S. RA launch from mid-2017 to 2020, and lowering our global sales forecast from $2.2-billion in 2027 to $1.6-billion.

"Despite the Bari setback, we are at the top end of Lilly's 2017 guidance primarily because of higher expectations for Trulicity. In 2017, we forecast 5-per-cent revenue growth as Lilly's growth drivers (e.g. Trulicity, Taltz, Jardiance, and Basaglar) should offset the decline of mature franchises. However, from 2015-2020, we forecast revenue CAGR of 4 per cent, below Lilly's guidance of 5 per cent partly because of more conservative assumptions for the mature franchises (e.g. Humalog)."

He added: "Although, we currently do not know the specific issues that led to this CRL, our understanding is that the CRL is because of a new issue, and seemingly unrelated to the prior three-month delay in Bari's PDUFA. Overall, we highly doubt that the stated FDA concerns could be addressed without new clinical trials; therefore, we believe the timing for Bari's U.S. RA launch is most likely pushed back at least three years. Moreover, we believe this news is incrementally positive for Pfizer given its leadership in the JAK market with Xeljanz, and AbbVie given its overall market leadership with Humira, which was going to be challenged by Bari's positive head to head study (RA BEAM). However, we believe that this news will likely increase uncertainty associated with other JAK-1s in development (e.g. AbbVie's ABT-494). We believe that the FDA may be taking a more conservative approach for new treatments in this class because the unmet need may not be as great given the number of treatment options available."

Moving the stock to "underperform" from "market perform," Mr. Arafaei also lowered his target price to $71 (U.S.) from $73. The analyst average is $81.24, according to Bloomberg.

"The major setback with Bari in the U.S., coupled with ongoing headwinds for the mature franchises (e.g. Humalog), and our cautious views on Abemaciclib, make the risk/reward in LLY shares unfavorable here," he said. "Despite solid growth from Trulicity and Taltz, we remain below Lilly's 2015-2020 revenue growth guidance of 5 per cent. We believe the Abema data at ASCO [American Society of Clinical Oncology] is more likely to disappoint. Thus, we expect multiple contraction and are downgrading LLY to Underperform. Finally, although we expect a light 1Q17, Lilly should still finish 2017 at the top-end of its guidance."

Elsewhere, Morgan Stanley analyst David Risinger dropped the stock to "equal-weight" from "overweight" with a target of $82 (unchanged).


Credit Suisse analyst Stephen Ju raised his target price for shares of Inc. (AMZN-Q) in reaction to the online retailer's annual release of its balance sheet.

"Although our operating profit estimates for 2Q17 & 3Q17 decrease as we take into account Amazon's ongoing investments into content, fulfillment centers, and data centers, the strategic and product-driven rationale behind these should already be well-familiar to investors," said Mr. Ju. "As far as we are concerned, this push to invest serves as positive demand indicators across its consumer and enterprise-facing businesses. As we have previously called out, we believe that Amazon will report a second derivative change in its operating margin, i.e. the amount of margin compression as implied in the 2Q17 guidance will start to abate as it has established a pattern of investing (in either fulfillment centers or data centers) and growing into the larger infrastructure. We maintain our Outperform rating and our updated investment thesis for AMZN shares is predicated on the following longer-term factors 1) re-establishment of e-commerce segment operating margin expansion as Amazon grows into its larger infrastructure, 2) ongoing margin benefit due to shipping loss moderation, and 3) upward bias to AWS revenue forecasts and likely more moderate deceleration path as suggested by ongoing capital intensity in the business."

Mr. Ju lowered his 2017 earnings per share projection to $11.30 (U.S.) from $12.08. His 2018 estimated decline to $15.97 from $16.39, while his 2019 expectation fell to $22.47 from $22.58.

"Looking nearer-term, the quarterly key metrics for Amazon are growth in North American and International Media, electronics and other general merchandise (EGM), as well as AWS revenue, FX-neutral growth rates, as well as core e-commerce gross profit dollars as well as CSOI [consolidated segment operating profit]," he said.

Mr. Ju maintained an "outperform" rating for the stock, raising his target to $1050 from $900. Consensus is $966.95.

He said: "Our long-term investment thesis for AMZN shares remain the following:  re-establishment of e-commerce segment operating margin expansion as Amazon grows into its larger infrastructure; ongoing margin benefit due to shipping loss moderation and upward bias to AWS revenue forecasts and likely more moderate deceleration path as suggested by ongoing capital intensity in the business."


In other analyst actions:

Cormark Securities Inc. analyst David McFadgen downgraded Transcontinental Inc. (TCL.A-T) to "market perform" from "buy" with a target of $25. The analyst average target is $23.75, according to Bloomberg.

Monness, Crespi, Hardt & Co analyst Chris Shaw upgraded Methanex Corp. (MX-T, MEOH-Q) to "buy" from "neutral" with a target of $89.05. The consensus is $74.62.

Axiom Capital analyst Gordon Johnson initiated coverage of Canadian Solar Inc. (CSIQ-Q) with a "buy" rating and $18 (U.S.) target. The average is $15.31.

Atico Mining Corp. (ATY-X) was raised to "buy" from "hold" at M Partners by analyst Stuart McDougall. He raised his target to $1 from 90 cents. The average is $1.10.

North West Co Inc. (NWC-T) was downgraded to "hold" from "buy" at Industrial Alliance by analyst Neil Linsdell. He maintained a $32.50 target, while the average is $31.29.

Industrial Alliance analyst Jeremy Rosenfield downgraded Boralex Inc. (BLX-T) to "buy" from "strong buy" with a $24 target. The average is $24.11.

Mr. Rosenfield downgraded Canadian Utilities Ltd. (CU-T) to "hold" from "buy" with a target of $41.  The average is $41.63.

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Globe Investor Content Editor

David Leeder is a content editor in the Report on Business. He was previously Deputy Sports Editor and Weekend Digital Editor at The Globe.  He holds an undergraduate degree from McMaster University and a graduate degree from Ryerson University. More


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