Monday's analyst upgrades and downgrades

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

Though long-term growth is likely to remain a challenge, Fairfax Financial Holdings Ltd. (FFH-T) is likely to see "solid" gains in the near term, according to CIBC World Markets analyst Paul Holden.

Citing a recent pullback in share price and "expected" investment gains in both the second and third quarters, Mr. Holden upgraded his rating for the Toronto-based holding company to "neutral" from "underperformer."

"Fairfax has sold off approximately 7 per cent since it reported Q1 results (April 28) despite what looks to be a solid quarter for investment gains," he said. "We believe this is primarily due to the depreciation in the USD versus the CAD of 8 per cent (Fairfax reports in USD and primarily holds USD assets). Flow back from the closing of the Allied World transaction would have also put some downward pressure on the stock (4.8 million shares were issued). Pro forma estimated Q2 investment gains, ICICI Lombard gains, closing of the Allied World acquisition and updating for the spot USD/CAD, the stock is trading at 1.1x P/BV [price to book value], down from 1.3 times as of April 28 and versus its 5-year trailing average of 1.2 times. The valuation multiple has dropped back down into a range that we think is more appropriate."

Previewing the release of its second-quarter financial results, scheduled for an Aug. 3 release, Mr. Holden said he expects a "solid" performance from Fairfax's investment portfolio, calling it a "good" quarter for both stocks and bonds.

"We estimate total investment gains in Q2 of $183-million (pre-tax) with nearly a 50/50 split between bonds and equities. The fixed income portfolio benefited from a modest decrease in sovereign bond yields (yield on the 10- year U.S. Treasury declined by 8 basis points quarter over quarter) and a modest tightening in corporate spreads. We estimate a gain of $105MM on Fairfax's fixed-income portfolio. We forecast a gain of $96-million on the common equity portfolio including a gain on sale from Tembec shares. We assume a small loss of $7-million on CPI-linked derivatives as inflation expectations saw a modest increase over the second quarter. Our estimate for Q2 ending BVPS [book value per share] is $369, up 2 per cent quarter over quarter but down 9 per cent year over year. We expect a more significant gain in Q3 due to transactions that have already taken place, but that will still leave BVPS short of where it was a year ago. Our thesis for modest BVPS growth over time has not changed."

He added: "We assume a Q2 combined ratio of 95 per cent, down modestly from 96 per cent in Q2 last year on lower projected cat losses. However, continued pricing pressure, as indicated by July reinsurance renewals, will pressure the combined ratio over time. We continue to expect an upward trend in the combined ratio through 2018, excluding the Allied World acquisition that closed in July. While the acquisition of Allied World improves the mix of business, and should have an associated benefit to Fairfax's trading multiple, we just don't see Fairfax as an underwriting story. Underwriting leverage is relatively low (as a consequence of soft pricing), and after including corporate expenses, runoff and minority interest, there isn't much underwriting income left. Fairfax remains an investment story and with a 40-per-cent allocation to cash, it's hard to envision excess returns. We expect BV growth to remain muted, consistent with what we have seen since the end of 2009."

Mr. Holden kept a price target of $600 for the stock. Consensus is currently $673.77, according to Thomson Reuters data.

"We estimate a pro forma P/BV of 1.1 times, which we think is a more appropriate valuation multiple given the muted growth outlook," he said. "We are expecting low-single digit BV growth over time and need to see a path to something higher before becoming more positive on the name."

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Raymond James analyst Chris Cox believes Encana Corp.'s (ECA-N, ECA-T) strong 2017 results support an improved outlook for its fortunes in 2018.

On July 21, the Calgary-based company reported second-quarter cash flow per share of 36 cents (U.S.), exceeding the 26-cent projection of both Mr. Cox and the Street.

"Following on the upward revision to the Permian type curves announced a month ago, Encana also made upward revisions to its Montney and Eagle Ford type curves, reflecting the impact of the enhanced completions approaches that have been applied over the past few quarters," he said. "This led to a 25-per-cent and 45-per-cent increase in IP180 rates, respectively, along with upward revisions to the premium return inventory count in both plays. Furthermore, with strong operational execution visible across the Core 4 portfolio, the company announced an upward revision to guidance, with full-year production now expected at 310–320,000 barrels of oil equivalent per day (boe/d), exit guidance for the Core 4 portfolio now sitting at 25–30 per cent (vs. greater-than 20 per cent previously) and with no change to overall spending guidance."

Mr. Cox said the company's improving operating efficiencies "bode well" for its 2018, adding: "Importantly, the strong operational execution visible through the first half of the year points to improved capital efficiencies across the business – a critical factor in assessing the ability of the company to self-fund a meaningful growth program next year under strip pricing. With the improvements announce to-date, we now believe the company can deliver on its previously announced 5-year growth program under strip pricing, funded entirely from cash flow from 2018 onwards."

In response to the results, Mr. Cox raised his full-year 2017 EBITDA and revenue projections to $1.429-billion and $4.242-billion, respectively, from $1.342-billion and $4.158-billion. His estimates for fiscal 2018 jumped to $2.136-billion and $4.678-billion from $1.94-billion and $4.451-billion.

Maintaining a "strong buy" rating for the stock, his target price jumped by a dollar to $15 (U.S.). The analyst consensus price target is $12.88.

"We continue to see Encana as a name with a differentiated growth outlook, driven by one of the deepest and highest-quality inventory positions among North American E&Ps, and with an attractive margin expansion story bolstering a robust cash flow growth profile," said Mr. Cox. "With the recent sale of Piceance further focusing the story on the Core 4 portfolio, and with the leverage profile now looking more in-line with its peer group (even under strip pricing), we now believe there are very few credible holes that can be poked in the Encana story. The company continues to demonstrate strong operational execution across its core assets, which should position the company to deliver on the robust 5-year growth program announced at its Investor Day last fall, even under the current commodity price environment."

Elsewhere, RBC Dominion Securities analyst Greg Pardy raised his target to $13 (U.S.) from $12 with an "outperform" rating (unchanged).

Mr. Pardy said: "Our bullish stance toward Encana Corporation was reinforced by its second-quarter results, which trumped our expectations amid wider upstream margins. Eagle Ford production was well above our estimate, but what stood out most was Encana's corporate margin (cash flow per boe), which advanced 25 per cent in the second quarter to $12/boe (despite WTI prices which retreated 7 per cent)."

TD Securities' Menno Hulshof raised his target to $12.50 (U.S.) from $11.50, keeping his "buy" rating.

"While ECA posted a material Q2 CFPS beat, the real story was several positive 2017 guidance revisions with no change to capex," said Mr. Hulshof. "It now also believes it can grow Q4/16- Q4/17 core four production by 25-30 per cent (greater-than 20 per cent previously). We upgraded ECA to BUY in late June. With higher cash flow estimates, our target price increase."

Macquarie analyst Brian Bagnell bumped his target to $10.50 from $9.50 with a "neutral" rating.

"We downgraded Encana to Neutral (from Outperform) in June following changes to our commodity price forecasts, which saw our 2018 WTI estimate fall to US$46/bbl (from US$52.50/bbl)," said Mr. Bagnell. "That led us to reduce our growth forecasts below company guidance, which was based on a flat US$55/bbl WTI forecast and no cost inflation. The company has since reduced its expected breakeven to $50/bbl from efficiency and netback improvements. Overall, Encana is showing some encouraging positive momentum, and we are incrementally more positive on the stock following 2Q17 results. Although we remain Neutral-rated, we are fairly comfortable with the company's improving risk profile; it is one of our preferred names within the Canadian Large Cap space."

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In reaction to a 7-per-cent slide in its share price last week "on no news," Industrial Alliance Securities analyst Elias Foscolos upgraded Computer Modelling Group Ltd. (CMG-T) to "buy" from "hold."

"Ahead of the Q1/F18 earnings expected in the next three weeks, we have elected to maintain our short-term financial projections and longer-term outlook," he said. "However, we have elected to take advantage of the weak share price and increase our rating. Therefore, our $10.50 target remains unchanged. Based on the latest closing price, CMG's stock price now represents a potential 15-per-cent one-year return (including dividends), which precipitates an upgrade in our rating."

The analyst consensus price target is $9.81.

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Blue Apron Holdings Inc.'s (APRN-N) new product and service initiates are likely to enhance its "consumer value proposition," leading to accelerated growth and a multiple-re-rating, according to RBC Dominion Securities analyst Mark Mahaney.

He initiated coverage of the New York-based meal kit delivery company, which began trading on June 29, with an "outperform" rating.

According to Bloomberg, 12 analysts initiated coverage of the stock on Monday. Seven analysts gave it buy ratings and four others pegged it a hold.

Only Northcoast Research's Charles Cerankosky called it a "sell," giving it a price target of $2 (U.S.) per share.

"Meal kits have yet to make a significant dent in the U.S. Food Retail market, but we believe they can offer distinct benefits – convenience, all-in cost, and meal variety," said Mr. Mahaney. "APRN's core subscription model allows consumers to choose from either a 2-person or Family plan with per unit meal prices ranging from $9-$10. APRN is in the midst of expanding its offering to enhance flexibility – different price points, more delivery options and more recipe choices. In our view, the success of this effort is key to whether APRN can re-accelerate growth – recent material growth deceleration & rising competitive risks are the biggest investor concerns."

Mr. Mahaney believes Blue Apron has a large market opportunity, believing it addresses a "large" multibillion-dollar market that is primarily offline and takes spending away from both grocers and restaurants.

"According to the company, total spend in the U.S. Retail Grocery and Restaurant market is $1.3-trillion, with collective Online sales accounting for $20-billion-plus+, or 2 per cent," the analyst said. "In our view, the bigger opportunity for Blue Apron is in Grocery. U.S. Grocery is $240-billion larger than Restaurants ($782-billion vs. $543-billion) while online spend is $2-billion less ($10-billion vs. $12-billion). To date, meal kits have not made a significant dent – we believe the percentage of U.S. Internet users who currently subscribe to a meal-kit service is likely in the low single digit  percentage. But we believe meal kits offer distinct benefits to consumers in terms of convenience, flexibility, cost and variety over traditional Food Retail options. We believe the market opportunity for Blue Apron is a sub-segment of each of the two markets and online penetration can grow from current levels."

Mr. Mahaney believes the company can take advantage of a "strong" leadership position in the untapped market and presents an "attractive" value proposition to consumers. He also highlighted its "intrinsically attractive" high-growth subscription business model.

"Over the last several years, Blue Apron's subscription model has delivered triple-digit growth. Revenue grew 338 per cent in 2015 and 133 per cent in 2016," he said. "In 2015 and 2016, substantially all of Blue Apron's net revenue growth was driven by new customers after the company introduced its Family Plan in Q1:15 and opened its fulfillment center in Arlington, Texas in Q3:15. In Q1:17, revenue grew 42 per cent and we expect growth for the remainder of 2017 to be materially impacted by the timing of the new fulfillment center in Linden, NJ and the successful rollout of Blue Apron's planned product expansion (scheduled Q3-Q4:17). For the year, we are modeling 27-per-cent year-over-year revenue growth. In 2018, we believe the company can re-accelerate revenue and deliver topline growth of 30-per-cent-plus driven by the expanded product offering, Blue Apron's leadership position in the market and the secular trend of the U.S. grocery industry moving online. We are modeling growth to remain greater-than 20 per cent through 2020. Over the long term, we believe the ultimate success of the model will be determined by management's ability to enhance the product offering by consistently improving the convenience, selection and value."

Mr. Mahaney set a price target of $10 (U.S.) for Blue Apron shares. The analyst average price target is $9.28, according to Bloomberg data.

Elsewhere, Canaccord Genuity analyst Michael Graham gave the stock a "buy" rating and $14 (U.S.) target.

"Blue Apron's value proposition resonates with over one million active customers (including your author), despite a reasonably limited product offering to date," he said. "That said, competitive moves from Amazon and investor concerns around customer retention have put significant pressure on the stock both before and after IPO pricing, and we believe this has created a bargain opportunity. We believe APRN's customer unit economics are quite healthy, and we look forward to an upcoming product expansion that should further strengthen the model through increased customer engagement. We also believe that APRN can co-exist with Amazon in this space, and that our estimates are likely to prove conservative. Therefore we suspect the stock can fairly easily recover from current levels."

Citi analyst Mark May initiated coverage with a "buy" rating and $10 target.

Mr. May said: "Countless industries have been impacted by the internet. But, after 20 yrs and numerous attempts, internet penetration of the food/grocery market remains at low single-digits. While internet penetration may never approach other categories, Blue Apron has emerged as the market leader in the meal-kit segment, which is estimated to be a $2.5-billion market in the U.S. today and growing greater-than 25 per cent per annum in a greater-than $45-billion TAM. While competition could remain fierce near term (and Amazon appears to be a new legitimate threat), like other internet categories, we believe the online meal-kit market will produce 1-2 companies that scale to $3-billion-plus in combined revenue over the next 10 years with operating margins potentially reaching 5-10 per cent. Assuming Blue Apron is one of those winners and near term execution is solid, the stock could reach $10 per share over the next year. That said, the typical risks associated with early stage companies and industries (required investments, dynamic competitive landscape, uneven execution, etc.) could result in volatility."

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Hydropothecary Corp.'s (THCX-X) reduced valuation compared to its industry peers is due largely the detection of trace amounts of a fungicide in a portion of its cannabis in early May, according to Canaccord Genuity analyst Matt Bottomley.

He believes the discovery of myclobutanil, which is not approved for use by Health Canada, is a temporary obstacle for the Gatineau, Que.-based medical marijuana company.

Adding it's "primed for a valuation re-rating," the analyst initiated coverage of the stock with a "speculative buy" rating.

"In our view, this issue is transient in nature, was at a lower concentration level than other industry contaminations, and has been adequately dealt with by management; however, the company still trades at a 58-per-cent discount to its 2017 highs compared to peers at (30 per cent)," said Mr. Bottomley. "As a result, we would be buyers of Hydropothecary at current levels as we believe the company's premium branding strategy and low-cost production should justify a multiple that is more in line with peers as the recent contamination issue is put further in the rear-view mirror while the company executes on a greenhouse expansion that we estimate could bring its total capacity to 25,000 kilograms by the end of 2018."

Mr. Bottomley is impressed by the company's "premium brand" strategy, touting its "diverse" offerings, "elaborate" packaging and "what the company believes is an industry-leading 24/7 concierge service."

He added: "As a result, the company has been able to achieve an average sales price of ~$10.50 in its current fiscal year, which is a 25-per-cent premium to average industry pricing. As the market matures and the supply/demand dynamics of the industry normalize, pricing pressures will likely begin to set in; however, in our view, Hydropothecary is currently executing one of the stronger branding strategies amongst all LPs and could be laying the foundation to market itself as a premium producer in advance of the recreational market.

"In addition to Hydropothecary's premium pricing in the current retail market, the company also operates as one of the lowest-cost producers in the industry. Due to its favorable geographic location in Quebec (which has much lower input costs compared to Ontario where a majority of LPs are based) and its greenhouse grow, we believe the company is one of the better suited LPs to manage margin compression once the industry transitions to wholesale pricing and cannabis starts to become commoditized (THCX has a current gross margin of 85 per cent versus peer average of greater-than 70 per cent). However, as the market begins to mature, we believe the company's current premium pricing will likely be subject to increased pressure over the longer term."

Mr. Bottomley set a price target of $3.10 for the stock. The analyst consensus is currently $3.85.

"Hydropothecary's stock has been under continued pressure and is currently trading 58 per cent lower than its 2017 highs," he said. "Although industry valuations have also pulled back, THCX's decline has been 1.7 times greater than the overall industry average over this same time period."

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The launch of Boeing Global Services is a "sound move strategically" for Boeing Co. (BA-N), said Canaccord Genuity analyst Ken Herbert, who sees "substantial" opportunity for growth.

On July 1, the new business unit began operations with a focus of Boeing's government, space and commercial customers.

"We believe that for Boeing, breaking out its services business into a separate operating segment makes sense, and we believe the positives from the push into services has the potential to be game changing for Boeing and the industry, but the ultimate margin upside is uncertain, and the strategy for growth in this business has not yet been articulated by the company," said Mr. Herbert.

He added: "We believe BGS will represent $18-billion in annual sales and $2.2-billion in operating profit, or approximately $2.50 in annual 2016 EPS. While we see the potential for 6-per-cent organic growth in BGS, based on the business mix, BA will have to look at over $20-billion in acquisitions for it to have a realistic chance of hitting its $50B revenue target for the services business by 2025. However, we do not believe investors will hold it against BA if it does not hit its long-term targets, as long as it is demonstrating growth, but we do see less margin upside than we believe is in consensus estimates (approximately100 basis points) due to the competitive nature of the services market. Cost savings as a result of the segment consolidation could potentially be a greater source of upside than anticipated."

With a "hold" rating (unchanged), Mr. Herbert raised his target price for Boeing shares to $200 (U.S.) from $170. Consensus is $204.33.

"We believe the expansion of the BSG can potentially contribute to higher multiples, but we believe FCF will remain the most important metric for investors," he said. "Moreover, while sentiment on the commercial aerospace cycle has increased substantially, the outlook for the defense market has also increased after the initial concern about incremental price pressure from President Trump passed. We have slightly increased out 2017 revenue and EPS estimates. Boeing has been one of the best performing stocks recently not just in A&D [aerospace and defence], but across the broader market. Part of this strength reflects a catch-up after a weaker 2016. However, as we look at Boeing, the fundamental outlook for both the aerospace and defence sectors has improved, and confidence specifically in the commercial OE sector (driven by the 737 outlook) was materially bolstered by the Paris airshow."

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Expressing caution over the impact of the ongoing NAFTA negotiations on the Canadian agriculture industry, BMO Nesbitt Burns analyst Peter Sklar lowered his target price for shares of Saputo Inc. (SAP-T).

Though he expects the company's first-quarter 2018 results, scheduled to be released on Aug. 1, to have a neutral impact relative to his estimates, Mr. Sklar dropped his target to $45 from $48 with a "market perform" rating. Consensus is $47.33.

"Our recommendation remains constrained by: i) uncertainty related to the potential fallout from additional cheese import quotas under CETA and ii) NAFTA renegotiation possibly further opening the Canadian dairy sector to U.S. imports," he said.

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In other analyst actions:

BMO Nesbitt Burns analyst Peter Sklar assumed coverage of Maple Leaf Foods Inc. (MFI-T) with a "market perform" rating and $36 target. Consensus is $35.92.

Mr. Sklar said: "MFI is essentially a mature branded consumer products company, which as a rule of thumb has a growth rate similar to that of GDP. However, management plans to enhance future growth by focusing on 'sustainability,' in traditional and alternative protein categories. We remain concerned the larger financial benefits of the reorganization are now reflected in current earnings, with less robust costcutting opportunities available to MFI."

BMO Nesbitt Burns analyst Joel Tiss upgraded Caterpillar Inc. (CAT-N) to "outperform" from "market perform" and hiked his target to $125 (U.S.) from $110, compared to a $106.61 consensus.

"We believe management will lay out a five-year plan at its investor event in September showing earnings power that could approach our $16 EPS forecast," said Mr. Tiss. "With valuations rising for nearly all industrial companies during the past several years, we assume that Caterpillar shares will trade at about 13–14x peak EPS. This conceivably yields an upside price of $208–224, roughly double current levels."

Expressing doubt over the possibility of a rebound in revenue, UBS analyst Brennan Hawken downgraded Goldman Sachs Group Inc. (GS-N) to "neutral" from "buy" with a $230 (U.S.) price target, down from $255. The analyst average price target is $234, according to Bloomberg data.

Nomura Instinet analyst Steven Chubak believes Charles Schwab Corp.'s (SCHW-N) premium valuation is difficult to justify, citing the outlook for interest rates. Accordingly, he downgraded his rating for its stock to "neutral" from "buy" and dropped his target to $43 (U.S.) from $46. The analyst average price target is $47.

Goldman Sachs analyst Judy Hong downgraded Constellation Brands Inc. (STZ-N) to "neutral" from "buy" and lowered her target to $210 (U.S.) from $212. The analyst average is $214.76.