Monday’s analyst upgrades and downgrades

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

The prospects of a near-term settlement to the lumber dispute between Canada and the United States have faded, according to BMO Nesbitt Burns analysts Mark Wilde and Ketan Mamtora.

In a research note released Sunday, the analysts said they now expected a period of countervailing and anti-dumping duties on Canadian lumber imports, forcing continued litigation on those charges.

"Comments by high-ranking Canadian government officials and some U.S. corporate executives have fed hopes that a negotiated settlement is close at hand," they said. "Our sources report little substantive negotiation between Canadian and U.S. interests and little real movement in positions. Moreover, internal divisions exist on both sides of the border. On the U.S. side, there appear to be differences between U.S. Commerce Secretary, Wilbur Ross, and U.S. Trade Representative, Robert Lighthizer, as well as amongst members of the U.S. Lumber Coalition. On the Canadian side, the divisions are between Eastern and Western Canada.

"Continued uncertainty on the trade issue isn't good for lumber stocks. Moreover, the combination of continued countervailing and anti-dumping duties during 2018 and a strengthening Canadian dollar are both apt to put pressure on FY18 earnings estimates. In our view, it's hard to see the stocks pushing much higher in the near term in the face of that headwind."

Accordingly, the analysts downgraded the following stock from "outperform" ratings to "market perform":

• West Fraser Timber Co Ltd. (WFT-T) with a target of $72. Consensus: $68.92.
• Canfor Corp. (CFP-T) with a $25 target. Consensus is $22.21.
• Interfor Corp. (IFP-T) with a $23 target, which is the consensus.

"To be clear, we aren't arguing the cycle is over for the lumber producers," said Mr. Wilde and Mr. Mamtora. "However, we think the prospect of continued uncertainty on the trade issue isn't good for stocks – especially, when they are trading near 52-week highs. In addition, the combination of continued countervailing and anti-dumping duties during 2018 and a strengthening Canadian dollar are both apt to put pressure on FY18 earnings estimates. In our view, it's hard to see the stocks pushing much higher in the near term in the face of that headwind."

"While we're backing away from the stocks in the near term, we expect to revisit these names at some point. We don't think the lumber cycle is over. The 'medium term' looks much more constructive. Over the next three-five years, we think the combination of reduced lumber supplies from Canada, improving lumber demand, and continued low southern sawlog prices could produce a period of abnormally rich margins for southern sawmills. We may be entering something of a Golden Age for southern sawmills. The three largest Canadian lumber producers have been increasing the proportion of their production in the southern U.S. and should benefit from the sawlog cost/lumber price arbitrage. Strong lumber prices have also dramatically improved balance sheets: net leverage is below 1x for all the three B.C. producers: WFT will be at 0.7 times pro forma for the Gilman acquisition, CFP is at 0.2 times, and IFP is at 0.9 times.

At the same time, they downgraded a pair of the largest timber REITs to "market perform" from "outperform." They are:

• Weyerhaeuser Co. (WY-N) with a $36 (U.S.) target, which is the current consensus.
• Rayonier Inc. (RYN-N) with a $31 (U.S.) target

"The outlook appears murkier for big owners of southern U.S. timberland like Weyerhaeuser, Rayonier, and Potlatch," they said. "A decade of subpar demand and improving forest productivity has created significant inventory build in southern plantation forests. That "overhang" has southern sawlog prices at 60 per cent of 2005 levels – in nominal terms – and threatens to dampen/delay a recovery in sawtimber pricing across many parts of the south. Indeed, after a modest price recovery, southern sawlog prices have declined for the past seven quarters. Southern timberlands are currently yielding $50-60/acre/year in EBITDA – a 2.75-per-cent EBITDA yield on transaction values in the $2,000/acre range. Adjusting for capital spending, the free cash flow yields are even a bit lower. These yields remain far below the returns targeted by many timberland investment managers. Improved cash flows will be driven by a mix of increased sawlog volumes and higher sawlog prices. We think sawlog demand will increase as lumber production continues to pivot toward the south. What's not clear is whether we will see a significant pricing recovery prior to a drawdown in inventories.

"At current demand levels, biological growth in trees still exceeds 'drain' (harvests). In private conversations, we're encountering an increasing sense of caution – even, skepticism – about the recovery amongst timber investment professionals. Most timberland professionals currently assume a $40/ton 'trend' southern log price in their discounted cash flow analysis (DCF). However, with current prices well below "trend" level for the past 10+ years, pushback on that $40/ton 'trend' price assumption is mounting. The prospect of rising interest rates could also impact southern land values, if log prices remain weak (undercutting the 'inflation hedge' thesis). Both these factors point to downside risk to southern land values. Against that backdrop, we're downgrading our ratings on Weyerhaeuser and Rayonier to Market Perform. We are not making any change to our WY and RYN price targets."

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Telus Corp. (T-T, TU-N) is "building a potent asset mix," according to RBC Dominion Securities analyst Drew McReynolds.

Despite weaker second-quarter margins, he believes the company is likely to reap the benefits of "much stronger" wireless subscriber and average revenue per user (ARPU) growth, which he notes includes industry-leading lifetime revenue results.

"Upon nearing completion of its FTTH [fiber to the home] build, we believe the TELUS asset mix (wireless, FTTH, TELUS Health, TELUS International, no media exposure) will rank as the most attractive within the group," said Mr. McReynolds. "The 5-year accelerated FTTH build is at its mid-point now reaching 1.3 million premises covering 42 per cent of the Optik footprint (50-per-cent coverage targeted by H1/18). Importantly, we view TELUS as best positioned for 5G given what will be extensive FTTH coverage, a capital efficient network sharing arrangement and a head start on potential 5G IoT/M2M [Internet of Things/Machine to Machine] use-cases with TELUS Health. Despite 5G commercial deployment still being a ways off (estimated 2020-2021), we expect the relative level of 5G "preparedness" (capex, wireless-wireline integration, fibre backhaul, use-cases) to increasingly carry weight among investors."

Telus shares fell 1.6 per cent on Friday in reaction to the quarterly results, leading Mr. McReynolds to suggest longer-term investors should be accumulating on weakness.

"We have confidence in TELUS' ability to sustain greater-than 4-per-cent consolidated EBITDA growth, which we believe is a level that is required to support industry-leading capital returns and balance sheet objectives," said Mr. McReynolds. "While elevated capex and Shaw competition concerns are likely to remain a near-term NAV and valuation headwind, we believe longer-term investors should be accumulating on weakness reflecting: (i) an expected improvement in FCF, dividend coverage and leverage in 2018E; (ii) our expectation that TELUS will 'hold its own' against a more competitive Shaw; (iii) with the passage of time, emerging visibility on what should be attractive post-'blanket-build' FTTH economics; (iv) a strong 5G position; and (v) the slight valuation discount to large-cap peers (FTM EV/EBITDA multiple of 7.8 times versus 7.9 times-8.2 times)."

He maintained a "sector perform" rating for Telus stock and raised his target price to $46 from $45 based on "upward revisions to wireless (postpaid net additions, ARPU) and data revenue growth assumptions, mitigated in part by lower margins and higher net debt." The analyst consensus price target is $49.03, according to Thomson Reuters data.

"While not immune to a more competitive Shaw (X1, wireless), we continue to expect TELUS to ultimately manage through elevated competitive intensity in Western Canada reflecting accelerated FTTH deployment, wireless bundling capabilities versus BCE and Rogers, a diversified wireline revenue mix (TELUS Health, TELUS International), the potential for additional cost-efficiencies and a strong track record on execution," the analyst said. "Although Shaw has yet to hit full stride on wireless, we believe TELUS' performance in Q2/17 is a case in point with the highest postpaid net additions among the big three (up 99,000), positive Internet and television net additions (up 22,000) and 4-per-cent increase in revenue and EBITDA growth."

Elsewhere, Echelon Wealth analyst Rob Goff reiterated his "buy" rating and $48 target, noting: "We were looking to raise our PT by [approximately] $2 with the quarter; however, we have elected to leave it unchanged given prospective downward forecast revisions. Discussion around a greater than usual mix of off-contract subscribers heading into the critical fall period are likely to raise some concern towards heightened competitive intensity. We are similarly cautious; however, we believe financial expectations will underpin a level of discipline across the providers."

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Magna International Inc.'s (MGA-N, MG-T) valuation remains "attractive" after "solid" second-quarter financial results, said RBC Dominion Securities analyst Steve Arthur.

On Aug. 11, Magna reported revenue of $9.68-billion (U.S.), an increase of 2.6 per cent year over year and ahead of both Mr. Arthur's projection ($9.59-billion) and the Street's expectation ($9.48-billion). Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of $1.056-billion was in line with the analyst's projection ($1.058-billion). Adjusted earnings per share of $1.48 were a penny less than his estimate and a penny more than the consensus.

Mr. Arthur emphasized that both revenue and earnings grew from the previous year despite a 3-per-cent decline in North American production and a 1-per-cent drop in European volumes, which he said is "indicative of the multiple earnings growth drivers at Magna."

The company also raised its full-year revenue guidance by 3 per cent to $37.7-39.4-billion from $36.6-38.3-billion, due largely to forex.

"Despite solid Q2 results, MGA continues to trade at only 4.5 times 2018 estimated enterprise value /EBITDA, well below the supplier group average of 5.3 times," said Mr. Arthur. "We see this as an undeserved discount, given Magna's global positioning, growth outlook, technology investments, and Balance Sheet strength. Looking ahead, we expect the shares will outperform the market and would be buyers on Friday's weakness, given i) expected earnings growth, even with declining NA production volumes; ii) strong FCF generation and cash deployment plans; and iii) a narrowing of the trading multiple relative to the group."

With an "outperform" rating (unchanged), Mr. Arthur raised his target price for the stock to $61 (U.S.) from $60. Consensus is $54.09.

Elsewhere, Canaccord Genuity analyst Aravinda Galappatthige did not change his "buy" rating and $50 (Canadian) target for Telus stock.

Mr. Galappatthige said: "As we think about the next 12-18 months we are encouraged by the outstanding wireless fundamentals being enjoyed by incumbents and TELUS with its heavy wireless mix stands to benefit nicely. TELUS also continues to deliver on its cost containment initiatives and given its wireline margins, there is still considerable running room there. Against that, we have to weigh the change in balance of power between Telcos and Cablecos that's occurring now, albeit more visible in Central Canada than the west. At this point TELUS is holding its ground well enough, particularly when it comes to the internet product, however as the X1 offerings goes deeper into the market there is a risk that some ground maybe lost. The mitigating factor for TELUS is that its exposure to residential wireline is significantly lower than its peers. We estimate well below 20% of its EBITDA. In that context, the financials would be quite resilient to the loss of some market share there, particularly given the strength in its wireless business."

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Canaccord Genuity analyst Mark Rothschild lowered his target price for units of Boardwalk Real Estate Investment Trust (BEI.UN-T) following "weaker" second-quarter results and a reduction in its guidance despite signs of a stabilization in the rental apartment market in Alberta.

On Aug. 10, the Calgary-based REIT reported funds from operations per diluted unit of 54 cents, a drop off of 29 per cent year over year and below both the projections of Mr. Rothschild (61 cents) and the Street (62 cents). Mr. Rothschild said the drop was "entirely due" to a 19-per-cent slide in same-property net operating income (NOI), almost a 25 cents per unit decline.

"While occupancy has appeared to stabilize, it seems like this is due to a large number of suites being taken offline for redevelopment," he said. "In order to stabilize the portfolio, Boardwalk has initiated a large program to improve the quality of its portfolio to compete with newer buildings. The budget for 2017 is $163-million ($4,818 per suite), and while it has a negative impact on near-term results, it is necessary in our view to maintain, and ultimately grow NOI."

"Same-property NOI dropped materially in Q2/17 and marked the fifth consecutive quarter of double-digit negative internal growth. Same-property expenses rose 13.7 per cent as operating expenses, utilities expense, and property taxes all increased. In addition, revenue from the same-property portfolio declined 6.5 per cent due primarily to lower rental rates and higher incentives in the Alberta and Saskatchewan portfolios."

Boardwalk lowered its 2017 guidance for FFO per unit to a ranger of $2.10 to $2.20, down from $2.30 to $2.65 previously. Mr. Rothschild is now projecting $2.18 (from $2.38) in 2017 and $2.39 (from $2.60) in 2018.

"Our 2017 FFO estimate is at the high end of the range," he said. "It is extremely difficult to have confidence in any estimate at this point and the success in completing the suite upgrades and leasing the vacant units will have a material impact on FFO."

Maintaining a "hold" rating, his target slipped to $45 from $47. Consensus is $45.16.

Desjardins Securities analyst Michael Markidis dropped his target to $40 from $44 with a "hold" rating.

Mr. Markidis said: "BEI's 2Q17 results were substantially below expectations. Management is ramping up the capital program to renovate a selected number of units to enhance portfolio value. This should compound revenue growth when fundamentals recover. In the interim however, increased pressure is being drawn on BEI's leverage metrics and the sustainability of the distribution."

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Raymond James analyst Chris Cox thinks the weaknesses exposed by Inter Pipeline Ltd.'s (IPL-T) will be "somewhat transitory."

However, he said they also accentuate the "considerable" increase in its commodity exposed cash flow stemming from its $1.35-billion acquisition of Williams Partners L.P.'s Canadian natural gas liquids midstream businesses in late 2016. He called Inter "now one of the most commodity-exposed Midstream operators in Canada."

"This, combined with our continuing view that growth opportunities in the core Oil Sands Transportation segment will be limited at best, serves to support a valuation that should trend in-line, if not lower than its peers – arguably, we are there today," said Mr. Cox. "Upside to the story largely rests on the prospects for the company's PDH-PP opportunity, which we have also held a more muted outlook on, a view that we feel more comfortable with following the additional FID delay announced with 2Q17."

On Aug. 10, the Calgary-based company reported second-quarter adjusted EBITDA of $245-million, below the estimates of Mr. Cox ($275-million) and the consensus ($267-million).

"Relative to our forecasts, the NGL Extraction segment drove the majority of the miss, posting operating margin of $28-million versus $45-million forecast," he said. "This was a noisy quarter for the segment, with turnarounds at the Cochrane and Redwater facilities; while we had included the impact of this in our volume forecasts, turnaround costs proved to be greater than expected, coupled with lower than expected frac spreads."

"The highlight for the quarter, in our view, was the indication from management that the FID on the project is being pushed out to 2H17, reflecting an inability to secure the necessary commercial contracts to underpin this project at this time. While the delayed timing is, admittedly, a relatively trivial amount of time (prior guidance was for a mid-2017 FID), it is concerning in our view that this is just another delay for the project. Recall, when the company initially acquired the Williams assets a year ago, the plan laid forth by Inter Pipeline management was to proceed with a PDH-only project, with a targeted FID before year-end 2016. We have long-held a much more cautious tone with respect to the company's pursuits in the petrochemical arena, given our view that a successful project would likely prove to be more complex than initially perceived. While we still believe the company will ultimately proceed with the project, another risk we believe investors need to consider is that the eventual contracting of the offtake could prove to be less profitable for the company and/or result in Inter Pipeline taking on a greater share of the commodity exposure of the project."

With a "market perform" rating, Mr. Cox lowered his target to $26 from $30. Consensus is $30.13.

TD Securities analyst Linda Ezergailis maintained a "buy" rating and $33 target.

Ms.Ezergailis said: "The off-gas processing acquisition created a new platform for growth, which also adds some positive leverage to improving commodity prices. Over the long term, IPL is well-positioned to service any additional oil sands volumes through cost-efficient bolt-on connections. When combined with the recent 7.0-per-cent dividend yield underpinned by a high proportion of cost-of-service and fee-based cash flows, we believe that investors should find the combination of stable long-term cash flows, income, and growth potential attractive."

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Baird analyst Ben Kallo thinks Tesla Inc. (TSLA-Q) stock will continue to rise with the introduction of its Model 3 vehicle.

"We expect strong demand for the Model 3 and believe the total addressable market will likely be underestimated, but think it will be an ongoing process to ascertain global demand," Mr. Kallo. "Tesla remains one of our top picks for 2017 and we are raising our price target as we continue to believe a successful Model 3 launch will be an inflection point for the stock."

He raised his target price for the stock to $411 (U.S.) from $368 with an "outperform" rating. Consensus is $308.75.

"Importantly, a positive reception to the Model 3 from early customers could significantly increase the value of the Tesla Brand and further accelerate demand," said Mr. Kallo.

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There's "light at the end of the tunnel" for AutoCanada Inc. (ACQ-T), according to CIBC World Markets analyst Matt Bank.

Though he said the Edmonton-based company is not "out of the woods yet," Mr. Bank said "momentum is turning in its favour." Expecting earnings to grow and sentiment to improve, he upgraded its stock to "neutral" from "underperformer."

" New car sales are the engine of the business and grew 7 per cent in the [second] quarter," he said. "The industry backdrop is helpful, if hard to predict, and while Alberta is still an issue comparables are easy and there are signs of life. Product and brand mix were once a major problem but product launch cycles are favourable for ACQ's OEMs over the next year and supply issues appear to be over.

"Financial discipline is commendable. The capex budget continues to be slashed and the plan is now $20-million this year and $125-million over five years, versus $75-million in 2015 alone, and management insists this is adequate capital to support the customer experience and growth. Meanwhile a couple of shrewd one-time moves put another $30-millionin the bank (discussed in report). Our net debt/EBITDA forecast has been reduced to 2.1 times at the end of this year versus 2.6 times previously, and our FCF forecast for next year implies a 5-per-cent FCF yield. The company sees about a turn of leverage available for M&A currently."

Mr. Bank raised his target to $22 from $19, which he said is "not sufficient upside (especially given the risk) to get overly excited, but we do upgrade our rating." Consensus is $23.94.