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Monday’s analyst upgrades and downgrades

A server pours a cup of coffee at a Tim Hortons in Toronto in this file photo.

Chris Young/THE CANADIAN PRESS

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

SNC-Lavalin Group Inc. (SNC-T) is currently positioned for earnings growth with multiple expansion as its legal issues get resolved, according to RBC Dominion Securities analyst Derek Spronck.

Touting its attractive risk-reward proposition to investors, Mr. Spronck initiated coverage of the company with an "outperform" rating.

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"SNC-Lavalin is at an inflection point in EBITDA growth, offering investors attractive concession assets that have yet to be fully monetized and upside optionality to a commodity cycle rebound, all at attractive valuations," the analyst said. "We like the underlying demand trends in the E&C sector and see SNC well positioned to participate to the upside. Our analysis and industry survey (of 12 private and public North American E&C firms) indicate that project spending levels are improving with several multi-billion dollar infrastructure contracts set to be awarded in Canada in the coming months. The difference compared to other cyclical names, and for that matter other E&C firms, is that the valuation of SNC shares still appears quite reasonable. With the E&C division trading at just 6.9 times our 2019 estimated EBITDA, SNC is trading at a 13-per-cent discount to the Global Integrated peers, providing an attractive entry point for investors in our view."

Mr. Spronck noted the company's corruption and fraud case remains a significant overhang, and it faces execution "challenges" related to the replacement of the existing Champlain Bridge. However, he predicted the resolution of both could act as catalysts for the stock moving forward.

"[These issues have] led to the valuation discount and share price underperformance (down 420 basis points versus the S&P/TSX year-to-date)," he said. "However, we were able to get enough comfort around these risks and have factored them into our $67 price target. The key is that as these issues are resolved, or where there is enough visibility to take the worst-case scenario off the table, then the overhangs on the SNC shares are likely to turn into positive catalysts leading the shares to re-rate higher."

"We believe the investor base for SNC is limited while the company is working through unresolved legal issues. This overhang would be removed if a Deferred Prosecution Agreement (DPA) regime were enacted in Canada. But what is intriguing is the potential for SNC to be viewed as an infrastructure asset play, and for that matter, to appeal to more traditional infrastructure focused investors. Not only do you get the 407 toll road concession, private-public partnerships are a growing trend in the industry that could yield new asset ownership opportunities for SNC over the next five years, and perhaps moving valuations towards infrastructure type multiples that trade between 10 times to 20 times forward EV/EBITDA."

Mr. Spronck also pointed to the presence of multiple avenues of growth, believing the acquisitions of Kentz Corporation Ltd. and WS Atkins have "repositioned and shifted" the company's risk profile.

"Kentz offers more recurring operational and maintenance contracts in the O&G sector, but still gives SNC upside potential to a rebound in the commodity sector," he said. "And WS Atkins brings with it a suite of design and consultancy capabilities that SNC can leverage on growing opportunities within its infrastructure and nuclear verticals. We also see SNC leveraging its larger scale and expertise in private-public partnerships (P3) to finance/own more infrastructure assets, with management also developing new investment vehicles and partnerships to explore other asset ownership opportunities."

Mr. Spronck set a price target for the stock of $67. The analyst consensus price target is currently $67.82, according to Thomson Reuters data.

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In separate research reports released Monday, Mr. Spronck initiated coverage of four other TSX-listed engineering and construction companies.

Calling it the "most compelling" investment opportunity within his E&C coverage universe, Mr. Spronck initiated coverage of WSP Global Inc. (WSP-T) with an "outperform" rating.

Calling it a "pure-play Global Design firm," he said: "WSP's platform is concentrated in major urban centers with expertise in transportation, infrastructure, and specialty skyscrapers. We like this positioning as it relates to the underlying urbanization trends and global infrastructure needs. And as management leverages and optimizes the platform, we see WSP offering above average EBITDA CAGR of 12 per cent (2017-2019) versus Global Design peers at 9 per cent."

"WSP has quickly grown into a top five Global Design firm in terms of revenue. This scale allows for the bidding of complex and highly-visible projects. There is a reinforcing cycle where access to better projects brings in top talent, which provides more work on better projects - a position WSP is now in. Combined with a still fragmented industry and a positive demand environment, we see plenty of room for WSP to grow both organically and by way of acquisitions."

Mr. Spronck said the company's management is on track to deliver 11-per-cent EBITDA margins by 2018 through a range of optimization initiatives. He noted it would place WSP with the top Global Design firms, which are currently trading at a 1-per-cent multiple premium.

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"We think 11-per-cent margins are just the beginning and over time, we see WSP reaching EBITDA margins of 12-per-cent-plus, aided by improved pricing power as the company moves towards large-scale and highly specialized projects," he said.

"WSP enjoys a committed investor base, but it is still narrow with two Canadian pension funds comprising 38 per cent of the float. With a new brand and realigned management team, we feel this is an opportunity for WSP to expand the investor base, particularly with non-Montreal institutional investors."

Mr. Spronck set a target price of $64 for WSP stock. Consensus is $56.

Believing it is set to benefit from "positive" sector trends, including increased infrastructure spending in Canada, he gave Aecon Group Inc. (ARE-T) a "sector perform" rating.

"Aecon is well positioned to capture a significant share of Canadian public infrastructure/PPP projects (33 per cent of revenue)," he said. "Revenue exposure to Energy and Mining verticals remains high at 45 per cent and 22 per cent, respectively. However, Nuclear refurbishment work has helped to offset the top-line decline. In Mining, we are seeing stabilization as operation and maintenance (O&M) contracts pick-up, but we see segment revenue staying 30 per cent below peak levels."

"Aecon announced that it was exploring a sale this August. We cannot say with certainty whether a sale will occur. Results from our industry survey highlight limited appetite from E&C firms to take on new or additional exposure to Construction. But we are not ruling out a sale completely as Aecon's strong position in Canada with exposure to the commodity cycle provides for a unique value proposition, in our view."

Mr. Spronck set a target price of $18 for the stock. Consensus is $20.23.

"With a potential sale that may or may not happen, the lack of a permanent CEO, and exposure to what has been an elusive upturn in the commodity cycle, there are sufficient reasons to take a more conservative approach to Aecon, in our view," he said. "We do see a case to be made to the upside in the scenario of a sale (with a take-out premium applied) and the potential for Aecon to win sizable infrastructure projects that would act as positive catalysts. However, when we look at our upside opportunity at $22 per share vs. our downside at $11 per share, we see risks as balanced without sufficient reason at present to recommend an overweight exposure."

Calling it a "top-tier" global design firm with above-peer margins and free cash flow profile, Mr. Spronck also gave Stantec Inc. (STN-T, STN-N) a "sector perform" rating.

The analyst called the company's 2016 acquisition of Colorado-based MWH Global, Inc. a "watershed" and took its international operations "to a new level." He noted the deal almost doubled its employee base and brought global expertise in the water sector.

"STN today is far more diversified, with total exposure to Oil & Gas now representing 10 per cent of revenue (from 35 per cent)," he said. "We like the longer-term opportunity in Stantec's current revenue mix, which is weighted to the U.S. (58 per cent) and Canada (23 per cent) and in verticals that are set to benefit from a pick-up in civil and social project funding in these regions, including healthcare and roads."

"The revamped revenue mix in Stantec led to positive organic growth in Q2/17 following two years of retraction, and we give Stantec full credit for this in our applied multiple. However, MWH also came with lower-margin Construction services (20 per cent of revenue from almost 0 per cent), and we see lower acquisition growth as Stantec completes the integration. Combined with ~2% FX headwind over the next few quarters, we look for revenue growth of 7 per cent annually out to 2019. With 60 basis points of anticipated margin improvement, we see Stantec delivering an EBITDA CAGR [compound annual growth rate] of 10 per cent (2017–19), in line with the Global Design peers."

Mr. Spronck set a price target of $40. Consensus is currently $38.06.

Believing recent acquisitions have "greatly improved" its scale, margin profile and organic growth outlook, he initiated coverage of CanWel Building Materials Group Ltd. (CWX-T) with an "outperform" rating.

"Since mid-2015, CanWel has completed 3 major acquisitions and 1 smaller tuck ($400-million in combined total annual revenue and a greater-than 50-per-cent increase vs. legacy CanWel revenues of $768-million in 2015)," said Mr. Spronck. "In a broad sense, the goal has been to add complementary businesses in attractive markets while trimming exposure to Canadian residential construction activity. In our view, CanWel looks to have executed in a strategic, margin-enhancing and disciplined manner (paying 5.0 times to 7.5 times EBITDA versus CWX's 5-yearr average forward multiple of 9.7 time)."

"While Canadian residential construction remains a key driver for CanWel, the recent acquisitions of California Cascade, Jemi Fibre, and Honsador highlight a strategy to diversify away from the historical linkage to Canadian residential construction activity as well as penetrate into the US market. We estimate that less-than 70 per cen tof revenues have primary underlying exposure to Canadian residential construction (versus effectively 100 per cent prior to the California Cascade deal)."

He set a price target of $7.50 for the stock. Consensus is $7.37.

"While historically a high-yielding and high payout stock (in our view a legacy of its past as an income trust), we remain comfortable with the dividend given a good line of sight to a manageable payout ratio (80 per cent of FCF in 2019), particularly as capex requirements for the business are quite low (0.5 per cent of sales)," he said. "We also note that management and insiders own 20 per cent of the company, providing a good degree of interest alignment."

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Expecting a lacklustre end to 2017 for the engineering and construction sector, National Bank analyst Maxim Sytchev said he's "taking some chips off the table."

"Global GDP is inching up concurrently across most geographies that matter – the U.S., China, the EU, Canada and emerging markets," said Mr. Sytchev. "This is the first time since 2010.

"Typically, the CAPEX cycle should follow suit and E&C/equipment distribution companies should be the main beneficiaries. The latter group is certainly showing up the former as the commodity rebound, M&A and plain execution have pushed the equipment names closer to all-time highs (and beyond in some cases). E&Cs have been in the land of 'great expectations,' but where we are sitting now there is still some backlog replenishment required to back into the 2018 estimated numbers. Hence the peer group with few exceptions only marginally inching out the broader TSX. Blame government squabbles around infrastructure financing, new faces in power (example, BC), pushback against resource development (pipeline project cancellations), and it looks like the year will finish more with a whimper."

In a research report previewing third-quarter earnings season, Mr. Sytchev downgraded his rating for Toromont Industries Ltd. (TIH-T) and Aecon Group Inc. (ARE-T).

Believing it could be time to "take a breather," he moved Toromont to a rating of "sector perform" from "outperform."

"We are in line with consensus on revenue ($535-million) but slightly below on EBITDA and EPS ($86.7-million/59 cents versus $90.3-million/63 cents) for Q3/17E reporting," he said. "Q2/17 was a small miss on transitory tougher comps in 2016 and some adverse weather impacts. Despite the miss there were several positive read-throughs for the latter half of 2017E; mining backlog increased dramatically off a low base on mine development / expansions, signs of tightening supply in used equipment boding well for new equipment sales and rentals were strong on increased activity / time utilization. Fast forward to Q3/17E and backlog replenishment in the Equipment group, gold prices at very respectable $1,303/oz levels (especially when translated into CAD), improving CAT North American retail sales and better comps / weather should bring revenue normalization for Q3/17E and the back half of the year.

"TIH shares are up 29 per cent since the Hewitt transaction announcement. The jump is certainly justified given the balance sheet deployment, high quality of the asset and margin upside. However, when running the numbers five years out, which does not assume any macro hick-ups, sustained revenue momentum for the combined entity and margin normalization on the part of Hewitt, we get 28 per cent (or 5.1 per cent CAGR) upside over the same time frame (using a 17x long-term P/E). This is not enough in our view (unless the business acquisition report will suggest a much stronger Hewitt YTD performance).
 
He maintained a price target of $60. Consensus is $58.64.

Mr. Sytchev also lowered Aecon to "sector perform" from "outperform."

"This is becoming a rather interesting situation," he said. "The company is for sale while the Street has stopped adjusting the expectations for what we clearly believe is a less robust backlog replenishment environment for the company in the short term. Why do we care about the short term? Because Aecon cannot be for sale indefinitely. A process is unlikely to last more than a year and buyers typically react to headline news.

"Year-to-date, we had pipeline project cancellations, no (significant) mining announcements and deferrals of infra announcements. 2018 consensus estimates are therefore at risk. Because Aecon's potential buyer would be using 'new' 2018 numbers as the anchor, those expectations are now being deflated because it takes time for contract announcements to actually cycle through the P&L. According to our math, without M&A ARE's shares are likely worth in the $17.50 per share rang. The Street will go through the typical dance of 'rolling' forward valuation into 2019E, providing some valuation offset as a result over the coming months, but this is hardly a reference especially when once again thinking about 2018E as being the valuation reference point for a potential acquirer."

"When thinking about Aecon as an investment in these terms, one unfortunately cannot be 'long' a percentage of M&A happening. It either happens or it does not. The 26.5% implied takeout probability is not investable."

He dropped his target for the stock to $18 from $20. Consensus is $20.23.

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Uncertainty remains "high" for Equifax Inc. (EFX-N), according to RBC Dominion Securities analyst Gary Bisbee.

On the heels of a recent rally in share price following its breach-driven lows, he downgraded his rating for the Atlanta-based credit reporting agency to "sector perform" from "outperform."

"A significant amount of uncertainty remains regarding the financial and operational impacts from Equifax's breach," he said. "We see four key questions/uncertainties that are likely to linger: 1) How much will the underlying earnings power of Equifax be impacted? 2) How much market share will Equifax lose? 3) How will the regulatory (and potentially legislative) environment change, and what impact will this have on Equifax and its industry? 4) How long will the breach impact take to work through Equifax's financials? We believe that it could take several quarters for these questions to come into focus, and we do not expect Q3 results to provide many answers."

Mr. Bisbee lowered his 2017, 2018 and 2019 earnings per share projections to $5.89 (U.S.), $5.80 and $6.18, respectively, from $5.92, $5.96 and $6.45 in order to "remove buybacks from our model and take a somewhat more negative cut at both U.S. direct-to-consumer revenue losses and the impact on USIS from a likely difficult bookings environment."

"EFX trades at 19 times/18 times our calendar year 2018/2019 adjusted EPS estimates (excluding direct breach related costs)," he said. "While this is below the 22 times information services peers average and EFX's 21.5 times 3-year average, we believe the many uncertainties discussed above plus a likely lost year of profit growth in 2018 warrant this discount. We see 20 times (approximately 10-per-cent discount to peers average) as the likely upside valuation limit until the uncertainty clears, and thus see limited upside for the stock. Downside is harder to quantify, though we believe that potential for lower estimates, regulatory/legislative changes, lawsuits, or other factors could lead the multiple lower. As a result, we see an unattractive risk-reward in the next 6–9 months and expect the stock to be range-bound."

He kept a price target for the stock of $113 (U.S.). Consensus is $124.62.

"Following an 18-per-cent bounce off the post-breach lows (versus the S&P 500 up 3 per cent), we see EFX at a more balanced risk-reward today," said Mr. Bisbee. "Longer-term, we believe that the company's core B2B business is likely to be only lightly impacted, and that Equifax will return to being a solid compounder over time. However, the short-term uncertainties, need for estimates to fall, and expected lost year of earnings growth in 2018 will likely keep the stock range-bound for several quarters."

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It's time to start normalizing the valuation for Air Canada (AC-T), according to Altacorp Capital analyst Chris Murray.

He raised his target price for the airline's stock in a research report previewing its third-quarter financial report, which is scheduled to be released on Oct. 25.

That increase came after Mr. Murray adjusted his fuel and foreign exchange estimates for both 2017 and 2018 to fall in line with the firm's price deck.

He is now projecting quarterly revenue, EBITDAR and adjusted fully diluted earnings per share of $4.935-billion, $1.471-billion and $3.60, respectively. The consensus on the Street is $4.882-billion, $1.372-billion and $3.36.

"With the company's investor day now behind it and some additional discussion regarding expectations longer-term, we believe some dialogue around valuation and what is appropriate is warranted," the analyst said. "We believe the path laid out by management remains credible as the company begins to slow capacity growth and focus on revenue optimization as it moves from the widebody and sixth freedom expansion plan into a process of narrowbody fleet renewal."

"On a longer-term basis we can see a path where the company is able to general annual free cash flow of $1.4-billion to $1.8-billion on EBITDAR of $4-billion-plus with debt of $5.0-billion in-line with a 1.2-times target. We also believe that the company's return on capital spread likely improves to a 14 per cent to 16-per-cent-plus range with the company's cost of capital (WACC) staying around 7.6 per cent with the impact of capital mix, tax shield on debt and lower effective debt rates. Capital intensity likely flatlines and as we said previously we anticipate growth at somewhere near 1.5 times GDP. Interestingly, using our theoretical model on the interplay of these factors, we come to range of forward multiple of 5.3 times to 5.6 times, which also happens to be where North American mainline airlines have traded on average over the longer term."

Maintaining an "outperform" rating, Mr. Murray's target jumped to $38 from $30. Consensus is $31.37.

"Despite achieving multiples of return to investors over the past several years, we believe further appreciation is likely with the next leg up for share prices a recognition of the sustainability of earnings leading to a normalization of multiples," he said. "With that in mind, we believe it appropriate to begin to increase our valuation multiples to reflect this path. We do not believe this happens in one step, rather this will be a series of step jumps as the company demonstrates its earnings performance. With robust demand and solid execution, we believe Q3/17, which we expect to be a record for quarterly earnings is likely to provide a catalyst to start this process."

Elsewhere, Canaccord Genuity analyst Doug Taylor increased his target to $33 from $31.

Mr. Taylor said: "Air Canada stock traded up 32 per cent following the strong Q2 beat and 11 per cent since the investor day in mid-September. We see this as a function of higher expectations for what appears to have been a strong summer quarter, and improved clarity on the mid-term outlook provided at the company's investor day. In this note, we make only modest model tweaks higher to our recently revised expectations alongside a bump in our target to $33 (from $31). Despite an impressive run for AC shares, Air Canada is still trading at an unwarranted discount to WestJet and U.S. peers and we believe the combination of significant FCF generation and narrowing that discount supports our long-term BUY thesis. With that said, we do believe that to some extent a Q3 beat may already be priced into the shares, given the strong run in the stock ahead of the results. Looking through this, with a 26-per-cent implied return to our target, we continue to rate Air Canada a BUY."

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Restaurant Brands International Inc.'s (QSR-N, QSR-T) premium valuation is deserved given its "highly visible" unit growth and same-store sales drivers, said RBC Dominion Securities analyst David Palmer.

He believes those factors could support long-term revenue growth of 7 per cent and a total return of 15 per cent or more, considering its "extraordinary" cash flow optionality.

"Our thesis remains that highly franchised/stable growth businesses like Restaurant Brands will see their valuations converge given similar characteristics of unit development and SSS drivers that may include a commitment to value, food quality upgrades, restaurant renovation, and digital infrastructure," he said.

"RBI's current 2018 estimate price-to-earnings multiple of 24.5 times implies a 2018 P/E to growth ratio of 1.6 times. Lastly, the company's 4.5-per-cent free cash flow yield (2017 estimate) and 5-per-cent free cash flow yield (2018) stack up well against peers when considering the outsized growth we expect in 2018 and potential for future concept growth through M&A."

Emphasizing "accelerating" trends for both Burger King in the U.S. and Tim Hortons in Canada, Mr. Palmer noted: "We model 3Q SSS growth for BK US of 3.5 per cent (consensus 2.7 per cent), as we believe the company's successful 2 for $6 Whopper promotion boosted trends to the mid-single-digit-plus range in August and early September. For Tim Hortons Canada, we expect 1-per-cent SSS growth (consensus 0.5 per cent), an improvement following three consecutive quarters of declines. We believe tie-ins with Canada's 150th birthday including 'Roll up the Rim' helped bring new energy to the brand. We also believe customers are beginning to embrace the espresso-based beverages and we look forward to hearing about early learnings from mobile ordering."

With an "outperform" rating, he raised his target for the stock to $77 (U.S.) from $69. Consensus is $67.41.

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In other analyst actions:

In reaction to a reduction in its 2017 production forecast for its flagship Kisladag mine in Turkey,  Credit Suisse analyst Anita Soni downgraded Eldorado Gold Corp. (ELD-T) to "underperform" from "neutral." Also emphasizing the company's arbitration issues in Greece and a $600-million debt repayment due in 2020, Ms. Soni reduced her target for its stock to $1.50 from $2.40. The analyst average target is $3.80.

Buckingham Research Group analyst Scott D Krasik downgraded Foot Locker Inc. (FL-N) to "neutral" from "buy" with a target of $29 (U.S.), down from $47. The analyst average target is $41.76, according to Bloomberg data.

BofAML upgraded General Electric Co. (GE-N) to "buy" from "neutral" with a target of $27 (U.S.), down from $28. The average is $27.07.

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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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