Monday’s analyst upgrades and downgrades

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

Though they have underperformed gold thus far in 2017, Desjardins Securities analyst Josh Wolfson said his outlook for gold equities going forward is "neutral," believing their valuation is currently fair.

"[Free cash flow] and investment returns, which in our view are a key driver of equity returns, have improved from trough levels but remain below the levels offered by alternative investments and are uninspiring for generalist investment," said Mr. Wolfson.

In a research report released Monday, Mr. Wolfson initiated coverage of 16 gold producers and royalty companies, linking their fortunes closely with monetary policy.

"Following the global financial crisis, extreme monetary easing has achieved a normalization of GDP [gross domestic product]as well as a normalization of inflation, and we believe interest rates are the next step in the process," the analyst said. "We believe negative sovereign debt yields in 2016 represent a bottoming of short-term rates, and in our view it is reasonable for long-term rates to also gradually rise. Drastic times called for drastic measures, but we believe these are now more normal times. Historically, gold has been most correlated to the inverse performance of U.S. long-term real rates. Thus far, increases in the Fed's short-term target rate have not yet translated into rising long-term rates. Nonetheless, real rates have not decreased as inflation has remained contained, despite improvements in GDP.

"In the current normalization process, we expect the Fed to continue to raise short-term interest rates. However, the stability of markets could become a challenge (yield curve levels, above-average market valuations, debt and entitlements relative to GDP). Should growth stall, absent major systemic risk, we believe the outlook for gold is uncertain as its track record during these events has been mixed."

Mr. Wolfson gave "buy" ratings to the following stocks:

- Agnico Eagle Mines Ltd. (AEM-T, AEM-N) with a $60 target. The analyst average target is $68.69, according to Bloomberg data.

Analyst: "In our view, Agnico Eagle is a unique operator that is focused on predictability and emphasizes long-term returns. We believe a key challenge for investors in analyzing Agnico Eagle is the company's culture of conservatism, where guidance and project forecasts at the surface seem uninspiring. However, on a five-year-trailing basis, we calculate that Agnico Eagle has achieved production results that are on average 12 per cent above guided levels when initially issued (typically 2 to 3 years prior), or 8 per cent when evaluating achieved results versus guidance for the same year. Similarly, costs on average over this period have been 8 per cent below guidance for the same year. Furthermore, we note Agnico Eagle's investment returns have also outperformed expectations. For reference, we calculate an IRR [in Iranian Rial] at spot gold of 30 per cent for Goldex's restart today compared with Agnico Eagle's initial estimated 13 per cent in 2012, and achieved returns for Meliadine (10 per cent IRR estimated in 2015) in our view also have the potential to exceed forecasts."

- Detour Gold Corp. (DGC-T) with a $15 target. The average is $20.37.

Analyst: "Following a 2.5-year construction period, the Detour Lake mine commenced operations in early 2013. Although Detour today is nearly finished its fifth full year of operations, over this period the company has faced various challenges, including its achieved mining rates and dilution, ore-handling, weather, permitting and financial liquidity. A consequence of this is partly reflected in DGC's relative valuation. Despite the company's operation of a world-class asset featuring an extensive minelife, long-term projected healthy margins and location in a premier mining jurisdiction, DGC shares trade at a P/NAV [price to net asset value] at spot gold of 0.76 times (versus peers at 1.08 times)."

- Iamgold Corp. (IMG-T) with an $8 target. The average is $9.53.

Analyst: "Following gold's sharp decline in 2013, IAMGOLD's position as a low-grade, high-cost producer yielded a challenging outlook for the company. However, management's early focus on margin improvement has yielded positive results and contributed to a successful turnaround of IAMGOLD's business. We calculate that 2017 will represent IAMGOLD's first year of positive free cash flow since 2012, and that its fully loaded costs have decreased over this period from greater-than $1,700 U.S. per ounce to an estimated $1,150/oz in 2017."

- Osisko Gold Royalties Ltd. (OR-T) with a $16.50 target. The average is $19.54.

Analyst: "OR is trading at the lowest P/NAV valuation in its comparable group but at elevated operating metrics, explained by high interim forecast growth from 2018-21 and the company's sizeable investment portfolio which does not generate cash flow. Osisko currently maintains $400-million in investments that account for 20 per cent of our operating NAV, where we note it may not be appropriate to apply premiums embedded within market valuations for the royalty sector to Osisko's public equity portfolio. Nonetheless, by adjusting our valuation for equity investments to be valued at 1.0 times, Osisko's remaining net operating portfolio would be trading at an implied 1.80 times, still a discount to its royalty peers."

- Royal Gold Inc. (RGLD-Q) with a target price of $90. (U.S.). The average is $94.88.

Analyst: "As a result of Royal Gold being a U.S.-domiciled company, current outstanding tax uncertainties for Canadian companies related to the treatment of offshore streaming profits does not affect it. Furthermore, upside to taxes could be realized with a potential reduction in the U.S. corporate tax rate, which we calculate would increase our NAV by 5 per cent."

- Wheaton Precious Metals Corp. (WPM-T, WPM-N) with a $32 target. The average is $33.35.

Analyst: "Despite discounted valuation metrics, Wheaton Precious Metals currently generates the highest cash flow amongst the royalty group. In our view, a key risk within its portfolio is concentration, whereby one-third of production is sourced from the Salobo mine. While highly productive, unexpected risks or changes that materialize would have an outsized influence on Wheaton Precious Metals. A key upcoming contributor to short-term growth will be Constancia's Pampacancha high-grade gold deposit beginning around 2019."

Mr. Wolfson gave "hold" ratings to the following:

- Barrick Gold Corp. (ABX-T, ABX-N) with a target of $19.50. The average is $23.03.

Analyst: "Barrick's success in recent years has in part been attributed to the company's ability to demonstrate its operating, exploration and dealmaking expertise. These attributes have enabled the company to surpass objectives, improve the long-term outlook and remedy the balance sheet. Although our forecasts outline a deterioration in Barrick's longer-term FCF [free cash flow], in our view these forecasts may not appropriately represent the company's outlook."

- Alamos Gold Inc. (AGI-T, AGI-N) with a $9 target. The average is $12.09.

Analyst: "Over the years, Alamos has evolved significantly from its origins as a single-asset operator of the Mulatos mine in Mexico. Through the company's growth-via-acquisition strategy, Alamos initially progressed to become an international growth company through its Turkish development project acquisition in 2010 and its Esperanza development project acquisition in Mexico in 2013. More recently, the company has transformed to become a Canada-weighted growth producer as a result of its acquisition of its flagship Young-Davidson mine in 2015, the Lynn Lake development project in 2016 and the Island Gold mine in 2017."

- Eldorado Gold Corp. (ELD-T) with a $1.50 target. The average is $2.24.

Analyst: "Historically, Eldorado has been a growth-focused gold producer with an emphasis on non-traditional mining frontiers for North American companies. Over time, the company's patience and focus in these new jurisdictions have enabled the team to navigate complicated new environments, including Turkey, Brazil and China. However, multi-year challenges and delays in Eldorado's key region of Greece have severely impacted the company's outlook and credibility. Today, the company's NAV is primarily composed of assets in Greece (55 per cent of NAV), Turkey (19 per cent of NAV) and Canada (20 per cent of NAV)."

- Goldcorp Inc. (G-T, GG-N) with a $17 target. The average is $21.52.

Analyst: "In our view, a key challenge for Goldcorp is its long-term grade profile across its portfolio. While the company has outlined an attractive five-year growth profile, we forecast long-term grades will decline across a majority of its core assets, including Peñasquito, Red Lake, Pueblo Viejo and Cerro Negro. As a result, we believe the company is incentivized to consider advancing ongoing growth opportunities, including major project development and potentially future M&A, where in our view assessing management's capital allocation is of critical importance."

- Randgold Resources Ltd. (GOLD-Q) with a $100 (U.S.) target. The average is $104.53

Analyst: "Randgold possesses a core competence in exploration, development and operations. Despite the company's production growth accomplishments to greater-than 1.30moz today, the team is continually focused on adding value through early-stage organic exploration to improve the company's long-term outlook. Of note, Randgold operates five top-quartile mines, four of which it discovered and advanced independently. Due to the company's high threshold required returns (20 per cent at $1,000 U.S. per ounce) and careful capital allocation, it is very rarely motivated to engage in M&A. Over time, this behaviour has enabled the company to minimize dilution and present impressive per-share growth metrics."

- Torex Gold Resources Inc. (TXG-T) with a $16 target. The average is $23.33.

Analyst: "Upcoming catalysts have the potential to improve Torex's outlook and re-establish investor confidence. In early 2017, Torex announced the discovery of its underground sub-sill target beneath the El Limon open pit, where a maiden resource outlined indicated and inferred resources of 413koz at 7.6g/t and further drilling has identified additional upside. Mining of this area has already commenced and is expected to ramp up more meaningfully in 2H18, but may be impacted in the interim by plant recovery constraints."

- Yamana Gold Inc. (YRI-T, AUY-N) with a $3.50 target, versus the average of $4.23.

Analyst: "2010, Yamana turned around its operations while avoiding peer shortfalls of capital cost inflation, missed targets and dilutive acquisitions. In our view, the company may today be in the early stages of a turnaround again, following the disappointing ramp-up of low-return projects in 2013-15 which resulted in missed targets and rising financial leverage. In our view, Yamana is well-positioned to achieve production guidance in 2017."

Mr. Wolfson gave the following stocks "sell" ratings:

- Franco-Nevada Corp. (FNV-T, FNV-N) with a target price of $95. The average is $110.47.

Analyst: "Over time, Franco-Nevada management has demonstrated a continued discipline toward capital allocation and risk management. Furthermore, the company's active investment strategy and broader acceptance of commodities beyond precious metals has enabled Franco-Nevada to deliver both high growth and high diversification. In response, FNV shares have been awarded the highest valuation amongst the royalty group."

- Kinross Gold Corp. (K-T, KGC-N) with a $4 target. The average is $6.65.

Analyst: "2013, Kinross embarked on a major corporate overhaul focused on achieving operating targets, reducing operating costs, improving its balance sheet and applying greater focus to capital allocation. Through this process, the company has improved its credibility by executing on targets, suspending production at higher-cost operations and substantially reducing expenses. 2017 is forecast to be Kinross's sixth consecutive year of achieving production guidance, and we calculate the company has instituted first-quartile net cost savings within our coverage universe. A recognizable change for the company has been a new focus on in-house technical expertise, which has contributed to operating improvements and project success."

- New Gold Inc. (NGD-T) with a $3.50 target. The average is $5.29.

Analyst: "The stock's attractive short-term valuation, but weaker long-term valuation, is driven by higher grades processed initially at Rainy River, higher short-term New Afton cash flow ahead of heavier development of the mine's C-Zone in 2021 and front-loaded cash flows for the shorter-minelife Mesquite mine. In our view, NGD's short-term operating metrics are attractive, but do not appropriately represent its long-term prospects as well as high outstanding debt."

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Raymond James' Chris Thompson added B2Gold Corp. (BTO-T) to the firm's "Canadian Analyst Current Favourites" list, replacing MAG Silver Corp. (MAG-T).

"We view B2Gold (BTO) as an intermediate gold producer on the cusp of delivering significant production growth and lower operating costs," he said. "Whilst BTO currently trades at a premium valuation to peers, we see BTO's share price benefiting from momentum driven by Fekola's ramp up (commissioned in December, ahead of schedule) and untapped exploration upside.

"We see Fekola as transformational for BTO, driven not only by the mine's ability to grow BTO's consolidated production (2018 estimate: 875,000 ounces versus 2017 estimate of 580,000 ounces), lower costs (2018 all-in sustain cost (AISC): $835 per ounce versus 2017 AISC of $935 per ounce), but also yield resource/reserve growth and new discoveries. We note that we are entering 2018 with a conservative stance with respect to our 2018 production and cost estimates versus BTO's (unofficial) guidance of between 925 – 975,000 ounces at a CC [cash cost] of $525 per ounce (versus estimates of 875,000 ounces and $545 per ounce, respectively). If the gold price rebounds (which we think it will), we believe that BTO's delivery of low cost production growth potential will be reflected by a year of peer-leading share performance."

Mr. Thompson currently has an "outperform" rating and $5 target on B2Gold share. The average target on the Street is $5.12.

He also has an "outperform" rating on MAG shares with a $22 target. The average is $24.05.

"While we still recognize MAG as a premier precious metals developer through the advancement of its 44-per-cent owned Juanicipio project with JV [join venture] partner Fresnillo plc., we see potential for near-term headwinds and a lack of positive catalysts as the JV tables a feasibility study to use as a basis for a production decision, anticipated in early 2018," he said. "Further, better value opportunities elsewhere in the precious metals sector prompt a switch."

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Though he believes the timing of Keyera Corp.'s (KEY-T) $494-million equity raise is "a little curious," Raymond James analyst Chris Cox said it's "no cause for alarm."

On Friday, the Calgary-based company announced the completion of the equity financing, which is allocated to support its capital growth program.

"While investors can nitpick over the size and timing of Keyera's $494-million equity raise, we believe the underlying story of attractive near-term growth within the NGL Infrastructure segment, coupled with growing momentum in the G&P [gathering and processing] segment from the liquids-rich Montney and Duvernay, largely remains intact," said Mr. Cox. "Indeed, we believe the size of the offering is indicative of management's confidence in the ability to secure a number of additional projects, which should further support our view that Keyera is the most attractive, growth-oriented Midstream in Canada at this juncture."

Maintaining an "outperform" rating for the stock, he lowered his target price to $41 from $44. The average target on the Street is $43.04.

"With the stock trading at two-year lows, largely on the back of lingering weakness in the Marketing segment, we believe it would have been more prudent to wait until after the company can post a solid print in 4Q17/1Q18 to show the full-year effect of the new contract structure within that business and/or wait for additional project announcements to have a more visible use of proceeds, especially with a balance sheet that remained the strongest in the Canadian midstream peer group heading into 2018," he said.

Elsewhere, BMO Nesbitt Burns analyst Ben Pham lowered his target by a loonie to $43 with an "outperform" rating (unchanged).

Mr. Pham said: "While the $494-million offering was unexpected, it bolsters KEY's balance sheet ahead of what we see as continued upside to growth. With the shares down 8.5 per cent since Nov. 1 compared to the midstream group at  2 per cent, we would look to use the pull-back to position for what we see as a rising FCF story in 2018 along with rising take-or-pay exposure."

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Desjardins Securities analyst Benoit Poirier said he has increased confidence in the management of Canadian National Railway Co.'s (CNR-T, CNI-N) ability to address capacity issues after hosting a group lunch with a pair of its executives.

"Since the beginning of the year, CN has generated significant volume growth through its network (average RTM [revenue ton mile] growth of 14.4 per cent over the last three quarters or 10.5 per cent quarter-to-date)," said Mr. Poirier. "Since 2010, has CN significantly outperformed its peers, with RTM growing at a CAGR [compound annual growth rate] of 4.7 per cent over the period, significantly above the second-best performer, which grew at a CAGR of 2.3 per cent.

"For 2017, the growth was mainly above management's initial expectation for 2017 of 3-4 per cent (we currently forecast 10.6 per cent). The recovery in volume took management somewhat by surprise and called for further investment across the network. While capex [capital expenditures] has already been deployed to respond to this impressive growth, it takes time before the network is fully operational. Consequently, management expects volume to remain challenging until the end of 1Q when further capacity comes online."

Mr. Poirier said the railway company's management stressed three areas where " impressive growth has created some pinch points in the network." They are Wisconsin, the intermodal terminal in Brampton and Western corridor in Canada.

"Accordingly, management is currently investing in its network to bring operating metrics back in line with historical levels and drive bottom-line expansion," he said.

He added: "Management has discussed projects highlighted at its most recent investor day with its clients, and now has greater confidence in these opportunities. Overall, we are pleased at its level of confidence and believe these opportunities will help the company achieve our revenue forecast of $15.4-billion in 2020."

However, Mr. Poirier lowered his fiscal 2017 and 2018 earnings per share projections to $5.01 and $5.35, respectively, from $5.04 and $5.45 in order to account for the short-term capacity shortage.

He maintained a "buy" rating and $116 target for CN shares. The average target is $109.27.

"We are pleased with management's initiatives to address capacity issues," the analyst said. "Overall, we still believe CN should trade at a premium due to its superior growth profile, pristine balance sheet and solid track record."

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Calling it a "roll-up story still in its early stages," CIBC World Markets analyst Hamir Patel initiated coverage of Hardwoods Distribution Inc. (HWD-T) with an "outperformer" rating.

"Over the last six years, Hardwoods has completed six acquisitions, adding 39 locations in the U.S. with revenues totalling $535-million (52 per cent of last 12-month sales)," said Mr. Patel. "Over the same period, revenues, EBITDA [earnings before interest, taxes, depreciation and amortization] and EPS [earnings per share] have grown at CAGRs [compound annual growth rate] of 29 per cent, 45 per cent and 26 per cent, respectively. Growth has been even more aggressive on the Rugby side, where the management team there (still leading the division for Hardwoods) has completed and integrated 17 acquisitions since 2009.

"While Hardwoods is now the largest distributor of architectural building products in North America, and generates four times the revenues as the next-largest competitor, its market share in North America is still only in high single-digit territory. We see room for more acquisitions to further diversify the geographic distribution of its network and increase the company's exposure to the commercial end-market. Given Hardwoods' track record of making small to medium-size acquisitions in the 4-6-times trailing EBITDA range (oftentimes closer to 4 times), growth by acquisition can be highly accretive as the company trades at 9.3 times 2017 estimated EBITDA and its distributor peer group trades at 12.5 times 2017E EBITDA. While less accretive, the company could also scale up quickly if it acquires a few of the dozen Rugby-type targets in the industry [with these larger vendor expectations likely in the 8-times range now (pre-synergies)]."

Expecting U.S. housings starts to continue to increase, leading to increased revenue and market share gains, Mr. Patel also thinks corporate tax reform  south of the border will provide upside to his forecasts.

"If U.S. tax reform is enacted this could reduce the company's effective tax rate from 35 per cent presently to approximately 25 per cent (20-per-cent federal and 5-per-cent state)," he said. "All else being equal, this could result in a 15-per-cent increase to our 2019 EPS forecast from $1.65 to $1.90. This would represent upside to our valuation. While our $24/share price target is based on an EV/EBITDA multiple, it equates to 14.5 times 2019E EPS. Simplistically applying that same 14.5x multiple to our 2019 EPS estimate if U.S. tax reform is implemented ($1.90) suggests potential upside to our price target of over $3/share."

Touting its "attractive" current valuation, Mr. Patel set a price target of $24. The average is $24.20.

"Our price target is based on a 2019 estimated EV/EBITDA multiple of 9.0 times," he said. "We see room for multiple expansion in the building materials distribution industry as consolidation continues to play out. While the hardwoods segment is far more fragmented than the other segments of the distribution business, with no close comparables, multiple expansion in other corners of the distribution business may lead to investors affording Hardwoods a higher multiple as well."

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In other analyst actions:

Eight Capital analyst Stephen Gordon Theriault upgraded Royal Bank of Canada (RY-T, RY-N) to "buy" from "neutral" with a target of $107, which is a penny below the current consensus on the Street.

GMP analyst Michael P Dunn downgraded Baytex Energy Corp. (BTE-T, BTE-N) to "hold" from "buy" and lowered his target to $4.50 from $5. The average is $4.01.

Goldman Sachs analyst Eugene King upgraded First Quantum Minerals Ltd. (FM-T) to "buy" from "neutral."

Evercore ISI analyst Sheila McGrath downgraded Brookfield Property Partners LP (BPY-UN-T) to "in line" from "outperform."

Cormark Securities Inc. analyst Gavin Fairweather downgraded Pure Technologies Ltd.  (PUR-T) to "tender" from "buy" with a $9 target, up from $6. The consensus is $6.65.

M Partners Inc initiated coverage of Northern Empire Resources Corp. (NM-X) with a "buy" rating and $1.60 target.