Thursday's analyst upgrades and downgrades

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

Royal Bank of Canada's (RY-T) indirect exposure to the oil and gas sector is the biggest issue facing the stock in the near term, according to Canaccord Genuity analyst Gabriel Dechaine.

"The 'story' of RY's first-quarter 2016 results was $120-million of provision for credit loss (PCLs) recorded in the bank's wholesale segment, driven by loan losses in the oil and gas portfolio (of which one syndicated loan represented two-thirds of the amount)," said Mr. Dechaine. "While clearly not a positive, wholesale loan losses can be volatile and this quarter may prove to be above trend. On the other hand, the 14-per-cent increase in Canadian retail PCLs, driven by higher credit card and personal loan losses, represents a more worrisome trend, in our view. To date, the market has focused most of its attention on the direct exposure to oil and gas lending, less so the indirect exposure. On this basis, RY has relatively higher exposure to lending in Alberta/Prairies than its peers, including an above-average level of credit card loans in the province (based on Golden Trust disclosures). With the Alberta unemployment rate climbing steadily, the bank's indirect oil & gas exposures will increasingly weigh on the stock, in our opinion."

Mr. Dechaine called the quarterly results from the bank's Canadian retail segment "disappointing," with 1-per-cent earnings growth falling below the results of its peers (including Bank of Montreal's 5-per-cent result and National Bank of Canada at 8 per cent).

He also suggested the bank's capital position could "re-emerge as an overhang" going forward.

"Last year, RY faced questions related to potential [global systemically important banks] designation that ultimately proved a non-issue," Mr. Dechaine said. "This year, we believe RY's capital overhang will be tied more to its: (1) relative [Common Equity Tier] 1 positioning that we expect to be at the low end of the peer group; (2) exposure to macro factors such as low rates that inflated the bank's pension liability, causing its CET 1 ratio to fall 9 basis points this quarter; (3) exposure to regulatory changes such as market risk-weighted asset (RWA) inflation, where RY's exposure is relatively more significant; and (4) potential downside due to credit downgrades in its corporate loan book. On the latter point, the bank quantified the impact of potential credit downgrades in the oil and gas book at 2-7 basis points, which is insignificant. We note, however, that RY also has 'topical' exposure to leveraged lending in the U.S. that may present additional downside risks from a capital standpoint."

With a "more conservative" PCL forecast, he lowered his target price for the stock to $72 from $81. The analyst average is $76.53, according to Bloomberg.

He maintained his "hold" rating.

Elsewhere, Cormark Securities analyst Meny Grauman downgraded the stock to "market perform" from "buy" with a target of $70 per share (down from $74,).

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Following the reduction in its guidance, CIBC World Markets analyst Arthur Grayfer downgraded Encana Corp. (ECA-N, ECA-T) to "sector underperformer" from "sector performer."

"Our downgrade is primarily based on the legacy cost structure of Encana's business, and the challenges it poses for sustainable growth relative to its peers," he said.

"We believe that management has done an admirable job with its core assets by pushing the envelope in terms of optimization of its practices, drilling and completion design, as well as lowering its costs. Beyond that, we believe there is significant upside from the asset base, but view Encana as being constrained in its ability to unlock that value in a reasonable time frame. In our view, the key risk to our [sector underperformer] rating is that Encana's depth of drilling inventory and NAV upside attract a hostile bid."

On Tuesday, along with the release of its fourth-quarter 2015 results, Encana said it expects production from its four key assets (Montney, Duvernay, Eagle Ford and Permian) to drop by an estimated 10 per cent this year. It also cut its budget to between $900-million and $1-billion, down substantially from the $1.5-billion to $1.7-billion it expected to spend as recently as December.

Mr. Grayfer said that, based on its revised spending plans of  approximately $950-million, he expects the company's "core four" assets decline from 275,000 barrels of oil equivalent (boe/d) at the end of 2015 to 245,000 boe/d at the end of 2016.

"In our view, the challenge for the company is that it needs capex of $1.1-billion in 2017 to stay flat on the core four, which requires a WTI price of $60 (U.S.) per barrel  for cash flow to match cape," he said. "This compares to $36/bbl to $50/bbl for other companies under coverage, which places Encana at a disadvantage on a relative basis. To get back to above 275,000 boe/d for the core four by the end of 2017, capex needs to be over $1.7-billion, which requires a WTI price of above $70/bbl for cash flow neutrality (or much higher gas prices). The risk we see is that a continual stream of dispositions or dilutive events are required, unless oil prices are much higher, for Encana to achieve sustainable growth."

He added: "We are cognizant that Encana offers meaningful torque to improving oil prices given its lower cash flow netback (transportation plus interest costs are $10/bbl), and that the sum-of-parts net asset value (NAV) offers a meaningful break-up value. Based on these reasons, Encana will likely outpace its peers as oil prices begin their climb higher."

Mr. Grayer lowered his cash flow per share projections for 2016 and 2017 to 96 cents and $1.73 from $1.05 and $2.25, respectively. He maintained an earnings per share projection of a loss of 50 cents for 2016 while lowering his 2017 estimate to 21 cents from 44 cents.

He also lowered his target price for the stock to $4.25 from $5.50. The analyst average is $6.58.

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Though he said the 2016 outlook for Lucara Diamond Corp. (LUC-T) is unchanged following the release of its fourth-quarter results, BMO Nesbitt Burns analyst Edward Sterck downgraded the stock based on price appreciation and the belief it is "fully valued."

On Wednesday, Lucara reported adjusted earnings per share of 3 cents (U.S.), missing the consensus forecast of 5 cents. He noted higher revenues were offset by increased costs and taxes. Combined with a cash balance of $135-million (up from $123-million in the previous quarter) and no debt, the company introduced a progressive dividend to be paid quarterly of 1.5 cents (Canadian) per share on March 31.

Mr. Sterck noted the company's share price has increased by almost 20 per cent since November and is currently trading close to his target of $2.40.

"Due to its unique production profile, Lucara is in a healthy position relative to its peers where demand for exceptional diamonds remains robust," he said. "However, pending the sales of the 1,111 carat (ct) type IIa and the 836 ct diamonds, we expect the stock to trend sideways. Reflecting the share price performance and that it now appears to be fully valued, we downgrade Lucara."

His rating moved to "market perform" from "market outperform." He did not change his target price, compared to a consensus of $3.04.

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Despite surprisingly low 2016 earnings guidance, Raymond James analyst Kenric Tyghe said he remains a buyer of Gildan Activewear Inc. (GIL-N, GIL-T) at its current level.

On Wednesday, the Montreal-based company reported fourth-quarter 2015 earnings per share of 28 cents (U.S.), meeting the analysts' consensus projection, despite what Mr. Tyghe called a "challenging backdrop."

"Gildan's better than expected share gains in retail and T-shirt sell-through in wholesale were offset by the negative mix impact of lower fleece for in line results," he said.

However, the company's full-year 2016 EPS guidance of $1.50-$1.60 fell well below the consensus estimate of $1.78.

"While the 2016 outlook was a negative surprise … the levers on the 2016 guide, combined with a 20-per-cent dividend increase and a new normal-course issuer bid (NCIB), cushioned the blow," the analyst said. "With the outlook essentially driven by higher-than-expected price investment in the printwear segment to aggressively grow share in fashion basics and performance wear (where Gildan has less than a 10-per-cent share), we believe investors should look through the disappointing EPS outlook. In addition, the decision to focus capacity expansion on Rio Nance (RN) VI (which will now be approximately 30 per cent larger than RN V and capable of producing an estimated 40 million dozens), serves to highlight both the urgency to bring new capacity on stream and de-risk the capacity expansion."

In reaction to the company's announcement, Mr. Tyghe lowered his 2016 EPS estimate to $1.60 from $1.87. His 2017 projection fell to $1.92 from $2.12. He also dropped his revenue projections to $2.636-billion and $2.894-billion from $2.769-billion and $2.954-billion, respectively.

Maintaining his "strong buy" rating for the stock, he lowered his price target to $34 from $38. The analyst average is $30.86, according to Bloomberg.

"Our new $34 target price is based on target multiples of 20.0 times 2016 estimated EPS and 16.0 times 2016 estimated EBITDA, which are a touch below Gildan's three-year average multiples of 21.0- times and 17.0 times, respectively," said Mr. Tyghe. "We believe our target multiples are well supported given the traction of Gildan's retail strategy (and brand), an improvement in the U.S. macro (and retail) backdrops, and current cotton market dynamics."

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Tamarack Valley Energy Ltd. (TVE-T) is "poised to separate from the pack," said BMO Nesbitt Burns analyst Ray Kwan.

Following the release of the company's year-end 2015 reserves, Mr. Kwan upgraded his rating for the stock to "outperform" from "market perform."

Tamarack reported 44.9 million barrels of oil equivalent (mmboe) of 2P reserves, an increase per fully diluted share of 5.1 per cent year over year. All-in finding, development and acquisition costs (FD&A) were $13.26 per barrel of oil equivalent for IP and $7.20/boe for 2P, a "significant" drop from $38.98 and $27.50, respectively, from 2014.

"Separately, Tamarack Valley provided a broader 2016 guidance range to adapt to the current volatile pricing environment," said Mr. Kwan. "Capital expenditures are expected to range between $40-million and $57-million (versus $52-57-million previously), while average production guidance is anticipated to be 8,700-9,700 boe/d (51-57 per cent liquids) versus 9,500-9,700 boe/d."

Mr. Kwan called the results "positive," saying: "Despite the tough operating conditions in 2015, Tamarack generated strong capital efficiency metrics, which we believe should rank top-quartile within the oily weighted peer group. In addition, we view the broader guidance range as positive and highlights the flexibility of Tamarack's business model. We also believe the lower capital program will allow for Tamarack to pursue small tuck-in acquisitions."

He also increased his target price to $4 from $3.50. The analyst consensus price target is $3.91, according to Thomson Reuters.

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In other analyst actions:

Calfrac Well Services Ltd (CFW-T) was raised to "market perform" from "underperform" at Raymond James by equity analyst Andrew Bradford. The 12-month target price is $1 (Canadian) per share. It was downgraded to "sell" from "hold" at Paradigm Capital by equity analyst Jason Tucker with a 12-month target price of 90 cents per share.

Charter Communications Inc (CHTR-Q) was raised to "overweight" from "neutral" at JPMorgan by equity analyst Philip Cusick. The 12-month target price is $210 (U.S.) per share.

Memorial Resource Development Corp (MRD-Q) was raised to "strong buy" from "outperform" at Raymond James by equity analyst John Freeman. The 12-month target price is $20 (U.S.) per share.

Morguard North American Residential Real Estate Investment Trust (MRG.UN-T) was raised to "buy" from "neutral" at Dundee by equity analyst Frederic Blondeau. The 12-month target price is $13.50 (Canadian) per share.

Microsemi Corp (MSCC-Q) was raised to "top pick" from "outperform" at RBC Capital by equity analyst Mitch Steves. The 12-month target price is $46 (U.S.) per share.

Mettrum Health Corp (MT-X) was downgraded to "neutral" from "buy" at Dundee by equity analyst Aaron Salz. The 12-month target price is $1.90 (Canadian) per share.

Omega Healthcare Investors Inc (OHI-N) was raised to "buy" from "hold" at Jefferies by equity analyst Omotayo Okusanya. The 12-month target price is $35 (U.S.) per share.

PHX Energy Services Corp (PHX-T) was raised to "outperform" from market perform" at FirstEnergy Capital by equity analyst Ian Gillies. The 12-month target price is $2.50 (Canadian) per share.

Insulet Corp (PODD-Q) was rated new "sell" at Empire Asset Management by equity analyst Cathy Reese. The 12-month target price is $15 (U.S.) per share.

Bankrate Inc (RATE-N) was downgraded to "hold" from "buy" at Topeka Capital by equity analyst Blake Harper. The 12-month target price is $9 (U.S.) per share. It was downgraded to "sector perform" from "outperform" at RBC Capital by equity analyst Rohit Kulkarni with a 12-month target price of $9 per share.

Restoration Hardware Holdings Inc (RH-N) was downgraded to "neutral" from "outperform" at Robert Baird by equity analyst Peter Benedict. The 12-month target price is $52.00 per share. It was downgraded to "sector weight" from "overweight" at KeyBanc by equity analyst Bradley Thomas.

With files from Bloomberg News