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Thursday’s analyst upgrades and downgrades

TricanWell Service employees work around liquid nitrogen storage tanks at a hydraulic fracturing operation near Bowden, Alta.

Jeff McIntosh/The Globe and Mail

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

Trican Well Service Ltd.'s (TCW-T) acquisition of Canyon Services Group Inc. (FRC-T) drives "much needed" consolidation in the Western Canada Sedimentary Basin (WCSB) oilfield, said Canaccord Genuity analyst John Bereznicki.

On Wednesday, the companies announced the all-stock deal valued at $637-million, including the assumption of $40-million in Canyon debt. Trican is offering 1.7 of its shares for each Canyon share.

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Mr. Bereznicki sees the transaction as "attractive" to shareholders and feels the probability of a competing bid is low.

"Trican expects to extract significant cost synergy out of this acquisition and believes operating scale has become increasingly important given the growing logistical challenges of the pumping business," he said. "According to management, $20-million in cost synergies reflects only "low-hanging fruit" and the company believes it could extract a further $7 to $8-million in savings as it consolidates overlapping real estate. In addition, Trican believes it could likely realize longer-term procurement savings through greater bargaining power with suppliers as a larger entity."

"Management from both companies reiterated their views that labour remains the primary constraint for the industry as idle equipment is returned to the field. Canyon recently estimated only 60 per cent to 70 per cent of the two million HHP [hydraulic horsepower] in Canada is currently crewed and believes it could take two to three quarters before there is a meaningful migration of workers returning to the oil patch ('Help wanted'). Both Trican and Canyon believe a larger combined entity will enhance Trican's ability to attract new labour."

In response to the deal, Mr. Bereznicki downgraded his rating for Canyon stock to "hold" from "buy" and dropped his target price to $6.15 from $9 in order to approximate Trican's offer at Wednesday's close. The analyst consensus price target is $8.82, according to Thomson Reuters.

He maintained a "buy" rating and $7 target for Trican. Consensus is $6.20.

"In addition to the operating benefits … we also believe this acquisition will greatly improve market liquidity for both Trican and Canyon shareholders," the analyst said. "Based on [Wednesday's] close, the market capitalization of the combined entity will be $1.2-billion which management believes will be sufficient to warrant Index inclusion (which could also drive positive fund flows)."

Elsewhere, GMP analyst Ian Gillies downgraded Canyon to "tender" from "buy" and raised his target to $11.73 from $9.50.

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RBC Dominion Securities analyst Douglas Miehm lowered his target price for shares of Valeant Pharmaceuticals International Inc. (VRX-N, VRX-T) to reflect its recent refinancing and adjustments to his outlook for Siliq.

"We note that the recent refinancing has removed financial maintenance covenants from VRX's term loans, which provides the company with additional flexibility," said Mr. Miehm. "We have updated our model to account for the recent refinancing, with 2017 estimated year-end net debt of $26.6-billion (previously $26.4-billion) and 2018 estimated year-end net debt of $25.3-billion (previously $24.8-billion).

"As per the [AstraZeneca] agreement, Valeant will recognize U.S. net revenues associated with Siliq and split profits with AZ (reflected as an expense). We ultimately forecast a 60–70-per-cent peak profit margin on Siliq. Our prior forecasts had 50 per cent of revenues recognized by Valeant. We note that our Siliq revenues actually decrease from $39-million to $34-million in 2017 due to a slightly slower launch and increase from $170-million to $200-million in 2018. Our new revenues for Siliq reflect 50–70 per cent of the expected Taltz revenues over the initial 18 months of its ongoing launch, which reflects the more onerous label for Siliq. We now have a $9-million incremental expense in 2017 and $55-million in 2018 associated with AZ profit sharing."

After lowering his revenue forecasts, Mr. Miehm's earnings per share projections for 2017 fell to $4.36 (U.S.) from $4.53, while his 2018 estimated moved to $4.36 from $5.19.

"Valeant commentary that 51–52 per cent of revenues will occur in the second half of 2017 could indicate more aggressive Siliq and Xifaxan forecasts," he said. "We note that on its Q4/16 call, management indicated it anticipates 48–49 per cent of revenues to be generated in the first half of 2017 and 51–52 per cent in the second half. While this does not include divestitures of L'Oreal ($168-million in revenues) and Dendreon ($290-million in revenues), we believe this could signal more aggressive Siliq and Xifaxan forecasts in the second half relative to our outlook. We note that if the dermatology assets and Dendreon are added back to our revenue forecasts, our split is 49.8 per cent H1 and 50.2 per cent H2. As such, we believe investors should closely monitor: (i) the impact that the new Xifaxan sales force will have on sales in H2/17; and (ii) the launch of Siliq in Q3/17, especially relative to Taltz, the most recent moderate to severe psoriasis drug approved."

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He maintained a "sector perform" rating for the stock. His target fell to $18 (U.S.) from $21, versus the consensus of $17.53.

"Our $18 price target is based on applying an 8.6x multiple to our 2018 adjusted EBITDA estimate of $3.67-billion to generate a $17.84 valuation," said Mr. Miehm. "The 8.6 times multiple is an 0.5-times discount to the Specialty Pharma group. We believe a discount is warranted owing to the heightened risk profile that Valeant faces due to ongoing government investigations and continued organizational issues."

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Though its prospects have improved, Amaya Inc.'s (AYA-T, AYA-Q) potential upside is not high enough to compensate for its elevated balance sheet leverage, said Desjardins Securities analyst Maher Yaghi.

On Wednesday, the Montreal-based gaming company reported fourth-quarter 2016 financial results that largely met its late January guidance update. Revenues of $310.4-million (U.S.) were in line with the consensus expectation ($308-million) and Mr. Yaghi's projection ($312.5-million), and were also with the implied guidance of $307.5-$312.5-million.

"Poker revenues of $217.2-million (down 5 per cent year over year) were slightly below our estimate; however, the company did report that constant-currency poker revenues—which are more reliable to forecast customer trends, in our view—were only down 1 per cent," the analyst said. "Poker revenues are a key metric to evaluate the company's prospects, and we have been highlighting this sluggish performance as a reason why we are not bullish on the stock. The company indicated on the call that it expects flat poker revenues in 2017, which we believe is reachable given it reported 4-per-cent growth in poker in January and February (3 per cent in constant currency). Quarterly active uniques (QAU) were also in line with guidance provided in January, but were still strong at 2.61 million, up 7.4 per cent. Constant-currency quarterly net yield was up 3.5 per cent year over year; however, this metric's year-over-year growth has decreased significantly since 1Q16. 888 Holdings, one of Amaya's closest peers, is also experiencing similar trends — a growing casino business and declining constant-currency poker business—leading us to believe the softness in poker results is not generally due to declining market share."

Mr. Yaghi expressed optimism about the company's "decent" guidance for 2017. It is forecasting revenues of $1.20–$1.26-billion (U.S.), compared to his projection of $1.29-billion and the $1.26-billion consensus. Its EBITDA forecast of $560–580-million topped the consensus ($557-million) while falling below his estimate ($596-million).

"We believe that EBITDA guidance is above consensus because the company has rolled out its operational excellence program, which we had already included in our estimates," said Mr. Yaghi. "Management indicated that its 2017 forecast includes the Australian operations until the end of April. We believe the expected outperformance of adjusted EPS vs adjusted EBITDA is due also to the renegotiation of the first-lien term loan, which is expected to save AYA $15-million in interest payments annually. The renegotiation of the loan will also give the company a waiver on using excess FCF [free cash flow] to make prepayments on the debt. Instead, it will be able to direct excess FCF to pay some of the remaining amount due on the deferred purchase price."

He added: "Odds of an equity issue decreased significantly during the quarter, as the company entered into an agreement to delay the payment due to former owners of the Rational Group. Basically, the previous owners agreed they would not force Amaya to issue equity during the course of 2017, even though a clause allowing them to do so was included in the initial agreement. Overall, this announcement was a positive for Amaya, as we believe some investors believed an equity issue may have been on the table in order to meet the obligation. The company indicated on the call that it expected the remaining amount of $122.5-million left on this obligation to be 'fully repaid by the end of the first half of 2017 using cash on the balance sheet and cash flow from operations.' Our current FCF forecast leads us to believe this goal is attainable. Once this payment is behind AYA, we believe the company will focus on debt reduction given that the balance sheet is still highly levered (net debt to EBITDA is at 4.4x at the moment)."

In reaction to the results and guidance, Mr. Yaghi slightly lowered his revenue and EBITDA projections for 2017. His adjusted earnings per share projection rose to $2.07 from $1.94.

"The company is still looking for a new CFO after a year that brought many management changes. No update was provided with regard to the Kentucky lawsuit, which is still an overhang on the stock," he said. "Net debt to EBITDA has improved in the quarter, but is still relatively high at 4.4 times. Management did hint that it is looking at possibly making some acquisitions in the casino or sports book segments in order to gain operational leverage. Given current leverage levels, we think any sizeable acquisition would likely require equity. We are also introducing our 2018 estimates. For the year, we expect revenue to increase 7.5 per cent (casino 21 per cent, poker 0.5 per cent) and adjusted EBITDA to grow 7.7 per cent."

With a "hold" rating, his target jumped by a loonie to $23.50. Consensus is $19.61.

"We would wait for further steady quarterly results with improving FCF growth trends before becoming more bullish on the name," said Mr. Yaghi.

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RBC Dominion Securities analyst Walter Spracklin downgraded Norfolk Southern Corp. (NSC-N), seeing the stock's risk/return as "unappealing."

Moving it to "underperform" from "sector perform," Mr. Spracklin said the railway company's valuation is "baking in (increasingly challenging) efficiency progress."

"NSC shares are up 22 per cent since November of last year, with a share price performance that has largely outpaced peers (ex-CSX)," he said. "The 2018 earnings multiple has now risen to 19.5 times 2017 estimate, the highest among the majors ex-CSX and certainly a high relative to historical. We believe this relative premium is effectively baking in a high likelihood that NSC will make significant progress in achieving its O/R [operating ratio] targets - targets we see as increasingly more challenging."

Mr. Spracklin believes the company will struggle to meet its "ambitious" efficiency targets of an operating ratio of less than 65 per cent and $650-million (U.S.) in annual productivity savings by 2020. He cited elevated risk in achieving risks given "slowing pace of gains during 2016, right-sizing efforts that appear front-end loaded and rising compensation costs."

"When providing 2016 guidance over a year ago, management was very forthcoming with targets and underlying assumptions (no doubt fueled by the unsolicited bid by CP at the time)," he said. "And indeed, 2016 did see significant inroads with $250MM in efficiency savings, on the back of a 2,400 headcount reduction. However, when announcing its 2017 guidance this past January, management was far less transparent. Management this year guided to $100-million in productivity savings, but did not provide the underlying specifics on revenue assumptions or O/R targets. Further, management noted that savings would come on the back of no change in headcount, a Comp & Benefit headwind of 5 per cent and a 160 basis points increase in tax rate year over year. This suggests that further savings are very much contingent on top line growth, not cost reductions. If true, we would view this as less favourable, especially given that top line drivers would not be exclusive to NSC (and thereby make a relative premium less warranted)."

Mr. Stracklin said his cautious view on its ability to meet its targets have caused him to project earnings per share below the Street's expectations. For 2017, his estimate is $6.03, versus the $6.15 consensus. His 2018 estimate is $6.71, versus $6.87.

The analyst maintained a price target of $113 (U.S.) for the stock. Consensus is currently $119.29.

"We believe the current valuation of NSC shares is stretched," he said.

"We highlight that NSC recently reached a 4-point premium to its 5-year average price to earnings (2018 estimate basis), compared to a 2-point premium awarded to peers during the same period. Moreover, NSC recently reached a 0.7-point premium (2018E basis) to the group (1-point premium excluding CSX), which bucks a historic trend of trading at a 1.3-point discount to the peer average. Given the risks to achieving the 2020 targets as detailed above, and the existing business mix challenges due to the structural decline in Coal markets, we believe the valuation is stretched. Further, positive sentiment surrounding potential operating gains at peers could also be a factor pushing the valuation higher. Should actual 2017 performance run shy of the implied annual targets ($100-miullion in productivity savings and an O/R improvement of 98 basis points) we believe the premium multiple could undergo contraction towards the long-term discount to peers."

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WPT Industrial Real Estate Investment Trust (WIR.U-T) continued its "solid" operating momentum in the fourth quarter, said BMO Nesbitt Burns analyst Troy MacLean.

On March 16, the Toronto-based REIT reported quarterly funds from operations per unit of 21.5 cents, in line with the 22-cent projection of both Mr. MacLean and the Street and up from 18 cents in the previous year. In explaining the beat, Mr. MacLean pointed to same property net operating income growth, acquisitions, a straight-line rent adjustment and lower strategic review costs.

Noting leasing is "on track" for 2017, Mr. MacLean said WPT is showing solid organic growth.

"SPNOI rose 3.6 per cent in Q4 and 3.1 per cent in fiscal 2016," he said. "Organic growth benefited from annual step rents, higher rents on renewal, and occupancy gains. Q4 SPNOI rose 1.3 per cent quarter over quarter, which supports our positive outlook on 2017 organic growth. We also expect 2017 and 2018 organic growth will benefit from the Zulily renewal (3.8 per cent of annual base rent at Q4, which will increase by 12.4 per cent in April 2017 with an annual 2.0-per-cent increase thereafter)."

Mr. MacLean maintained an "outperform" rating for the stock. He raised his target price to $13.50 from $12.20 "based on a higher NAV [net asset value] estimate and the application of a premium to NAV, which we think is justified by favourable property fundamentals and the prospect for continued solid SPNOI growth." Consensus is $13.06.

"Our positive outlook is based on the REIT's favorable organic growth outlook and the solid property fundamentals in most of its markets," he said.

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Credit Suisse analyst Edward Kelly lowered Dollar General Corp. (DG-N) to "underperform" from "neutral," calling the retailer's expectations "too optimistic."

"DG's long-term growth algorithm looks unachievable, as increasing competition and rising cost pressures should weigh on earnings for some time," said Mr. Kelly. "While Q4 beat low expectations, the update highlighted underlying concerns related to sales momentum, margin sustainability, and the logic behind ramping openings to 1,000 stores per year. We believe DG will ultimately be forced to reset expectations and disappoint a street consensus that has assumed a reacceleration to 10% annual growth after a flat 2017."

Mr. Kelly said the company is likely to face "sustained" competitive pressures, which will affect both its comparable same-store sales and margins moving forward.

"DG's comps at mature stores turned negative and margins have declined, due in part to increased price competition," the analyst said. "While management seemingly expects the environment to normalize after 2017, this is unlikely given competitors' focus on food and consumables to drive traffic. The expansion of hard discount only exacerbates the problem over time. We believe DG will be forced to invest further in price to drive comps, resulting in weaker margins than expected."

Mr. Kelly dropped his target for the stock to $62 (U.S.) from $69. Consensus is $79.39.

"DG's stock price is well off its summer 2016 high, but still trades at just over 9 times EBITDA," he said. "It's at a premium to [Dollar Tree Inc.] for the first time since that company announced its acquisition of [Family Dollar] and not inexpensive relative to its historical gap to large cap food and staples retailers."

"We see risk to valuation if the company ultimately disappoints on its return to 10-per-cent earnings growth. Our grey sky scenario has the stock trading below $55 if earnings are flat once again in 2018, which would assign a multiple of 7.5 times to 2018 EBITDA. Our blue sky scenario assumes the company can hit consensus and achieve its long-term target in 2018, which we see yielding a stock price of about $85 based on a multiple of 10.0 times EBITDA. Our $62 target price assumes a weighted average using a 60/40 probability of each scenario, discounted back a year."

At the same time, Mr. Kelly called Dollar Tree Inc.'s (DLTR-Q) risk/reward proposition "more balance," upgrading the stock to "neutral" from "underperform."

"We have been negative on the stock given concerns about the FDO transaction," he said. "Challenges clearly remain, particularly given the deteriorating industry backdrop, as most industry participants seemingly need to invest to sustain share. However, DLTR differentiates itself at this point by having the resources at its disposal to address its momentum in transaction synergies. It may be one of the few large cap staples retailers to actually grow earnings in 2017."

He maintained a target of $73. Consensus is $89.43.

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In other analyst actions:

TD Securities analyst Jonathan Kelcher upgraded InterRent Real Estate Investment Trust (IIP.UN-T) to "buy" from "hold." His target rose to $9 from $8.50. The analyst average target is $8.49, according to Bloomberg.

B Riley & Co analyst Eric Wold initiated coverage of DHX Media Ltd. (DHX.B-T) with a recommendation of "buy" and $7.75 target. The average is $8.02

Pattern Energy Group Inc. (PEG-T) was downgraded to "neutral" from "outperform" at Macquarie by analyst James Ward. His target fell to $27 from $35, versus the average of $33.64.

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