Thursday's analyst upgrades and downgrades

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

National Bank Financial analyst Maxim Sytchev is expecting M&A activity to pick up for Toromont Industries Ltd. (TIH-T).

"While we often encounter fine print stipulating that 'past performance is not an indicator of future outcome,' as far as capital allocation is concerned, past actually provides very valuable clues about the thought process and likely timing/quantum/ type of capital commitment of a given corporate entity," he said. "Over the last 10 years, Toromont shares are up 167 per cent versus 10 per cent for TSX and a decline of 16 per cent for Finning. While a more favourable geographical skew is certainly a part of the outperformance story (Eastern Canada has been less cyclically-pronounced over the same time frame versus Alberta where the gyrations have had a greater amplitude), we do believe that it is the judicial capital allocation that shareholders in Toromont continue to appreciate as demonstrated by the above-average ROE [return on equity] generation.

"Here is the potentially $1(billion?) dollar question… When will Toromont once again pull a trigger on a relatively sizeable transaction … We argue that the timing is likely to be this year even though (admittedly) we are extrapolating from a very limited sample size. That being said, past corporate behaviour does create a very real what-if playbook, helping us guide our thought process; hence 'past performance' being indicative in our case."

Touting its "consistent" execution as well as "(some) mining tailwind" and material M&A optionality, Mr. Sytchev upgraded his rating for the Toronto-based company to "outperform" from "sector perform."

In anticipating timing of any M&A potential, Mr. Sytchev noted Toromont's leverage has "consistently" been below a net debt to EBITDA (earnings before interest, taxes, depreciation and amortization) multiple of 1.0 times. Accordingly, he said its "ability to pull a trigger on a transaction has always been there," emphasizing its "premium" valuation and 3.1-per-cent yield-to-maturity on its $150-million debentures.

Mr. Sytchev anticipates Toromont can make acquisitions of $500-million to $1-billion without equity raises, creating a "significant" lift to its 2018 earnings per share.

"Recall that management is very mindful of looking at businesses that generate a service component, sport a high ROE and do not compete against CAT's extensive range of equipment," he said. "In addition, any transaction involving a CAT dealer obviously requires a blessing from the OEM; hence, a lot of moving parts that are not entirely in Toromont's control. However, when examining the history of material capital deployment on the part of Toromont, it took place at or slightly post the timing of net debt / EBITDA cresting into a negative territory. More specifically, the $700-million Enerflex acquisition occurred in 2009 when after years of strong results and deleveraging, Toromont saw an opportunity (and arguably) at the bottom of the cycle to act.

"Fast forward to now and we are in a similar -0.5x net debt to EBITDA territory, with Toromont once again needing to think about capital deployment. The obvious caveat of course, is the longevity of the business cycle this time around as forecasts of an (eventual) recession tend to come across our desk more often now. Pre 2009, Toromont went through an acquisition spurt in 1996, having bought four business (all the shares of Battlefield Equipment Rentals, MBS Equipment, Coad Rentals and Newfoundland Tractor and Equipment Company)."

Mr. Sytchev raised his target price for Toromont shares to $52 from $46. The analyst consensus price target is $49.23, according to Thomson Reuters data.

"Recall that we have been tactical on TIH (while having a positive long-term positive view); with the stock now back to the levels of when we downgraded it in late December 2016 and what we view as improved M&A visibility, we are comfortable with this probabilistic approach," he said. "Essentially, we do not want to wake up one morning, see an announcement from Toromont and move our target to mid-$50's after the fact. We believe investors should adopt the same stance. On the other hand, we also believe it's more prudent than simply 'juicing' up the forward multiple in order to get to a higher target. With some of the froth coming off TIH on the back of what we saw as an in-line Q1/17 quarter … going long the name at these levels we believe once again is the right strategy."

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CAE Inc. (CAE-T, CAE-N) set a notable milestone in fiscal 2017, reaching the "elusive" dollar per share in earnings mark, said Raymond James analyst Ben Cherniavsky.

On Wednesday, the Quebec-based company, which provides training for the civil aviation, defence and security, and health care markets, reported fourth-quarter EPS of 25 cents, below the analyst's expectation of 31 cents and the 30-cent consensus. Adjusted for restructuring costs, the result was 31 cents.

It ended the fiscal year with EPS of $1.03.

"Investors who have been around a while will know that this has been a long-time coming: Back in fiscal 2001, when CAE first embarked on its training solutions strategy, our fiscal 2005 EPS estimate for the company was $1.00," said Mr. Cherniavksy. "Shortly thereafter the cycle collapsed and EPS troughed at 19 cents. After hitting the reset button, growth resumed and we projected EPS of $1.00 in fiscal 2010, which failed to transpire as well. Now, three cycles later, the target has finally been hit.

"The purpose of this history lesson is not just to show the cyclicality of CAE's EPS; rather, what's important is to emphasize the capital investments involved in this journey. In 2001 CAE's balance sheet totaled just $330-million of assets generating $890-million of revenue and $152-million of EBIT; by contrast, its fiscal 2017 assets are nearly 10 times higher ($3-billion) but generate only a little more than twice the revenue ($1.9-billion) and EBIT ($400-million). While today's CAE is bigger, more geographically diverse, and arguably more stable, we still struggle with its capital-intensity and relatively low returns. This — combined with our view that demand for simulation is still prone to downturns—is why we are reticent to 'pay up' for the stock at this point in time."

In reaction to the results, he raised his target price for the stock to $23 from $20.75. Consensus is $22.98.

He did not alter his "market perform" rating.

"Over the past 12 months, CAE's stock has broken out of the trading range in which it had been stuck over the previous 15 years," he said. "With fiscal 2017 EBIT landing just shy of our initial $400-million forecast one year ago, and rising 10 per cent year over year on an adjusted basis (up 8.7 per cent including the $64-million of restructuring charges taken over the last two years), we attribute the majority of the 33-per-cent TTM [trailing 12-month] share price gain (versus 9 per cent for the TSX) to multiple expansion. CAE has had some good news to report, and the aerospace sector is certainly in favour right now. However, in the absence of any game-changing corporate developments or upward revisions to our estimates over the last year, we cannot rationalize a rating upgrade at this much higher valuation level."

Elsewhere, Desjardins Securities analyst Benoit Poirier bumped his target to $25 from $23 with a "buy" rating.

Mr. Poirier said: "CAE reported decent 4Q results, with decent revenue and margins. The company also introduced positive FY18 guidance, supported by a record backlog and a strong bidding pipeline. Overall, we are maintaining our positive stance on CAE in light of the solid industry fundamentals, which should drive operating leverage and margin improvement. We also like CAE for its leading position in its markets and solid balance sheet, which provides potential for cash-deployment opportunities."

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Descartes Systems Group Inc.'s (DSGX-Q, DSG-T) "predictable and profitable" growth continues, according to Canaccord Genuity analyst David Hynes.

On Wednesday, the Waterloo, Ont.-based global provider of on-demand, cloud-based software-as-a-service (SaaS) solutions reported fourth-quarter revenues of $54.5-million, an increase of 11 per cent year over year, and EBITDA of $19-million, up 14 per cent. Both results met Mr. Hynes's projections.

Mr. Hynes said: "Recurring services revenue once again accounted for 97 per cent of the mix, gross margins were up 2 percentage points year-over-year driven by an increasing mix of data solutions revenue, and EBITDA advanced 14 per cent year over year, towards the high-end of 10-15-per-cent targets; early feedback and User Group customer conversations suggest that Datamyne (essentially trade statistics) has broad appeal within the base and management sees some interesting internal data projects that could be taken on with the incremental talent; management alluded to a healthy M&A pipeline and the firm remains well capitalized with nearly $55-million in balance sheet cash, a $150-million undrawn revolver, and a $500-million shelf on file; management continues to expect the business to operate in a 32-37-per-cent EBITDA margin range, which is top-tier in the SaaS space."

After minor increases to his 2018 and 2019 EBITDA estimates, he raised his target price for the stock to $28 (U.S.) from $26. Consensus is $25.80.

He continues to rate the stock a "buy."

"Descartes reported another solid quarter highlighted by in-line revenues, EBITDA margins of 35 per cent, and incremental color on the firm's recent ShipRush tuck-in acquisition," the analyst said. "Our positive view has been and continues to be predicated on the idea that this firm is operating at the intersection of several major trends in logistics: regulatory compliance in an increasingly complicated global landscape, data-driven optimization of logistics decisioning, and last-mile delivery coordination and efficiency. Each of these is a compelling standalone opportunity, but combine them and consider that Descartes is executing with best-in-class profitability and you have the makings of a very interesting business."

"This view has not been lost on investors, who are now valuing the stock at 25 times EV/FCF [enterprise value to free cash flow] on calendar 2018 estimate. Our view is that there's plenty of opportunity ahead for Descartes to execute against its strategy (modest organic growth, semi-regular M&A, and a focus on EBITDA growth), so we're willing to stick with our BUY at these levels. Thus, we think this is an expensive stock and an excellent business. DSGX is OK to buy here, but we'd be more aggressive on pullback."

Meanwhile, Raymond James analyst Steven Li increased his target to $27.50 from $24.50 with an "outperform" rating (unchanged).

"We continue to see a lot to like about Descartes: 85-per-cent-plus recurring revenues (transaction/subscription), 35-per-cent-plus EBITDA margins with 94-per-cent-plus CF [cash flow] conversion to boot. Some strong organic growth opportunities (trade content, omnichannel, security filings) are progressing well which coupled with its M&A strategy should sustain adjusted EBITDA growth of 15-20 per cent CAGR [compound annual growth rate] for the next few years."

BMO Nesbitt Burns analyst Thanos Moschopoulos raised his target to $26 from $22.50 with a "market perform" rating.

"We believe that Descartes can continue to execute successfully on its strategy of achieving 10-15-per-cent annualized adjusted EBITDA growth (including acquisitions)," said Mr. Moschopoulos. "However, while we believe Descartes is a well-managed business, we struggle with the stock's significant valuation premium relative to other software consolidators."

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Founders Advantage Capital Corp.'s (FCF-X) new credit facility "brings the story together," said Canaccord Genuity analyst Raveel Afzaal.

On Wednesday, the Calgary-based investment issuer announced that it has entered into a $75-million (U.S.) senior secured credit facility with Sagard Holdings ULC.  The proceeds are set to be used to repay its existing senior indebtedness, complete acquisitions and for general corporate purposes.

"After replacing the ATB credit facility, Founders should not only remain within debt covenants but also have up to $73-million (Canadian) available under the new credit facility to execute on new acquisitions," said Mr. Afzaal. "Furthermore, the company's updated EBITDA guidance increase confidence in our forecasts and provides support to its current share price."

Accordingly, he upgraded the company's stock to "buy" from "speculative buy."

"Founders new credit facility is with Sagard Holdings, which is a subsidiary of Power Corporation of Canada (POW-T)," he said. "Power Corp's investment portfolio includes Great-West Life Co, Mackenzie Investments and Investors Group. We highlight this fact to show that similar to Mosaic Capital's (M-T) recent partnership with Fairfax Financial (FFH-T), Founders Advantage too has been able to secure a well-capitalized and long-term strategic investor that could over time significantly expand the initial $75-million credit facility.

"The $75-million (U.S.) credit facility bears an interest rate of LIBOR plus 7 per cent and will have a five-year term. Our financial model already assumes an 8-per-cent interest rate to derive our estimates. The initial draw on this facility is  $42-million, with additional draws subject to Sagard's further approval. Founders provided Sagard with 1 million warrants exercisable at $3.51 per share and another 1 million warrants at $3.97 per share, implying 5-per-cent potential dilution."

He maintained a price target of $4.25 for the stock. Consensus is $4.56.

"Updated guidance helps back-fill current valuation," said Mr. Afzaal. "However, the existing portfolio companies contribute $3.60 per share if we assume existing portfolio companies generate $20-million in 2017 (in-line with management's guidance) which grows at our mid-single digit growth rates to $23-million by 2019. Hence, we see $1 per share upside to our target price if existing portfolio companies are able to perform in line with management's forecasts and Founders is able to complete new acquisition (we believe it is competitively positioned to execute on the latter, based on a robust acquisition pipeline and new credit facility)."

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Sun Communities Inc. (SUI-N) has visibility for "sustained outsized" growth, said RBC Dominion Securities analyst Neil Malkin.

He initiated coverage of the Michigan-based REIT, which has a portfolio of properties both in the United States and Ontario, with an "outperform" rating.

"SUI has produced comparable revenue growth of 5.1 per cent since 2010 and 6.1 per cent in 2016," said Mr. Malkin. "Through '19, we have forecasted a 4.4-per-cent revenue CAGR [compound annual growth rate] for SUI (ex. transient conversions) compared to a 3.0-per-cent CAGR for our multifamily universe. Healthy demand for SUI's affordable and highly amenitized housing and vacation offerings against a backdrop of non-existent supply has led to the strong operating results despite the low GDP growth environment. Additionally, SUI can continue to generate healthy internal growth from MH [manufactured home] occupancy gains, transient conversions, and expansion lease-up."

Mr. Malkin emphasized demographic trends "appear supportive" of its business model.

"The size and health of SUI's core demographic, those with an annual income of $30,000- $40,000 and generally less educational attainment, should remain a boon for the company," he said. "the largest income cohort in terms of working households makes $20,000-$45,000 per year. This represents the vast majority of Sun's targeted residents and gives the company a very large potential rental/owner pool from which to generate demand. What's more, significant amounts of equity needed for down payments and tightened postrecession lending standards make traditional housing (site built) less feasible for this demographic. From an educational standpoint, wages for less educated workers have kept pace with college-educated workers, actually producing modestly better wage growth since the start of this cycle. When looking at Sun's core income cohorts – those making $25,000-$45,000 annually – there has been a consistent and steady upward trend in consumer confidence."

"In our view, all of these undercurrents are likely to persist, which should increase demand for MH community ownership and allow SUI to continue to push rents around 3-per-cent per annum, while keeping move-outs low. From the RV side of the ledger, the large baby-boomer demographic (born between 1946-1964) should continue to drive demand as they look to downsize, increase flexibility, and pursue more leisure focused activities post-retirement (exhibit 5). Lastly, as demand continues to persist, we look for continued occupancy upside from current levels. For example, SUI's MH portfolio, which contains the lion's share of its sites, is currently 94.8% occupied. However, approximately 150 of SUI's 230 MH communities (65 per cent) have occupancy of 98% and above, thus giving the company several years of occupancy growth on a total portfolio basis. We have assumed a 150 basis points increase in occupancy in the same store portfolio through 2019."

He set a price target of $92. Consensus is $87.50.

"SUI has both good internal growth and external growth, which is hard to find at the moment," said Mr. Malkin. "SUI has room to run organically from expansion lease-up, transient conversions, and pricing power given a healthy supply/demand backdrop. SUI should continue to drive meaningful value creation via its expansion platform which has a backlog of 7-plus years."

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In other analyst actions:

Cormark Securities Inc. analyst Richard Gray upgraded Richmont Mines Inc. (RIC-T) to "buy" from "market perform" with an unchanged $14 target. The analyst average target price is $14.27, according to Bloomberg data.

Cormark Securities Inc. analyst Jeff Fenwick upgraded Element Fleet Management Corp. (EFN-T) to "buy" from "market perform" with an unchanged $13.25 target. The average is $14.08.