Tuesday's analyst upgrades and downgrades

Share

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

Though he remains confident Valeant Pharmaceuticals International Inc. (VRX-N, VRX-T) has several "high quality" businesses, RBC Dominion Securities analyst Douglas Miehem says "unresolved issues" limit his ability to maintain conviction on its shares.

Following Monday's announcement that Valeant is the subject of a probe by the U.S. Securities and Exchange Commission, Mr. Miehem downgraded his rating for the Laval, Que.-based company to "sector perform" from "outperform."

"With respect to the SEC probe, VRX confirmed that it received a subpoena from the SEC in the fourth-quarter 2015 and intended to include it in its 2015 10-K disclosures," said Mr. Miehm. "Details of the probe were not provided, but we believe that if VRX counsel did not see it as necessary to disclose the subpoena at the time received, then it was likely viewed as a 'minor' issue. Even so, this is yet another element that investors will want clarity on before the valuation multiple is expanded. As such, management and board credibility may, unfortunately, be further eroded in the short term. In addition, it will likely lead investors to question what remains undisclosed today that may be released with the 10-K."

Mr. Miehm added: "Our ability to have high conviction [toward the company's outlook] is impaired at present. We had previously highlighted headline risk in Q1 and Q2 of 2016 but expected strengthening operations through the year to lead to multiple expansion later in 2016. While we still believe operations will improve, especially given the recently announced, unique Walgreens access program, our lack of visibility on various issues makes it difficult to call for an expansion in the multiple at present."

The analyst believes the stock will trade at a discount to its peers in the near term given the issues surrounding the company. He pointed to the following issues: a delayed 10-K filing and fourth-quarter 2015 results; guidance withdrawal; ongoing SEC investigations; an ad hoc committee of board members reviewing the company's Philidor and accounting issues; and its "potentially strained relationships with constituents in the U.S. health-care system," including managed care organizations and pharmacy benefit managers (PBMs).

He dropped his target price for the stock to $85 (U.S.) from $194. The analyst average price target is $140.15, according to Bloomberg.

"Our $85 price target (previously $194) is based on applying a 7.25-times multiple to our 2017 adjusted EBITDA estimate of $7.8-billion (previously 12.0 times EPS of $16.18)," said Mr. Miehm. "The target multiple reflects uncertainty relating to ongoing regulatory concerns, the strategic/growth outlook of the company in 2016 due to the withdrawal of guidance, and potential residual Philidor network problems. The multiple represents a 10-per-cent discount to the group average of 8.0 times. While we had previously utilized an enterprise value/EBITDA multiple to support our price/earnings valuation, we believe that given the lack of visibility at present, a focus on the levered balance sheet must be considered with greater weight. The valuation is supported by a discounted cash flow value of $85.97 (disc rate 15 per cent and terminal growth 1.5 per cent — we would expect to lower the admittedly high discount rate once we have greater clarity on operations)."

Elsewhere, TD Securities analyst Lennox Gibson downgraded the stock to "hold" from "buy" and dropped his target price to $110 from $155.

Deutsche Bank analyst Gregg Gilbert suspended his rating and estimates for Valeant. He previously had a  "hold" rating for the stock and a target of $140 (U.S.)

"We have long been skeptical of the VRX business model that had formerly depended heavily on fast-paced acquisitions, aggressive cost cutting, tax arbitrage, aggressive U.S. price increases, and a heavy debt load," said Mr. Gilbert. "As the company transitions to more of an 'organic' execution and de-leveraging story, it will become increasingly important, if not crucial, to be able to track the company's financial performance. With the stock having sold off significantly, and with some other analysts having become more cautious, we would acknowledge that the risk/reward profile of the stock has become more interesting."

=====

Dorel Industries Inc.'s (DII.B-T) bicycle division might have no choice but to join the major discount war that has broken out between its three big U.S. rivals and see pressure on its profit margins ratchet up, says TD Securities analyst Derek Lessard.

There are signs that a "massive inventory glut" is resulting in early-season discounting by the Big 3 players – Specialized, Trek and Giant – and Dorel's Cannondale brand may have to enter the fray, Mr. Lessard said.

Mr. Lessard is downgrading Dorel shares to "reduce" from "buy" as "the significant earnings recovery we were forecasting in 2016 likely gets pushed back at least by another year."

Montreal-based Dorel's balance sheet is "significantly weaker" than it was the last time there was a bicycle discount war, in 2013, he said.

Industry reports indicate that discounting at retail ranges from $50 (U.S.) to $800 and the activity is taking place in the spring, much earlier than the usual late-summer/early-fall period for price chopping, Mr. Lessard said.

Cannondale "may have little choice but to follow the leaders, in our view."

"We were expecting the premium bike business to turn the corner in Q4/15 on easing [foreign exchange] pressure, continued bike demand, new model introductions, and muted discounting. However, the big-3 have recently turned up the promotional heat and we expect Cannondale to follow suit which in turn will apply substantial pressure on margins," Mr. Lessard said.

Dorel, which is also in home furniture and juvenile products such as car seats and strollers, acquired Cannondale in 2008 for $202-million (Canadian). Other bicycle brands it owns include Schwinn, Mongoose and GT.

Dorel also has a majority stake in Brazil's largest bicycle company, Caloi.

Mr. Lessard is reducing his 12-month target on Dorel to $26 from $36 and is "now assuming no growth in Dorel Sports profitability in 2016 due to the anticipated promotion-driven margin pressure." The analyst consensus is $37.78.

The odds of a dividend cut "down the road have risen," he adds.

=====

Operating pressures for Artis Real Estate Investment Trust (AX.UN-T) are expected to persist throughout 2016, impacting both operations and property values, according to BMO Nesbitt Burns analyst Heather Kirk.

Though the company's fourth-quarter funds from operations (FFO) of 38 cents met her forecast (39 cents), Ms. Kirk downgraded her rating for the REIT to "market perform" from "outperform."

"We view the REIT as well positioned to navigate the challenges of the demand/supply imbalance in the Alberta office market; however, we expect continued pressure on both operating performance and asset values in this portfolio segment," said Ms. Kirk.

She noted Artis' portfolio includes 6.7 million square feet in Alberta, which accounts for almost 35 per cent of its net operating income.

"The REIT took a $252-million ($1.80 per unit) fair value write-down in the fourth quarter 2015, which was largely the result of the economic downturn in Alberta and continued downward pressure on market rents, most notably in the Calgary office," she said. "Operationally, Canadian same-property net operating income (SPNOI) was [down] 0.7 per cent due to a 10.7-per-cent  slide in Alberta, which dragged the Canadian average down to negative 4.8 per cent. U.S. SPNOI was [up] 19.4 per cent on FX; however, as the Canadian dollar stabilizes, we expect this hedge to low oil to wane."

Though Ms. Kirk said she feels the REIT's 8.7-per-cent yield is "secure" given its 85-per-cent payout rate, she lowered her target price to $13.50 from $15.25. The analyst consensus target is $15.43, according to Thomson Reuters.

=====

Industrial Alliance Securities analyst Dylan Steuart said Monday's announcement from Home Capital Group Inc. (HCG-T) that long-time chief executive officer Gerald Soloway is retiring does not change his "largely favourable" view of the company.

However, Mr. Steuart downgraded his rating for the Toronto-based company to "buy" from "strong buy" based on share price appreciation.

"HCG has shown considerable share appreciation since the start of the year, up 26.3 per cent in the year to date (compared to a negative 3.3-per-cent performance for the peer domestic lenders)," he said. "The stock has rallied due to: 1) Q4/15 results that were largely in line with consensus expectations; 2) a dividend increase of 9 per cent announced last quarter; and 3) the announcement of a $150-million share buyback via a substantial issuer bid."

"Regarding the share repurchase, the regulatory filing is expected to be issued in 'weeks,' so it should be a near-term event. The repurchase would represent [approximately] 6-7 per cent of the outstanding shares."

Mr. Steuart maintained a target price of $39 for the stock, compared to a consensus target of $34.60. He noted: "[We] still see upside to current valuation (17.5 per cent to our target valuation) particularly with the expected implementation of the announced share buyback in short order."

"The announcement of the CEO transition does not alter our largely favourable view of HCG as the change at the top was largely expected," he said. "While the announcement could create some near-term valuation volatility, our overall positive investment view remains unchanged given: 1) HCG's strong capital position generating flexibility; and 2) favourable geographic focus with [approximately] 4 per cent of the overall portfolio located in Alberta."

=====

After weaker-than-expected fourth-quarter 2015 results, Desjardins Securities analyst Chase Bethel said he has "low visibility on the trendline of profitability change within the business" of GDI Integrated Facility Services Ltd. (GDI-T).

Accordingly, he downgraded his rating for the stock of the Quebec-based commercial janitorial services provider to "hold" from "buy."

"Our decision to downgrade GDI … is driven by three primary considerations," he said. "Firstly, profitability margins have proven to be more volatile than expected. While we understand that there are limits to management's ability to sustain margins in the near term due to macro pressures, we do believe that margins can be guided back toward historical levels over time. Our issue is that we have low conviction that we have seen the bottom in margins. Of particular concern is that according to CBRE [Ltd.] forecasts, vacancy rates are expected to continue to trend higher in Canada during 2016. Among the key VECTOM [or Vancouver, Edmonton, Calgary, Toronto, Ottawa and Montreal] markets that we track, each of Edmonton, Calgary and Toronto are expected to see downtown vacancy increases of 100 basis points or greater.

"Secondly, we are less confident that GDI will be able to attain at least $1.5-billion in revenue over the next 4–6 years (original target was 5–7 years but that was set a year ago) without raising equity. As a reminder, this was a key tenet of our investment thesis. Our original long-term forecast was based on the assumption of an average organic revenue growth rate of 5 per cent over the medium term. Given 0.9-per-cent organic growth attained in 2015 and continued market weakness expected in 2016, a 5-per-cent organic growth rate assumption over the medium term appears aggressive. Also, given that GDI's leverage ratio is above management's threshold of 3.0–3.5 times, we do not expect any sizeable acquisitions for the next 12–18 months.

"Thirdly, on account of the two factors above, we expect valuation multiple compression. We previously valued GDI based on an enterprise value/EBITDA multiple of 10.5 times our 2016 EBITDA estimate. However, given the lack of visibility on margins and margin improvement, as well as a reduction in expected growth over the medium term, we have reduced the multiple we accord in our valuation of GDI's business to 10.0 times."

Mr. Bethel dropped his target price for the stock to $13.50 from $17.50. The analyst consensus is $17.42.

"Given poor visibility on margins over the next 12 months (particularly considering that office vacancy rates are expected to rise further in Canada) and less conviction that medium-term objectives can be attained, we now accord a lower valuation multiple on the business," he said.

=====

The decision by PrairieSky Royalty Ltd. (PSK-T) to cut its dividend "allows for sustainability in challenging times," said CIBC World Markets analyst Arthur Grayfer.

On Monday, PrairieSky reported fourth-quarter production of 17,651 barrels of oil equivalent per day (boe/d), ahead of Mr. Grayfer's estimate of 16,700 boe/d and the consensus of 16,800 boe/d. Cash flow per share was 36 cents, topping the 30-cent consensus but below the analyst's 40-cent estimate.

"PrairieSky has numerous levers beyond royalty production to generate revenue, which ultimately supports a more sustainable business model in a difficult environment," said Mr. Grayfer. "Compliance revenue, lease bonuses, non-performance fees, and rentals all combined to [approximately] 16 per cent of Q4/15 pre-tax cash flow (these pre-tax cash revenue streams were 24 per cent in 2015)."

The company also eliminated its dividend reinvestment plan (DRIP) and lowered its dividend by 45 per cent to 72 cents per share annually from $1.30.

Maintaining his "sector outperformer" rating, Mr. Grayfer increased his price target for the stock to $27.50 from $25. He said it is "supported by a sustainable yield in a weak commodity environment, a robust balance sheet, and long-term growth visibility due to a very large land position."

The analyst average is $24.86.

Elsewhere, GMP analyst Stacey McDonald downgraded the stock to "hold" from "buy"  with a target of $22.50 (from $27.50.)

=====

Onex Corp. (OCX-T) is likely to endure near-term net asset value (NAV) growth that is below targets, according to BMO Nesbitt Burns analyst Bert Powell.

 "Onex continues to face a difficult investment environment as the instability in the markets has made it challenging to source and finance new investments," said Mr. Powell. "Onex remains disciplined in its investment approach and continues to look for opportunities to allocate its $5-billion of cash and undrawn capital commitments.

"NAV per share growth has been below the 15-per-cent target since Q2/14. Given where we are in the invest-fix/build-harvest cycle, the near-term NAV growth is likely to remain below target. Onex also indicated that it would be challenging to raise further collateralized loan obligation (CLO) capital in the near term. Onex's holdings are mostly in U.S. dollars, and the 2015 appreciation in the stock has been mainly due to the favourable FX impact."

Maintaining his "market perform" rating, Mr. Powell raised his target price due to foreign exchange to $88 (Canadian) from $85. Consensus is $88.14.

=====

In other analyst actions:

Acadian Timber Corp (ADN-T) was rated new "sector perform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $20 (Canadian) per share.

Bank of America Corp (BAC-N) was downgraded to "neutral" from "overweight" at Atlantic Equities by equity analyst Christopher Wheeler. The 12-month target price is $15 (U.S.) per share.

Citigroup Inc (C-N) was downgraded to "neutral" from "overweight" at Atlantic Equities by equity analyst Christopher Wheeler. The 12-month target price is $45 (U.S.) per share.

Cascades Inc (CAS-T) was rated new "sector underperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $8 (Canadian) per share.

Conifex Timber Inc (CFF-T) was rated new "sector perform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $3.50 (Canadian) per share.

Canfor Corp (CFP-T) was rated new "sector outperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $21 (Canadian) per share.

Canfor Pulp Products Inc (CFX-T) was rated new "sector outperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $15 (Canadian) per share.

Diplomat Pharmacy Inc (DPLO-N) was downgraded to "neutral" from "buy" at Mizuho Securities USA by equity analyst Ann Hynes. The target price is $30 (U.S.) per share.

Express Scripts Holding Co (ESRX-Q) was downgraded to "neutral" from "buy" at Mizuho Securities USA by equity analyst Ann Hynes. The target price is $77 (U.S.) per share.

First Solar Inc (FSLR-Q) was downgraded to "neutral" from "overweight" at JPMorgan by equity analyst Paul Coster. The target price is $69 (U.S.) per share.

GDI Integrated Facility Services Inc (GDI-T) was downgraded to "sector perform" from "sector outperform" at CIBC by equity analyst Stephanie Price. The 12-month target price is $15 (Canadian) per share.

Helmerich & Payne Inc (HP-N) was raised to "outperform" from "sector perform" at RBC Capital by equity analyst Kurt Hallead. The 12-month target price is $65 (U.S.) per share.

Interfor Corp (IFP-T) was rated new "sector outperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $17 (Canadian) per share.

McKesson Corp (MCK-N) was downgraded to "neutral" from "buy" at Mizuho Securities USA by equity analyst Ann Hynes. The target price is $164 (U.S.) per share.

Norbord Inc (OSB-T) was rated new "sector outperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $34 (Canadian) per share.

Polaris Industries Inc (PII-N) was rated new "neutral" at Sterne Agee CRT by equity analyst Lee Giordano. The 12-month target price is $97 (U.S.) per share.

Transocean Ltd (RIG-N) was raised to "hold" from "sell" at Canaccord Genuity by equity analyst Alex Brooks. The 12-month target price is $8.50 (U.S.) per share.

Domtar Corp (UFS-N) was rated new "sector underperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $36 (U.S.) per share.

United Technologies Corp (UTX-N) was raised to "outperform" from "sector perform" at RBC Capital by equity analyst Robert Stallard. The 12-month target price is $109 (U.S.) per share.

Walgreens Boots Alliance Inc (WBA-Q) was raised to "buy" from "neutral" at Mizuho Securities USA by equity analyst Ann Hynes. The target price is $90 (U.S.) per share.

Western Forest Products Inc (WEF-T) was rated new "sector outperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $2.50 (Canadian) per share.

West Fraser Timber Co Ltd (WFT-T) was rated new "sector underperform" at CIBC by equity analyst Hamir Patel. The 12-month target price is $50 (Canadian) per share.

Avante Logixx Inc (XX-X) was rated new "Buy" at Mackie Research Capital by equity analyst Russell Stanley. The 12-month target price is 40 cents (Canadian) per share.

With files from Bloomberg News