Tuesday’s analyst upgrades and downgrades

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

Despite a strong start to the year, the Canadian real estate sector is faced with a "muddle-along" macro environment, according to Raymond James analyst Ken Avalos.

In a research note recapping the first quarter, Mr. Avalos said he is concerned about the duration of those macro pressures, and despite a rebound in oil price, he calls them "difficult" for both the near and intermediate term.

"Canadian REITs as an index rode falling rates, improving sentiment around the oil situation and multi-year low valuations to deliver a strong 11-per-cent return for 1Q16, outpacing the broader Canadian equity markets and comparing favourably to the 6 per cent delivered by U.S. REITs," the analyst said. "While returns were positive overall, there was sizable volatility across some names that were heavily shorted and delivered stable if not solid operating results, and investors saw several names have double-digit up days as shorts covered and buyers returned.

"The macro backdrop in Canada remains difficult; although it has modestly improved over the outlook at year end 2015 given that oil prices have rebounded. Large deficit spending is expected in an effort to stimulate the economy, but the ultimate question remains how the energy/resource sector will perform. At this point, there is clearly far too much uncertainty for benchmark rates to materially rise in Canada. In the U.S., our view is that the U.S. continues to post a slow, steady recovery and we don't expect a material slowdown in the near term. Bolstering the case for REITs, the U.S. Fed has turned dovish on the rate front most recently, further lessening the probability of rate increases at the long end."

Emphasizing "the strong recent move, still soft macro outlook, and changing valuations," Mr. Avalos downgraded his ratings for Smart REIT (SRU.UN-T) and RioCan Real Estate Investment Trust (REI.UN-T) to "market perform" from "outperform."

He noted: "Strong gains [in the year to date] and premium valuations, coupled with increasing concerns about retail overall have diminished the risk/reward proposition. Admittedly, these are both strong franchises with excellent management teams, balance sheets and portfolios; however, recent performance and valuation, we think, warrant the ratings adjustments."

He also downgraded Killam Apartment REIT (KMP.UN-T) to "outperform" from "strong buy." He said the move was "based solely on its strong run recently and lower upside to target in the short term. The REIT continues to execute well within its core markets and portfolio performance has been sound; however, with a strong 13-per-cent year-to-date return and smaller NAV [net asset value] discount, we think it's prudent to move to an outperform rating."

At the same time, he moved Canadian Real Estate Investment Trust (REF.UN-T) to "outperform" from "strong buy."

"[The change is] based on recent price performance and shrinking NAV discounts," he said. "CREIT remains one of the best run companies in our universe, but with sentiment still challenged around Alberta, and recent gains, we think the stock warrants a move to an outperform rating."

Mr. Avalos also upgraded H&R Real Estate Investment Trust (HR.UN-T) to "outperform" from "market perform" to reflect the company's "strong" balance sheet, "attractive" yield and diversified portfolio.

With the changes, he also tweaked his target prices for the companies. The changes were:

- Killam to $12.50 from $12. The analyst consensus is $12.17.

- CREIT to $47 from $45. Consensus is $45.75.

- H&R REIT remains at $23. Consensus is $23.66.

- Smart remains at $34. Consensus is $33.69.

- RioCan remains at $28. Consensus is $27.93.

"Even with the recent strong move, the Index is only back to August 2014 levels; however, rates are lower, net operating incomes (NOIs) are generally higher, and private market valuations are as strong if not stronger across most property types," said Mr. Avalos. "Based on those factors, we continue to hold the overall view that many of our REITs under coverage are trading at sizable discount to private market value, when measured by implied cap rate or price per pound. Barring dramatic deterioration in fundamentals, or a seismic shift in interest rates, we expect private market valuations to remain relatively firm across most property types. The defensive characteristics of real estate, we think, make it all the more attractive in this difficult to underwrite environment."

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CIBC World Markets analyst Ben McEwen downgraded his rating for Dundee Precious Metals Inc. (DPM-T), expressing concern over the future outlook of the company following a recent analyst lunch.

Moving the Toronto-based gold mining company to "sector performer" from "sector outperformer," Mr. McEwen said the status of its Tseumeb smelter in Namibia remains a significant question. He noted the company is aiming to sell a portion of the facility to finance current projects.

"DPM is not considering an equity raise at current levels and believes options such as a forward gold sale or partial sale of Tsumeb are more likely sources of future funding," he said. "As such, financing Krumovgrad's development and/or Tsumeb's expansion remains uncertain given total working capital is currently less than $80-million."

Mr. McEwen maintained his target price for the stock of $2.40. Consensus is $2.59.

"We think a financing overhang on DPM shares will persist," he said. "While it was clear building Krumovgrad is a priority, it may mean selling a stake in Tsumeb may be necessary. Given the level of uncertainties around future revenues … we reduce our rating."

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Tidewater Midstream & Infrastructure Ltd. (TWM-X) is recommended for risk-tolerant investors seeking capital gains, said CIBC World Markets analyst Robert Catellier.

He initiated coverage of the Calgary-based company with a "sector outperformer" rating.

"Shares of Tidewater provide investors with small-cap, dividend-paying exposure to a potentially high-growth midstream vehicle," said Mr. Catellier. "The company's strategy is to acquire and develop infrastructure and engage in the purchase, sale and transportation of natural gas liquids (NGLs) throughout North American and overseas export markets. The management team is proven, having previously delivered strong returns to shareholders by following a similar market access strategy in the crude-by-rail market before selling the company after about two and a half years."

Mr. Catellier said he expects growth going forward to come from enhancements to its current assets as well as M&A activity.

"Market conditions are favourable for this strategy as producers seek to outsource their infrastructure requirements, in an effort to conserve capital, and need enhanced market access for NGL production to improve netbacks," he said.

"With $120-million of available credit and no debt on the balance sheet pro forma the recent financing, the company is well-positioned to continue its M&A strategy and enhance its asset portfolio."

He set a price target of $2. Consensus is $2.27.

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The price paid for Lake Shore Gold (LSG-T) by Tahoe Resources Inc. (THO-T, TAHO-N) is "fair but long on optionality," said Canaccord Genuity analyst Tony Lesiak.

On Friday, the companies announced the completion of the deal after Tahoe shareholders voted for its approval. Based on the agreement, Lake Shore shareholders receive 0.1467 common shares of Tahoe for each outstanding share. Lake Shore is now a wholly-owned subsidiary of Tahoe.

"Overall, we view the transaction as neutral on a NAVPS [net asset value per share] basis and positive on earnings (16 per cent) and cash flows (4 per cent)," said Mr. Lesiak. "The key benefit is that the deal further diversifies Tahoe's perceived geopolitical risk and moreover provides for significant optimization and exploration potential, which may be detailed in the coming months. Our financial analysis of the LSG transaction assumed significant (90 per cent) resource to reserve conversion, which we believe ultimately may prove conservative given the potential at 144Gap, Whitney and along the Timmins trend.

"On a pro-forma basis, we estimate that THO is currently trading broadly in line with the larger peer average at 0.88 times NAV and 8.0 times EV [enterprise value]/EBITDA. Given THO's top-rated overall asset quality, management, balance sheet (0.3 times net debt to EBITDA versus sector at 1.3 times), growth (16-per-cent compound annual growth rate from 2016 to 2018), exploration (all jurisdictions) and optimization potential (Timmins), we believe THO should trade at a premium (1.1 times target NAV multiple versus sector average of 0.95 times NAV) valuation multiple to its peer."

Maintaining his "buy" rating for Tahoe, he raised his target price to $18 from $15. The analyst consensus is $17.29.

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The value of Ruckus Wireless Inc. (RKUS-N) has been realized in its acquisition by Brocade Communications Systems Inc. (BRCD-Q) for about $1.2-billion (U.S.), according to BMO Nesbitt Burns analyst Tim Long.

Mr. Long downgraded Ruckus to "market perform" from "outperform."

"We believe the deal makes strategic sense for both companies and the price seems reasonable, though it is at a discount to HPE's acquisition of Aruba last year on an enterprise value/sales basis," said Mr. Long. "As the deal is more than half funded by stock, it could potentially open the door for another bidder to emerge. We do not see many other potential bidders out there, with Juniper probably making the most sense, in our view, as it does not have a LAN offering."

The deal, announced Monday, values Ruckus at $14.42 per share. Accordingly, Mr. Long raised his target price to $14 from $11 to reflect the offer of $6.45 in cash and 0.75 times his Brocade target price of $10.

The analyst average is $12.51, according to Bloomberg.

Several other analysts also downgraded the stock, including RBC Capital analyst Mitch Steves to "sector perform" from "outperform." Macquarie's Rajesh Ghai moved it to "neutral" from "outperform," at Needham & Co.'s equity analyst Richard Valera lowered it to "hold" from "buy." William Blair analyst Jason Ader moved his rating to "market perform" from "outperform."

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In other analyst actions:

AO Smith Corp. (AOS-N) was rated new "outperform" at BMO Capital Markets by equity analyst Scott Graham. The target price is $90 (U.S.) per share.

Actuant Corp. (ATU-N) was rated new "market perform" at BMO Capital Markets by equity analyst Scott Graham. The target price is $23 (U.S.) per share.

Bruker Corp. (BRKR-Q) was downgraded to "market perform" from "outperform" at Leerink Partners by equity analyst Daniel Leonard. The 12-month target price is $27 (U.S.) per share.

CMS Energy Corp. (CMS-N) was downgraded to "neutral" from "outperform" at Macquarie by equity analyst Andrew Weisel. The 12-month target price is $43 (U.S.) per share.

Capital One Financial Corp. (COF-N) was downgraded to "underperform" from "market perform" at Oppenheimer by equity analyst Ben Chittenden. The 18-month target price is $58 (U.S.) per share.

WW Grainger Inc. (GWW-N) was rated new "outperform" at BMO Capital Markets by equity analyst Scott Graham. The target price is $300 (U.S.) per share.

Hormel Foods Corp. (HRL-N) was downgraded to "underweight" from "hold" at BB&T Capital by equity analyst Heather Jones.

McDonald's Corp. (MCD-N) was rated new "hold" at Evercore ISI by equity analyst Matthew Mcginley.

NextEra Energy Inc. (NEE-N) was downgraded to "neutral" from "outperform" at Macquarie by equity analyst Angie Storozynski. The 12-month target price is $122 (U.S.) per share.

Panera Bread Co. (PNRA-Q) was rated new "hold" at Evercore ISI by equity analyst Matthew Mcginley.

Pioneer Natural Resources Co. (PXD-N) was rated new "buy" at Drexel Hamilton by equity analyst Robert Christensen. The 12-month target price is $193 (U.S.) per share.

Starbucks Corp. (SBUX-Q) was rated new "buy" at Evercore ISI by equity analyst Matthew Mcginley.

Sunoco Logistics Partners LP (SXL-N) was raised to "buy" from "hold" at Evercore ISI by equity analyst Timm Schneider. The 12-month target price is $28 (U.S.) per share.

Trevali Mining Corp. (TV-T) was rated new "buy" at Laurentian Bank by equity analyst Pierre Vaillancourt. The 12-month target price is 80 cents (Canadian) per share.

Xylem Inc. (XYL-N) was raised to "buy" from "neutral" at Sterne Agee CRT by equity analyst Kevin Bennett. The 12-month target price is $52 (U.S.) per share.

With files from Bloomberg News