Tuesday’s analyst upgrades and downgrades

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

Freshii Inc. (FRII-T) brings investors an attractive investment opportunity, according to RBC Dominion Securities analyst Sabahat Khan.

Believing the Toronto-based company can successfully deliver against its network expansion and earnings growth targets, he initiated coverage of the stock with an "outperform" rating.

"We believe the affordable build-out cost for Freshii locations (approximately $260,000 on average for 'traditional' locations), strong cash-on-cash returns (40-per-cent-plus before reflecting a manager salary), and solid same-store sales trends driven by a health-focused food offering will continue to attract qualified franchisees," said Mr. Khan. "For the twelve months ended September 2016, Freshii received more than 4,100 applications and less than 2 per cent of these applicants were awarded a franchise. We forecast 155 net new store openings in 2017 and 195 net new store openings in both 2018 and 2019, driving the total store count to 823 by 2019 (versus 278 as of year-end 2016)."

Mr. Khan said Freshii's competitors, which he bills "high-growth Fast Casual peers," have enjoyed have "very strong" network expansion in recent years, which he said "highlights the ability of on-trend restaurant concepts to deliver outsized unit growth, and increases our confidence in Freshii's ability to successfully meet its targets."

He pointed to Shake Shack Inc. (SHAK-N), Wingstop Inc. (WING-Q) and Zoe's Kitchen Inc. (ZOES-N) as examples of chains that have "significantly" expanded their footprints over the recent years. They are aiming to deliver unit growth compound annual growth rates (CAGR) of 42 per cent, 17 per cent and 26 per cent, respectively, from 2013 through 2016.

"We expect Freshii to deliver SSS of [approximately] 3.5 per cent over our forecast horizon (guidance: 3.0 per cent to 4.0 per cent through to 2019), driven by: 1) increased focus on non-lunch dayparts, primarily breakfast, which has been growing as an away-from-home meal occasion for restaurants in the U.S.; 2) continued growth of its meal box, juice cleanse, and catering offerings; 3) further investments in its mobile app, which we believe will drive traffic and customer loyalty; and, 4) increased focus on marketing activities," he said. "We also expect Freshii's SSS trends to benefit from its go-to-market strategy, which we expect will include 'clustering' in larger city centers and an enhanced marketing strategy following the addition of a new VP of Marketing (who has significant experience with the Subway brand)."

Mr. Khan set a price target of $17 for the stock, which began trading on the TSX on Jan. 31. The analyst average is $16.73.

"We believe Freshii is well positioned for growth given our outlook for the food deflation drag to moderate into H2 2017, the potential for wage pressures to moderate over time, and from the potential benefits of a number of policy changes being considered by the new U.S. administration," he said. "Some of the policy changes the new administration could implement include fiscal stimulus and lower corporate taxes. These factors could all result in a more supportive operating environment for restaurants and also lower 'hurdle rates'for entrepreneurs, which should in effect drive stronger interest from potential franchisees. While many unknowns remain, including the scope, depth, and timing of any proposed tax relief, the personal disposable income benefit from lower taxes could boost consumption growth by 2.5 per cent, according to RBC U.S. economist Tom Porcelli. In theory, legislation that materially supports economic growth from tax reductions should increase demand for restaurant meal occasions. Following a food deflation cycle which has impacted quick service restaurant SSS trends in 2016, potential fiscal stimulus by the new administration would be supportive of restaurant sector trends in 2017."

Elsewhere, CIBC World Markets analyst Mark Petrie initiated coverage with an "outperformer" rating and $18 target.

Mr. Petrie said: "A pursuit of healthier living has grabbed larger swaths of society for years. Companies across the globe have capitalized on this trend, but until Freshii, arguably no fast food chain had launched a global growth strategy centred on healthy eating. Freshii's menu is diverse and continually evolving, but a base of bowls, salads and juices underpins the company's mission of bringing healthy food to the masses at affordable price points. In our research, we find that Freshii offers attractive value and quick service, with many easily customized options. Just as important as a compelling offer to customers is attractive financial returns for franchise partners, and Freshii delivers in spades. The company targets cash-on-cash returns of 40-per-cent-plusin year 2. This is best-in-class, though in many cases results exceed this. The popularity of additional locations to existing franchisees underscores the health of the model.

"We also believe Freshii offers significant upside to investors, and see Freshii as well-positioned to meet or exceed its 2019 targets. These represent compelling growth in units, revenues and earnings, and at a valuation not far off slower-growth peers. Furthermore, we do not expect the growth to end there and see Freshii as offering a compelling investment opportunity with significant upside potential over the long term."

Canaccord Genuity's Derek Dley gave the stock a "buy" rating and $15.50 target.

"We believe Freshii is well-positioned to grow ahead of the high-growth fast-casual restaurant market, which is forecast to grow at a 10.3 per cent CAGR until 2018, given the company's robust network expansion potential, ability to increase sales in certain dayparts, and innovative menu platform," he said.

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There are "not enough of the right growth levers" for Fairfax Financial Holdings Ltd. (FFH-T), said CIBC World Markets analyst Paul Holden.

In reaction to the release of financial results last week, Mr. Holden downgraded his rating for the stock to "underperformer" from "neutral."

"Fairfax reported a bigger decline in BVPS [book value per share] than expected (down 10 per cent quarter over quarter)," he said. "Positioning in the investment portfolio changed significantly during the quarter with all equity hedges closed out and the duration of the fixed income portfolio reduced to approximately one year. Sensitivity to the U.S. equity market has increased (and is now positive) and interest rate sensitivity has been significantly reduced. The levers to growth have changed and we think this is good.

"The first, and most important, lever to BV growth is the investment portfolio. For every dollar invested in Fairfax, one gets 92 cents of cash, 86 cents of short duration bonds, 60 cents of equities and 9 cents of Fairfax India. Fairfax's equity investments have to do significantly better than the market to make the math compelling. The second lever to growth is underwriting margins, net of other expenses. We measure this as operating income and operating ROE. We estimate a 2016 operating ROE of 6.4 per cent, roughly 200 bps lower than the average for U.S. and international comps. With a soft pricing environment for most lines of business and a big benefit from reserve redundancies in recent years, we believe underwriting margins will trend lower. We assume a combined ratio of 96.0 per cent in 2017 vs. 92.5 per cent in 2016."

Mr. Holden is now projecting book value growth of 3 per cent to 4 per cent over the next two years, though he said better investment and underwriting profits could bump it to a range of 6 to 8 per cent.

"The path to something even higher seems unlikely given the allocation to low-yielding, low-duration investments," he said.

He reduced his price target for the stock to $600 from $650. The analyst consensus is $715.62, according to Thomson Reuters.

"Fairfax is trading at 1.3 times BV, a premium to its 10-year average of 1.1 times," he said. "We think the outlook for growth does not support a premium relative to its historical average."

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Desjardins Securities analyst Michael Parkin downgraded his rating for Mandalay Resources Corp. (MND-T), hoping for clarity on its medium-term outlook from its reserves update this week.

On Thursday, Mandalay reported quarterly earnings per share of 2 cents (U.S.). After adjustments, the result fell to a 2-cent loss, a penny below the expectations of both Mr. Parkin and the Street.

"We will be revising our estimates after the reserves update is released [this] week as we know to expect a negative revision at Cerro Bayo due to a greater amount of internal waste in one of the main veins," said Mr. Parkin. "We were unable to gather sufficient information from the quarterly earnings release and conference call to have a sense of what this update may look like, and thus have relatively low conviction in our current estimates. We believe this reserves update is acting as an overhang on the stock, and we are therefore downgrading."

His rating fell to "hold" from "buy" and his target dropped to 95 cents from $1.30. The analyst consensus price target is $1.17, according to Thomson Reuters.

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Choice Properties Real Estate Investment Trust's (CHP.UN-T) strategy remains on track and there's "plenty of pipeline left," said BMO Nesbitt Burns analyst Troy MacLean.

"We think the REIT will deliver low-risk moderate growth in 2017 and 2018 through acquisitions from its parent company, modestly rising occupancy and base rents, and development activity," said Mr. MacLean. "We think these positive attributes are already priced into CHP's unit price, but think the REIT is well positioned to deliver high-single-digit to low-double-digit total returns due to its 5-per-cent yield, and 4-per cent plus FFO/AFFO [funds from operations/adjusted funds from operations] growth."

On Feb. 15, the Toronto-based REIT reported fourth-quarter FFO of 25.1 cents per unit, an increase of 1.6 per cent year over year and in line with the projections of both Mr. MacLean and the Street. In explaining the rise from the previous year, Mr. MacLean pointed to a 1-per-cent increase in same property net operating income and "completed property investments including intensifications and Loblaw vend-ins as well as third-party acquisitions." He said the rise in SPNOI was due largely to higher capital recoveries, lower operating expenses and higher base rents from its new ancillary leasing as well as increases in Loblaw leases.

"We estimate Loblaw has 8.5 million square feet of GLA [gross leaseable area] available to vend into CHP (the REIT has bought 7.1 million square feet from Loblaw since the IPO), which should provide sizable annual acquisition activity (avg. annual acquisitions from Loblaw have equaled 2.1 million square feet per year over the last three years)," said Mr. MacLean.

He also pointed to an increase in development activity, noting: "The REIT has increased its development deliveries in each of the last three years, and expects to deliver $256-million of deliveries over the next two years at yields from 6 per cent to 9 per cent. CHP is also getting closer to starting larger developments (mixed-use high-rise properties near transit nodes). CHP has two mixeduse projects in the GTA in early stages (the West Block project, and the redevelopment of the Golden Mile property). Ancillary Occupancy Nearing Target: Occupancy in CHP's ancillary portfolio (i.e., non-Loblaw tenanted) reached 90.0 per cent at Q4, up 250 basis points quarter over quarter and up more than 10 percentage points."

Mr. MacLean maintained his "market perform" rating for the REIT with a target of $15 per unit, up from $14.50. Consensus is $14.47.

"We view Choice Properties as fairly valued, with a 17.1 times 2017 estimated price to adjusted funds from operations (P/AFFO) multiple compared to 16.0 times for the overall universe and 16.8 times for retail REIT peers," he said. " We believe CHP REIT is fairly valued due to the defensive nature of its grocery-anchored portfolio and development pipeline."

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Celestica Inc.'s (CLS-N, CLS-T) current valuation discount is "undeserved," said Canaccord Genuity analyst Robert Young.

"The EMS [electronics manufacturing services] neighborhood appears to be improving but despite strong quarterly performance, Celestica continues to trail its peers on valuation," said Mr. Young. "We believe that Celestica is at the beginning of a more aggressive phase of growth buoyed by an under-levered balance sheet which may be put to work on M&A as early as late 2017. We feel that the risk related to Celestica's 70-per-cent mix of revenue from legacy businesses (collectively communications, server and storage) is lower than perceived given exposure to current optical trends and strength of Celestica's differentiated JDM [joint design and manufacturing] offering. Stronger double-digit growth is expected from the diversified segment, supplemented by acquisitions, but temporarily impeded by a 3-per-cent solar headwind, driving our outlook for 4-5-per-cent overall annual growth moving forward. In our view, there is potential for margin uplift from an increased mix of sticky, high-margin diversified business and as Celestica's existing diversified footprint stabilizes."

Noting the company's guidance for the first quarter points to a sixth consecutive quarter of growth, after 16 quarters of revenue decline, Mr. Young said he expects GDP-level growth from its legacy markets, a key priority in a successful strategic shift, going forward. He said that growth will be supported by optical trends and revenue growth of 10 per cent from the higher-margin diversified segment.

"Mix shift and stabilization of the current diversified footprint underpin our view of further margin expansion," he said.

"After recent marketing, we have confidence that while early in the process, management is assessing targets. Having recently bulked up on its corp. dev. team, we see potential for activity as early as late 2017. M&A is likely to be used to accelerate the mix shift towards sticky, complex, higher-margin diversified and target capability and market exposure rather than new footprint or capacity. Celestica has a strong balance sheet, which could be levered to 3-3.5 times net debt/EBITDA, providing access to $0.75-billion of incremental cash."

Despite its recent "strong" results, Mr. Young said Celestica's valuation continues to lag peers.

"Celestica currently trades at 5.5x next twelve month enterprise value/EBITDA, well below peers Flextronics (FLEX-Q) at 7.3x, and Sanmina (SANM-Q) at 8.0x, while slightly above Jabil Circuit at 4.5x," he said. "Celestica also trades at near the average of its historical range of 2.8-6.8x … If we ignore the period before 2014, Celestica is trading at the lower end of its historical valuation range. Moreover, the valuation has diverged significantly from peers despite improving execution, we believe due to perceived risk from its high reliance on communications, storage and server end markets. While this remains a risk, we believe that Celestica, as proven by its strong performance, has positioned its self on strong programs within the mix of available business. We believe that the valuation of Jabil (JBL-N) is company-specific and reflects a high exposure to the mobility sector and Apple, where Celestica has a nominal impact. On their latest quarterly conference call, Jabil highlighted a continued weak demand environment within its mobility business with challenges expected to impact its F2017 results, although they are bullish on a strong product ramp in Q4/F17. We believe that this valuation gap is an opportunity for investors."

With a "buy" rating for the stock (unchanged), he raised his target to $16.25 (U.S.) from $14.25. Consensus is $13.90.

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Boardwalk Real Estate Investment Trust (BEI.UN-T) felt the impact of low oil prices and increased apartment vacancies in key western Canadian markets in the fourth quarter, said BMO Nesbitt Burns analyst Heather Kirk.

"It was a rough end to a challenging year with SPNOI [same property net operating income] declines accelerating to 20.5 per cent in the quarter on a 9.7-per-cent decline in revenues and an 8.4-per-cent rise in costs," said Ms. Kirk. "The decrease in stabilized revenue was driven by lower in-place occupied rents and higher incentives in Alberta and Saskatchewan, which accounts for approximately 79 per centof BEI's NOI. Operating expenses increased primarily as a result of higher advertising, bad debt, and property taxes. The 2017 operating environment is expected to remain challenging as a result of low oil and gas prices and new rental supply compounded by higher operating expenses including rising property taxes and the introduction of a carbon tax in Alberta in 2017. The back half of 2017 may provide some stabilization as we roll forward to easier comps. However, unlike the 2009 pullback where NOI was relatively stable, BEI has undergone a significant decline in margins and NOI, which we believe will take years to recoup. Q4 NOI margins fell 810 basis points to 53.1 per cent and total NOI declined 14 per cent year over year despite $144-million of acquisitions in 2016."

On Feb. 16, Boardwalk reported funds from operations per unit of 58 cents, a drop of 33 per cent year over year and below the projections of both Ms. Kirk and the Street of 69 cents.

Based on the results, Ms. Kirk lowered her 2017 and 2018 FFO per unit projections to $2.35 and $2.40, respectively, from $2.73 and $2.86.

With a "market perform" rating, she lowered her target price to $40 from $42.50. Consensus is $44.73.

"We expect continued challenges in the Alberta market to remain a drag on operating performance, FFO/unit and NAV through 2017," she said.

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In other analyst actions:

Computer Modelling Group Ltd. (CMG-T) was downgraded to "hold" from "buy" at Industrial Alliance by analyst Elias Foscolos with a target price of $10.50 per share. Consensus is $9.19.

MacDonald Dettwiler & Associates Ltd. (MDA-T) was rated new "buy" by Cormark Securities analyst Robert Peters with a $90 target. Consensus is $85.90.

Russel Metals Inc. (RUS-T) was raised to "outperform" from "sector perform" at RBC Capital by equity analyst Sara O'Brien with a target of $31. Consensus is $26.33.

Verizon Communications Inc. (VZ-N) was raised to "buy" from "neutral" at MoffettNathanson by analyst Craig Moffett. His target is $54.00 per share. Consensus is $52.48