Tuesday’s analyst upgrades and downgrades

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

It was a "strong" start to 2017 for Canadian banks, according to CIBC World Markets analyst Robert Sedran.

"In the lead-in to Q1/F17, we raised our estimates for the quarter primarily in expectation of favorable capital markets conditions during the period," said Mr. Sedran, in a research note reviewing the sector's earnings season. "The U.S. election lined up well with the start of F2017 and we were inclined to believe that this and the buoyant market conditions that followed would drive the capital markets related lines and overall results meaningfully higher. That directional inclination was correct and capital markets segments across the sector had a great quarter, beating our above-consensus expectations.

"Capital markets may prove to be strong throughout the year, but given their relative unpredictability even later in the same year (let alone into the next), we opted to only nudge our forecast higher for these lines. On balance, however, we are becoming more confident in the operating environment. Credit quality continues to improve and conditions on the ground in central Canada and the United States appear to be firming. Even in geographies where there are lingering concerns, conditions appear to be stabilizing and this quarter's results prove that banks can earn through these challenges. As for Q1/F17 results, average adjusted earnings per share were up 7 per cent quarter over quarter and 15 per cent year over year, much better than our forecast of 2 per cent and 10 per cent, respectively. All banks beat consensus and fiscal 2018 EPS estimates were revised, on average, 1 per cent higher."

Mr. Sedran raised his rating for Bank of Nova Scotia (BNS-T) to "outperformer" from "neutral."

He cited a trio of reasons for the change:

1. The bank’s “solid” operating performance: “First, the bank has been operating well, not only in the Canadian market, but in its International Banking business as well. To be sure, there are some clouds in the sky as the rhetoric from Washington since the U.S. election has weighed on currencies and slowed the economic growth outlook. The difference between this bank and its ancestors that were lifted by the secular bull market in emerging markets is that it is now relying on its own operational performance to drive earnings growth. Because of those clouds, it may not grow as quickly as it could. However, we expect solid internally driven growth. Moreover, the expense opportunity is an above-average one for this bank, in our view.”
2. Its “strong” balance sheet: “The CET1 ratio again sits at the second highest level in the group at 11.3 per cent. The buyback has been active, deployment is an ongoing opportunity and, if nothing else, it provides a measure of defence if we are too optimistic (or not pessimistic enough) on its ability to earn through challenges in the international business.”
3. A “discounted” valuation: “The bank trades at a discount to the large Canadian bank average. Over the last many years, we have seen this bank move from a discount to the highest in the group and now back to a discount. Even if all we assume is an average multiple, the total return profile is consistent with our rating upgrade.”

Mr. Sedran raised his target price for Scotiabank stock to $86 from $83. The analyst consensus price target is $84.04, according to Thomson Reuters.

His other target price changes were:

• Bank of Montreal (BMO-T, “neutral” rating) to $109 from $104. Consensus: $105.21.
• Canadian Western Bank (CWB-T, “neutral”) to $33 from $32. Consensus: $31.
• Laurentian Bank of Canada (LB-T, “neutral”) to $62 from $61. Consensus: $60.70.
• National Bank of Canada (NA-T, “neutral”) to $62 from $60. Consensus: $60.50.
• Royal Bank of Canada (RY-T, “outperformer”) to $106 from $101. Consensus: $99.42.
• Toronto-Dominion Bank (TD-T, “neutral”) to $74 from $71. Consensus: $71.79.

"As of the close on March 6, the group traded at 12.8 times our fiscal 2017 EPS estimates and 12.0 times our 2018 estimates," said Mr. Sedran. "On a [price-to-book] basis, the shares traded at an average of 2.0 times, while the average dividend yield was 3.7 per cent. We have noted, in various publications so far this year that bank stocks rarely have back-to-back years like the average 26-per-cent simple return they delivered in 2016. We stand by that position even after seeing a very strong start to the year from an earnings growth perspective. The shares have a had a good start to the year, delivering an average 8-per-cent simple return.

"So what to do now? We are more preoccupied with the operating environment than we are with valuation, at least given that we are only sitting modestly above historical averages in terms of [priceto-earnings] multiples … and to create an average, we do need to spend a little time above the average too. We think the conditions are as good as they have been since before the global financial crisis and so we remain constructive on the sector. We are taking our target multiple to 12.5 times on our F2018, which takes our targets approximately 4 per cent higher. Essentially from here, we are thinking something closer to earnings growth since that target multiple on fiscal 2018 is basically where the shares are now trading on fiscal 2017 numbers."

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General Motors Co.'s (GM-N) management should be applauded for "narrowing" its focus with its European exit, said BMO Nesbitt Burns analyst Richard Carlson.

On Monday, the auto maker announced it would sell its European Opel and Vauxhall operations to France's PSA Group in a deal valued at €2.2-billion ($2.3-billion U.S.).

"GM management has made it very clear its long-term strategy is to focus on areas of high profit potential and shed businesses/exit regions not capable of earning their own cost of capital," said Mr. Carlson. "After nearly two decades of losses in Europe and despite the region being one of the most advanced auto markets, management is proving it is prepared to make tough decisions in executing this strategy by exiting auto building in Europe. Key headwinds limiting profit improvement in the region include a complex regulatory environment, tough labor laws, far too much industry capacity and a consumer preference for smaller cars. The company has also recently been facing FX and other headwinds associated with Brexit (ex-Brexit, the company believes it would have reached breakeven in 2016). With the synergies from PSA and Opel/Vauxhall combined, PSA's goal is for the acquired business to reach 2-per-cent operating margin and positive free cash flow by 2020, which is well below levels GM likely would have deemed satisfactory to keep the business. We also note GM's market position in Europe was No. 8, versus being a top three player in all other regions where it competes. Despite ridding itself of a manufacturing footprint in the region, management was quite confident on the call that it would still be able to penetrate the European market for mobility as a service, as well as work with PSA on electrification (Europe is expected to be a leader in this area)."

Mr. Carlson noted 2017 will bring the 18th consecutive year of operational losses for the company's European division, estimating total losses of $23-billion.

"While Europe is one of the most advanced automotive markets, business is challenging with a complex regulatory environment, tough labor laws, excess industry capacity and a consumer preference for smaller cars," he said. "We believe it's unlikely the firm would have reached breakeven in Europe this decade."

"Europe is GM's weakest market share region where it currently sits in eighth place. Once the Opel transaction closes, it will be a top three player in all regions where it competes and able to focus more on these areas of strength."

He did call the value GM gets from the transaction "more modest than significant" and did not adjust his 2017 earnings per share projection, given the deal is expected to close late in the fiscal year.

"We applaud management for making this move as shedding Opel allows the company to put more focus on fewer and more profitable brands while also allocating capital towards projects such as autonomy, personal mobility and alternative propulsion," said Mr. Carlson. "The de-risking of the business will also allow the company to reduce its target cash position by $2-billion, which will be used to fund an accelerated share repurchase once the deal completes."

His 2018 estimate rose to $6.25 from $6 based on the transaction and the share repurchase plan.

With a "market perform" rating, he raised his target price for GM stock to $39 from $38. The analyst consensus price target is $39.05, according to Thomson Reuters.

"GM shares now trade at 6.2 times its time-weighted, forward year consensus EPS estimate, nearly a full turn below its five-year average," the analyst said. "Compared to our custom auto group, this valuation represents a 46-per-cent discount to the group versus a five-year average of 38 per cent. While we expect further multiple expansion from our custom auto group, we continue to believe it will primarily come from the suppliers and remain comfortable with our valuation target being based on GM shares trading at a 45-per-cent discount to the group. With our belief that our custom auto group should trade at 11.5 times 2018 EPS estimates, this implies a [price-to-earnings] target of 6.3 times our revised 2018 EPS estimate of $6.25, reaching our new price target of $39. With the shares just below that level currently, we reiterate our Market Perform rating."

He added: "Even with significant transformation occurring, we believe it is critically important for strategic investors to be very disciplined about the point of entry for auto OEM shares late in the cycle. We are optimistic about the efforts GM is making to serve the future mobility needs of its customers, though we see few catalysts for nearer-term multiple expansion."

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Despite a drop in its capital budgets for 2017 and 2018, Raymond James analyst Jeremy McCrea feels upside remains for Painted Pony Petroleum Ltd. (PPY-T).

On Monday, the natural gas company, based in Calgary, lowered its capital budgets for 2017 and 2018 to $288-million and $216-million, respectively, from $319-million and $385-million based on a lower gas pricing strip "as North America is expected to exit the second winter in a row with above-average inventories."

Painted Pony's production forecasts fell to 43,000 barrels of oil equivalent per day (boe/d) in 2017 from 48,000 boe/d. For 2018, its estimate declined to 60,000 boe/d from 72,000.

"With the indications in its 4Q16 results that it was going to lower its capital program, we preemptively lowered our spending and production estimates," said Mr. McCrea. "As a result, the impact of [Monday's] budget release on our outlook is more modest. We have lowered our capital spending and production outlook for 2017 and 2018 in-line with PPY's guidance. Our outlook for beyond 2019 has remained unchanged as PPY reviews the time line for Phase 3 of the AltaGas Townsend Facility. Painted Pony also provided updated cash cost estimates for 2017 in its March corporate presentation – we have adjusted our modeling accordingly."

Mr. McCrea's cash flow per share projections for 2017 and 2018 now sit at $1.35 and $2.50, respectively, from $1.69 and $2.74.

His target price for the company's shares moved to $12 from $12.50 with an "outperform" rating (unchanged). The analyst consensus price target is $11.46.

"While the market may initially have mixed feelings about the lower growth profile, we believe that in time, it will come to agree that this is a prudent move to protect the balance sheet during an uncertain gas market," he said. "The lower capital spending and well hedged production in 2017 – 75-per-cent of total gas volumes hedged – should allay concerns around PPY's bank debt burden. Under either our estimated bank debt/cash flow of 1.4 times in 2018 under our current price forecast ($2.86/mcf AECO in 2018) and Painted Pony's 2018 year end estimate of 1.5x at February 1 strip pricing, we do not see PPY's bank debt as a point of concern. With production growth under our forecasts of 88 per cent in 2017 and 38 per cent in 2018, we think PPY still provides plenty of upside for growth investors."

Elsewhere, Desjardins Securities analyst Jamie Kubik lowered his target by a loonie to $9 with a "buy" rating.

He said: "While we view capital discipline as a positive outcome for the company and one that is prudent toward maintaining its balance sheet, the stock could trade sideways until improved visibility surrounding gas pricing and forward funding ensues. That said, the company's production per share growth and current valuation remain attractive relative to its Montney peers."

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BMO Nesbitt Burns analyst Tim Casey raised his target price for shares of Transcontinental Inc. (TCL.A-T) in reaction to better-than-expected first-quarter financial results.

On Friday, the Montreal-based printing company reported adjusted earnings per share of 53 cents, exceeding the consensus projection of 48 cents and in line with the result of a year ago. Consolidated revenue increased by 1 per cent to $504-million, also beating the Street's estimate ($495-million). Adjusted earnings before interest, taxes, depreciation and amortization of $88-million represented a 5-per-cent increase year over year, and topped the consensus of $84-million.

"Commercial printing continues to face volume pressures (despite the new Toronto Star and Lowe's Canada printing contracts), while Media remains challenged due to a permanently impaired print advertising market," said Mr. Casey. "The Packaging division appears to be recovering from some organic execution headwinds in recent quarters. To protect margins, the company's focus is on cost cutting, pursuing new growth verticals through M&A (i.e., flexible packaging), and divesting/closing non-core assets."

With the results, Transcontinental raised its annual dividend by 8.1 per cent, or 6 cents, to 80 cents per share. It attributed the increase to its "solid" cash flow position.

Mr. Casey also noted the company's 2017 growth outlook appears "relatively flat," despite completed acquisitions. He raised his 2017 and 2018 EPS projections to $2.37 and $2.26, respectively, from $2.28 and $2.24.

"In Printing, the company expects flyer printing volumes and door-to-door distribution services to current retailers to remain stable," he said. "The contract to print the Toronto Star and Lowe's Canadian flyers will have a positive impact. However, the company expects these items to be offset by the ongoing negative pressures on print media and the non-recurring contract to print the Census (Q2/F16). In Packaging, the company expects the acquisitions of Robbie Manufacturing and Flexstar Packaging will have a positive impact through 2017. In Media, the company expects ongoing pressures in advertising to be offset by cost efficiencies."

Mr. Casey's target price for the stock rose to $22 from $18. Consensus is $22.54.

"We rate Transcontinental Market Perform based on relative asset mix and growth potential," he said. "Over two-thirds of the company offers exposure to niche commercial printing services, an industry facing a continuing weak pricing environment and one that is plagued with overcapacity. Roughly 20% of the company is a printing publishing concern, with a focus in community newspapers. The company has aspirations of growing its presence in the flexible packaging industry following its acquisitions of U.S.- based Capri Packaging (May 2014), Ultra Flex Packaging (September 2015), Robbie Manufacturing (June 2016), and Flexstar Packaging (October 2016), which represent roughly 15 per cent of pro forma revenues and EBITDA."

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Spin Master Corp. (TOY-T) remains "well positioned to remain a key consolidator in the highly fragmented toy products industry," said Canaccord Genuity analyst Derek Dley, believing product innovation will drive its near-term growth.

"The company's balance sheet is healthy, with net debt/EBITDA of only 0.5 times," he said. "The company has commented it would prefer to remain under 1.5 times net debt/EBITDA, but would leverage up to 2.5 times if an accretive, transformational acquisition were to present itself. Therefore, we believe Spin Master has plenty of 'dry-powder' available to continue its consolidation strategy."

In a research note reviewing the Toronto toy maker's recent investor day and previewing its fourth-quarter 2016 financial results, scheduled to be released on March 13, Mr. Dley said he's forecasting quarterly adjusted earnings before interest, taxes, depreciation and amortization of $20-million, slightly below the consensus of $21-million, and emphasized the fourth quarter is normally "seasonally slow" given the majority of holiday purchases occur in the third quarter.

"Globally, the toy products and games market continues to experience healthy mid-single digit growth, with global toy product sales increasing by [approximately] 6 per cent during 2016, and accelerating over the last 5 years at a [compound annual growth rate] of 5 per cent," said Mr. Dley. "Data gathered by market research firm NPD group suggests the U.S. toy industry grew by 5 per cent in 2016, despite recent media reports suggesting a low single digit growth rate.

"In our view, Spin Master is well positioned to exceed industry growth rates given the company's: (i) focus on increasing international sales exposure from 30 to 40 per cent of overall sales; (ii) strength of its Paw Patrol property which represents 25 per cent of sales, (iii) recent product launch success and product innovation potential, including Hatchimals; (iv) growing content and digital platform; and (v) position as a key consolidator. All of these growth initiatives were laid out and evident when we met with the company at the American International Toy Fair in mid-February. We believe Spin Master represents the most attractive avenue to participate in growth within the global toy products market."

With an unchanged "buy" rating, he raised his target to $39 from $37. Consensus is $40.53.

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A shift from traditional bricks-and-mortar sales to online e-commerce remains "in the early innings," said Echelon Wealth analyst Ralph Garcea, who initiated coverage of four diversified industrial companies.

"As this secular trend continues to unfold, logistics and internet access companies become increasingly important," he said. "This is a highly investible theme in Canada."

Mr. Garcea initiated coverage of the following stocks:

* Cargojet Inc. (CJT-T) with a "buy" rating and $60 target. Consensus is $55.60.

Mr. Garcea said: "As customers increasingly shop online and demand rapid receipt of packages, CJT continues to be at the forefront of this theme. The net result of this large-scale shift in behaviour is increasing demand for time-sensitive air freight, which Cargojet provides. As the dominant provider of high priority air freight cargo in Canada, Cargojet should continue to witness strong volume growth for its services translating to greater capacity utilization of its fleet and expanding margins."

* International Road Dynamics Inc. (IRD-T) with a "buy" rating and $4.50 target.  

Mr. Garcea: "IRD provides interesting exposure to major global issues - traffic congestion, increasing wear on aged and overexerted highways, and overall safety. There is a disproportionate relationship between the number of drivers and vehicles on the road, and total highway infrastructure. Congestion's real economic costs are seen in higher transportation expenses, resulting from longer transport times, to higher fuel and labour costs. Indirect costs include increased working capital requirements due to the need to maintain higher inventory levels to larger warehousing and handling costs. It is estimated that approximately half of these indirect costs are passed on directly to consumers. The solution to global congestion and all its problems require environmentally friendly ITS systems, services, and real-time data that IRD provides. We expect 10-15-per-cent organic growth coupled with one or two acquisitions over the next couple of years. A blue-sky scenario would see IRD at $100-million in revenues and $10-million-plus in EBITDA."

* TFI International Inc. (TFII-T) with a "hold" rating and $37 target. Consensus: $35.86.

Mr. Garcea said: "TFI International provides unique exposure to a robust North American macro theme - the constantly growing demand by customers for receipt of expedited packages. We believe this trend is part of another global macro theme, which is the evolution of consumer shopping behaviour from traditional bricks and mortar to online ecommerce. The impact of online shopping is overwhelmingly reshaping the transportation and logistics business, creating a margin expansion opportunity for TFI."

* Tucows Inc. (TCX-Q) with a "hold" rating and $52.50 (U.S.) target. Consensus: $27.20.

Mr. Garcea: "The Domain Registry business is consolidating around three or four big players, with Tucows now  No. 2 by number of domains under management. Verisign (VRSN-Q) announced that there are approximately 329.3 million domain registrations in the world, up 6.8% y/y. Conversely, the fiber optics market is still in its relative infancy and we see this segment as the next major catalyst for TC once further developed. Zion Market Research estimates that the global fiber optics market will reach $3.72-billion by 2022, up from $2.75-billion in 2016. However, the high initial capex cost is considered as the key hurdle for the growth of fiber optics market."

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In other analyst actions:

Toronto-Dominion Bank (TD-T) was downgraded to "neutral" from "outperform" at Macquarie by analyst Jason Bilodeau. His target price rose to $70 from $68, while the analyst average price target is $72.29, according to Bloomberg.

Paradigm Capital analyst David Davidson downgraded Major Drilling Group International Inc. (MDI-T) to "hold" from "buy" and raised his target to $8.50 from $8. The analyst average is $8.20.

Anadarko Petroleum Corp. (APC-N) was raised to "overweight" from "neutral" at Alembic Global Advisors by analyst James Sullivan with a target of $74 (U.S.), up from $71. The average is $82.64.