Tuesday’s analyst upgrades and downgrades

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

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Pembina Pipeline Corp.'s (PPL-T, PBA-N) "Montnopoly" continues with its $5.8-billion acquisition of Veresen Inc. (VSN-T), according to Desjardins Securities analyst Justin Bouchard.

Emphasizing the potential dominance of combined unit's position in the Montney formation in northern Alberta and British Columbia, Mr. Bouchard moved his rating for Veresen to "tender" from "hold" while raising his target price for shares of Pembina.

"We believe that Pembina has markedly increased the barriers with regard to its already dominant position within the Montney—spanning gathering and processing, regional NGL pipeline transportation, and NGL fractionation and storage," he said. "From our perspective, Pembina's NGL midstream value chain is near fully integrated and is poised to capture a considerable portion of the growth over the coming years as gas and liquids volumes continue to increase from the NW AB/NE BC fairway.

"The cash flows of the combined entity are expected to generate $800–900-million of free cash flow (after dividends), which when combined with 50-per-cent debt would give Pembina the ability to organically fund $1.6–1.8-billion of annualized growth opportunities before requiring equity issuance. In addition to generating the cash flow required to maintain a dominant position in NW AB/NE BC, the scale of the combined entity should allow it to credibly pursue larger and more complex projects."

Under the deal, announced Monday prior to market open, Pembina is offering either 0.4287 of one of its shares or $18.65 in cash for each Veresen share. The offer represents a premium of 22.5 per cent from Veresen's closing price after Friday trading. Pembina will also take on Veresen's outstanding debt.

"From our perspective, the business case for the transaction is underpinned by the integrated nature of the two asset portfolios, and enhanced by Pembina's size and more conservative capital structure," said Mr. Bouchard.

"The proposed combination creates a host of operational synergies, largely stemming from the horizontal and vertical overlap between the two midstream networks. Meanwhile, the combination is expected to create corporate synergies (stemming from the overlap of head office location and similar business lines), financial synergies (stemming from Pembina's lower cost of capital and employed leverage) and tax synergies. In total, Pembina estimates the synergies will average $75–100-million on a pre-tax basis."

Mr. Bouchard does not expect a competing bid for Veresen, adding: "The question (from our perspective) is—"has Pembina built such a wide moat in the region that it has effectively turned the Montney into a Montnopoly?' In our view, unless the other midstream and pipeline companies move relatively quickly, it certainly looks to be shaping up that way. The readthrough for Canadian energy infrastructure, in our view, is that there necessarily has to be more M&A and consolidation in the space if others want to compete."

Maintaining a "buy" rating for Pembina, he raised his target price for the stock to $50 from $49 to reflect increasing long-term cash flow per share growth and "materially widened moat around its business in the Montney." The analyst average target price is currently $49.41, according to Bloomberg Data.

Mr. Bouchard's target for Veresen is now $18.50 (up from $14). The average is $17.46.

Meanwhile, Raymond James analyst Chris Cox kept his "market perform" rating for Veresen stock and increased his target to $20 from $16.

"We have a constructive outlook on the combination of the Pembina and Veresen asset bases and believe both investor groups can benefit from the improved scale, diversification and service offering of the combined entity," said Mr. Cox. "In our view, the price paid by Pembina for Veresen is fair, and reflective of the synergy opportunities available in the deal, the attractive growth profile within Veresen Midstream and the recently improving outlook for the Jordan Cove LNG project. Accordingly, we recommend investors tender the offer."

Mr. Cox lowered his target for Pembina by a loonie to $49 with an unchanged "outperform" rating, calling it a "good strategic fit."

"We see attractive benefits from marrying the Veresen asset base with Pembina's. For one, there is a good deal of overlap between the two businesses – for example, much of the Alliance Pipeline falls along the same right-of-way as Pembina's Peace Pipeline system, and the Veresen Midstream assets flow into that same system, along with a host of other asset/business overlaps," he said.

"We believe the combination of these two asset packages should allow the pro-forma entity additional opportunities with respect to service bundles for producers, with the most notable impact being the ability for Pembina to now offer producers a parallel midstream solution on the gas value chain vs. a generally liquids-focused offering previously. Finally, with the transaction providing enhanced scale (45-per-cent rise in enterprise value) and diversification, we see cost of capital benefits that should better position the company to compete for new developments within an increasingly competitive midstream sector."

BMO Nesbitt Burns analyst Ben Pham raised his target for Pembina by a dollar to $48 with an "outperform" rating, while increased his target for Veresen to $18.65 from $15 with a "market perform" rating.

He called it a "compelling" transaction, adding: "A common question we have received from investors is: What does VSN bring to the table for PPL? On top of greater scale, diversification and an improved customer service offering, the true value of the acquisition in our opinion is PPL's ability to surface additional growth opportunities that could result in upside to expectations. In particular, PPL highlighted robust pro-forma unsecured growth portfolio of $20-billion in addition to a secured backlog of $6-billion. We believe the market is underappreciating the unsecured growth opportunities, particularly the potential Alliance expansion and additional VSN Midstream opportunities in the Montney."

Elsewhere, Veresen was upgraded to "buy" from "hold" with a target of $20 (from $13) by Canaccord Genuity analyst David Galison.

RBC Dominion Securities analyst Robert Kwan downgraded the stock to "sector perform" from "outperform" with a target of $18.65 (up from $16).

Pembina was upgraded to "outperform" from "sector perform" by National Bank analyst Patrick Kenny, who raised his target to $49 from $47.

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Trinidad Drilling Ltd. (TDG-T) is "on a serious mission to grab market share" through enhancements to its rig building program, said Raymond James analyst Andrew Bradford.

On Monday, the Calgary-based company announcement an increase to its capital expenditure budget for 2017 of $80-million (to $175-million), citing "strong demand from customers, particularly in the Permian Basin in the U.S." It now expects to spend approximately $175-million in capital expenditures, with $155-million directed towards rig upgrades and the rest bound for maintenance capital.

"This expanded $155-million upgrade program encompasses more rigs (we'd estimate 37 in all now)," said Mr. Bradford. "These recent additions to the program are likely to be substantially more expensive, on average, than the first 27 upgraded rigs. But TDG is also expanding the scope of upgrades within the 27 rigs that were already being upgraded. These upgrades and upgraded upgrades include all the usual trinkets and baubles we've become accustomed to: x-y moving systems, 7,500-psi fluid systems, additional mud pumps, additional generators, and in at least one instance, a full conversion from SCR to AC power. By the time TDG is done, and assuming customers commit to the full $155-millionprogram, TDG will have about half of its U.S. rig fleet walking and equipped with high-pressure fluid systems."

Based on the enhancements, Mr. Bradford's EBITDA projections for 2017, 2018 and 2019 jumped to $137-million, $214-million and $231-million, respectively, from $134-million, $201-million and $231-million.

He emphasized the rig building program provides value for shareholders, noting the impact of the upgrades on EBITDA is "less than the usual trading multiple for public drilling contractors."

"[Monday] night's press release aside, TDG's stock has been caught in a sufficiently vicious downdraft that it is now within 3 per cent of its 52-week low. While we acknowledge the enhanced cyclical risk, at this price we believe the risk-reward ratio is tilted heavily to the upside."

Accordingly, he raised his rating for the stock to "strong buy" from "outperform." His target remains $3.45, while the analyst average is $3.84.

"We'd be remiss if we ignored the basic truth that TDG's cyclical risk is now increased as a function of this incremental spend," said Mr. Bradford. "TDG has 31 rigs under long-term contract today – this will likely be elevated in the coming months as commitments are signed – TDG indicated that it expects to have 11 additional rigs working in the Permian Basin in the coming months alone (taking its Permian total up to 37). But if some global event or set of events drives crude demand below the current trajectory, TDG's shorter-term rig contracts could expire unrenewed, and TDG's leverage ratios could move higher as a consequence."

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Citing increased confidence that a recovery in equipment demand is under way, Canaccord Genuity analyst Yuri Lynk upgraded his rating for Finning International Inc. (FTT-T) ahead of the release of its first-quarter financial results on May 4.

He moved the Vancouver-based company to "buy" from "hold" and raised his target to $30 from $26 in order to reflect "recent sector valuation multiple expansion." The average target is $26.88.

"We are increasing our target multiple to 20 times 2018 estimated EPS from 17.5 times previously," he said. "This is in line with the equipment group, which trades at 20 times 2017 estimated EPS.

"Finning shares have lagged year-to-date posting a 1-per-cent decline. This compares to year-to-date increases of 14 per cent and 10 per cent by Toromont and Caterpillar, respectively. As such, on 2018 estimates, Finning's P/E multiple of 17.6 times is 12 per cent below Caterpillar's and 16 per cent Toromont's. We see room for this gap to close as, historically, these stocks have generally traded in a tighter range."

Expecting to see "encouraging" quarterly results from Finning, Mr. Lynk is projecting a 21-per-cent year-over-year rise in adjusted earnings per share growth. He raised his quarterly EPS estimate by a penny to 23 cents to account for "slightly" higher Canadian product support. The consensus projection is 22 cents.

"We note our estimate endeavors to capture the 43 day strike at the Escondida copper mine in Chile," he said. "We expect the quarter to feature still depressed new equipment sales but improved product support revenue and the benefit of management's cost reduction efforts.

"Mid-cycle EPS is still a long ways away, implying good EPS upside potential. It is entirely possible that adjusted-EPS could double from 2016 and still not achieve midcycle, which we believe is close to $2.00 per share. Recall, management has taken close to $200-million of costs out, most of which were fixed; that's $1.20 per share. Additionally, management has made strides improving the supply chain, leveraging IT, and improving service profitability, which should lead to much higher ROIC [return on invested capital] than the 17-18-per-cent achieved last cycle."

Mr. Lynk noted his upgrade for the stock is an "out-of-consensus call," saying: "We believe it is worth noting that there are only two BUY ratings on Finning and five Holds. If others were to become more bullish on Finning's long-term prospects like we are it could act as a share price catalyst."

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The IPO pricing for STEP Energy Services Ltd. (STEP-T) "seems very attractive," said Industrial Alliance analyst Elias Foscolos.

On Tuesday morning, the Calgary-based company announced the completion of its previously announced initial public offering of 10 million common shares at a price of $10.00 each.

Mr. Foscolose initiated coverage with a "buy" rating.

"STEP is poised to capitalize on the uptick in drilling activity in Canada and the U.S. through a combination of organic growth and previous strategic acquisitions, which will position it as a significant player in the coiled tubing and hydraulic fracturing business," he said. "STEP has a clear path to significantly increase its revenue from $169-million in 2016 to $821-million by 2018."

He set a price target of $13.

"Managing exponential growth and limited market liquidity remain risk factors for investors," he said. "The exponential increase in deployable capacity anticipated over the next 18 months is likely to cause some growing strains. Furthermore, post IPO, the Company's liquidity will remain limited as the 10-million share float is likely concentrated in institutional accounts."

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CIBC World Markets analyst Paul Holden raised his target price for shares of both CI Financial Corp. (CIX-T) and IGM Financial Inc. (IGM-T) ahead of the release of their first-quarter earnings.

In justifying his moves, he cited an expectation of assets under management growth, "strong" demand for standalone mutual funds and management guidance hinting at more moderate expense growth.

"Fund returns over the last year are eye catching and we expect that will continue to support demand for mutual funds," he said.

"Bargain hunters have found good value in the asset managers who continue to produce plenty of free cash flow and offer attractive dividend yields. Companies finding positive business momentum in the last few quarters have seen a healthy amount of multiple expansion (i.e., AGF and IGM). CI continues to trade at a substantial discount to its historical levels and is producing improving fund performance. The company repurchased 2.2 million shares in Q1 at an average price of $27.01 and subsequently upsized its NCIB. We see significant upside to CI if fund performance can be converted into net sale."

Mr. Holden is projecting operating earnings per share of 53 cents for CI Financial, which is scheduled to report on May 11. That is a cent above the consensus estimate and a "healthy" rise from 46 cents a year ago.

"We are assuming $350-million of net redemptions, comparable to the $330-million of net redemptions reported a year ago," the analyst said. "A number of large CI funds have put up 1st or 2nd quartile performance over the last year. Fund performance is improving, which should lead to better net sales in due course."

With an "outperformer" rating, his target rose by a loonie to $32. Consensus is 29.61.

He is projecting EPS of 75 cents for IGM, which reports on May 5. That's a 3-cent drop from the previous quarter based on the assumption of lower commissions from insurance sales.

"Momentum for both Investors Group and Mackenzie is positive," he said. "However, we remain cautious about potential changes, such as fee reductions, that could impact earnings in the near term."

 Mr. Holden kept a "neutral" rating and bumped his target to $44 from $42. Consensus is $43.

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SNC-Lavalin Group Inc.'s (SNC-T) $4.2-billion acquisition of WS Atkins Plc is a "win-win" transaction with its ability to reduce risk while improving margins, said Raymond James analyst Frederic Bastien.

"Atkins is void of construction risks, which we believe could play a big role in the market re-rating SNC's E&C operations," he said. "The pure-play engineering firm is also more profitable, with EBITDA margins in the 9–10-per-cent range that compare favourably to the already much enhanced 6–7-per-cent we forecast for SNC's core business through 2018. It should be noted that the combined entity would derive over 70 per cent of its top-line from low-risk cost-plus and service-heavy activities. This should go a long way in improving E&C's valuation, which consistently lagged its peer group average for the past 3- 4 years."

Mr. Bastien raised his target for SNC shares following the closing of its $880-million bought deal, with the proceeds assigned to the acquisition.

"We view the deal favourably as it should materially de-risk the Montreal-based E&C firm, augment its exposure to global infrastructure markets and optimize its capital structure.

He added: "We have layered into our model consensus expectations for Atkins, over $100-million in incremental interest expense annually and cost savings of $90-million for 2018. The result is a 35-per-cent jump in our adjusted E&C EPS estimate for next year and a 16-per-cent increase in our EPS forecast for all of SNC (before integration and intangible amortization expenses related to Atkins). We caution, however, that the proposed acquisition is just that. We see SNC as an ideal strategic partner for the Brit consultancy, but with limited deal protection in place under UK regulatory rules, a higher bid could still emerge before the shareholders' vote.  … We feel this deal makes a ton of sense strategically. The combined entity will employ 53,000 professionals across the world and generate over $12-billion in consolidated revenues. Atkins notably bolsters SNC's capabilities in the rail, road and nuclear power sectors, while expanding its footprint in the UK, the U.S. and the Nordics. We particularly like that there's no real overlap between the two companies and, hence, limited risk of redundancies and layoffs for revenue generators."

Mr. Bastien kept an "outperform" rating for the stock with a new target of $68, rising from $63. Consensus is $64.65.

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In other analyst actions:

TD Securities analyst Greg Barnes upgraded Sherritt International Corp. (S-T) to "speculative buy" from "hold." His target rose to $2 from $1.50, while the consensus average is $1.60.

Cormark Securities Inc. analyst Tyron Breytenbach initiated coverage of Timmins Gold Corp. (TMM-T) with a "speculative buy" rating and $1.20 target. The average is 90 cents.

National Bank Financial analyst Vishal Shreedhar initiated coverage of Sleep Country Canada Holdings Inc. (ZZZ-T) with an "outperform" rating. He set a target of $40, while the average is $38.43.