Tuesday’s analyst upgrades and downgrades

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

Toromont Industries Ltd.'s (TIH-T) $1.02-billion deal for privately held Hewitt Group is a "transformative" acquisition, according to Canaccord Genuity analyst Yuri Lynk.

Citing the accretion potential stemming from the addition of rival Hewitt, a Pointe-Claire, Que.-based heavy equipment supplier, Mr. Lynk raised his rating for Toromont to "buy" from "hold."

"We believe this acquisition is well timed," he said. "While Hewitt's EBIT margins have increased dramatically since 2014, as Quebec's construction and mining markets have improved, they stand at only 6.3 per cent, roughly half of Toromont's Equipment Group. With $91-billion of infrastructure spending planned by the Quebec government over the next 10 years and increasing signs that demand from the mining patch for Caterpillar equipment, parts, and service may have bottomed, we see good growth potential for Hewitt. Meanwhile, sharing of best practices between the two companies could allow Toromont to increase Hewitt's EBIT margins beyond what a cyclical recovery might imply. To be conservative, however, we model rather modest EBIT margin improvement for Hewitt of 150 basis points by 2019.

"There are a number of other compelling reasons we like this acquisition. First, it provides Toromont with the opportunity to build a rental service model across central and eastern Canada by deploying the Battlefield rental store concept in Quebec and the Maritimes. Second, there is an opportunity to leverage investments Hewitt has made on the technology front, specifically connected machines, which could drive incremental product support revenue. Last, Toromont and Hewitt have a number of common customers that should benefit from the expanded capabilities of the pro forma company."

Mr. Lynk said Toromont, based in Concord, Ont., has a long history of acquiring, integrating and "wringing value" from Caterpillar dealerships. Accordingly, he expressed confidence in its ability to integrate Hewitt, which is its largest acquisition, and "realized bottom line accretion."

He raised his 2018 earnings per share projection by 10 per cent to $2.50 (from $2.28), while his 2019 estimate jumped 13 per cent to $2.75 (from $2.43). His revenue expectations rose by 51 per cent for both years to $3.27-billion and $3.48-billion, respectively.

"Toromont maintains a strong balance sheet post acquisition," said Mr. Lynk. "We peg Toromont's pro forma net debt-to-EBITDA ratio at 2.15 times and management noted on the call that it expects the net debt-to-total capitalization ratio to be 30 per cent by the end of 2018."

Mr. Lynk increased his target price for the stock to $58 from $50. The analyst average price target is currently $53.42, according to Bloomberg data.

"Toromont trades at 20.0 times our pro forma 2018E EPS compared to Finning (FTT-T, "buy" rating) at 18.1 times and Caterpillar (CAT-N) at 17.7 times," he said. "We believe Toromont deserves a premium multiple given its superior track record of value creation and the upside we see to our estimates should management deliver synergies and/or margin improvement in excess of what's captured in our conservative model."

Elsewhere, Raymond James analyst Ben Cherniavsky bumped his target to $58.50 from $55 with an unchanged "outperform" rating.

"Although our Outperform rating on Toromont has not been exclusively premised on a prediction of this specific development, we had explicitly identified 'balance sheet optionality' as a reason to own this stock," said Mr. Cherniavsky. "We also understood that Toromont has an exemplary track record of capital allocation, which gave us high confidence that, with the right amount of patience, the company's idle capital would be deployed in a very accretive manner. Finally, 'dealer consolidation' has been a key component of our investment thesis on the equipment sector for many years.

"In the CAT world alone, we have tracked over 25 transactions of dealers buying dealers over the past 20 years. Putting this all together, we have been openly musing about a Toromont-Hewitt transaction for a long time. As a result, [Monday's] news does not come as a big surprise to us; nor does it fundamentally alter our view of the stock. We have, however, increased our financial forecasts for Toromont to reflect the projected accretion from this deal. We also believe that the Hewitt acquisition will improve the growth visibility of Toromont over the next few years as the company capitalizes on a cyclical recovery in the equipment markets along with the strategic benefits of integrating two contiguous, high quality CAT dealers into one operation. Thus, despite the stock's jump on this news (up 11 per cent versus 0 per cent TSX), we see further long-term upside to Toromont shares and continue to urge investors to buy them."

National Bank analyst Maxim Sytchev increased his target to $55 from $52 with an "outperform" rating (unchanged).

Mr. Stytchev said: "The beauty of Toromont's business model has always resided with company's ability to deploy capital when it matters. This is what the management team did with Enerflex and this is what they are doing now with Hewitt by buying a contiguous operation (in addition to Western Labrador and the Maritimes, as well as the Caterpillar lift truck dealer for most of Ontario. Hewitt is also the MaK dealer for Québec, the Maritimes and the Eastern seaboard of the United States (from Maine to Virginia) at what we estimate as reasonable multiple (8.4-9.0 times post synergies vs. TIH at 10.8 times enterprise value/EBITDA pre today's announcement). Balance sheet will remain very solid – 2.4x net debt / pro-forma EBITDA. More importantly from positioning perspective, TIH's best-in-class operating metrics if applied to Hewitt, should provide years of upside when it comes to instituting an ROIC-focused culture across the entire organization."

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The focus is on the performance of Dominion Lending Centres after "mixed" second-quarter financial results for Founders Advantage Capital Group Corp. (FCF-X), said Desjardins Securities analyst Gary Ho.

On Monday, the Calgary-based investment issuer reported adjusted earnings before interest, taxes, depreciation and amortization of $6.2-million, falling below Mr. Ho's projection of $7.4-million. He blamed the miss largely on lower contributions from DLC.

"By our estimate, to hit FCF's 2017 adjusted EBITDA guidance, FCF will need to generate two-thirds of the total in 2H17," he said. "We believe DLC will be the swing factor—3Q tends to be DLC's strongest quarter and Newton is expected to be a contributor. DLC's (54 per cent of NAV) broker count increased by 87 sequentially (159 year to date or $1.7-billion in additional mortgage volume) due to 'reflagging' efforts. However, total funded mortgage volume decreased 6.6 per cent year over year, which is a concern. Mortgage rule changes effective October 2016 lowered qualified mortgage amounts and reduced growth on a per-broker basis. Club16 (25 per cent of NAV) benefited from a $2.2-million equipment refresh fee. Memberships also grew 4 per cent year over year. Impact 's (closed March 2017, 8 per cent of NAV) growth is expected to be driven by adding distributors. In 2Q17, it established/renewed its relationships with 32 dealers. We note corporate G&A of $1.1-million was below our $1.2-million.

"We reduced our estimates predominantly within DLC due to industry headwinds. In our view, 3Q will be a key focal point for investors."

Mr. Ho dropped his 2017 earnings per share projection to a 1-cent loss from a 1-cent profit, while his 2018 estimate fell 2 cents to a 4-cent loss.

He maintained a "buy" rating and lowered his target price for the stock to $3.50 from $4.50 to reflect the lower estimates and a reduced multiple for DLC. The analyst consensus is $4.31.

Mr. Ho said: "Our investment thesis is predicated on the following: (1) FCF's concept aligns investees with FCF and shareholders, while there is downside risk with a controlling stake, (2) future investments will reduce concentration risk, (3) accretive new investments will produce a steady and growing dividend stream, and (4) the CEO has a proven track record and strong relationships with M&A advisors."

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Crius Energy Trust (KWH.UN-T) is "generating yield from doorstep to rooftop," said Raymond James analyst David Quezada.

He initiated coverage of the Toronto-based company with an "outperform" rating.

"With a mixture of M&A and organic growth we believe Crius' core deregulated retail energy business has a sizable opportunity to further penetrate a large addressable market," said Mr. Quezada. "Since the company's late 2012 IPO Crius has acquired a mix of 8 retail energy businesses and customer books bringing pro-forma Residential Customer Equivalents ('RCEs') from 596K in 2Q13 to 1,378K in 2Q17 (a 24 per cent compound annual growth rate). Moreover, with the exception of the polar vortex weather anomaly in 2014, Crius has also consistently seen solid organic net customer growth. We also believe Crius' strategic partnerships with telecommunications providers give access to a large pool of potential customers."

Mr. Quezada added the company's leveraging of its sales channels is likely to lead to "strong" growth in its solar segment.

"We believe Crius' large retail energy footprint makes the company unique among rooftop solar developers and facilitates a significantly lower cost of customer acquisition, representing a meaningful competitive advantage," he said. "Accordingly, we believe the company can succeed in a space where many players have struggled. We see the continued decline in costs of rooftop solar units making them an increasingly compelling proposition for many customers."

Mr. Quezada believes Crius is currently trading at a "significant" valuation discount to its peers, but he expects that to continue to narrow. He set a price target of $12 for the stock, versus the consensus of $11.88.

"Currently trading at just 4.4 times 2018 enterprise value to EBITDA, Crius trades at a significant discount to its most logical peer Just Energy (JE-T) at 7.0 times despite having a relatively similar business and risk profile," he said. "While we acknowledge that Just Energy is larger with 4.2 million RCEs versus Crius at 1.4 million and a market cap of just over $1.0-billion versus Crius at just $510-million, we highlight several other metrics augur more in Crius' favour, in our view.

"Mostly notably, Crius is growing with RCEs having steadily increased of late and poised to continue rising whereas Just Energy's RCEs have declined recently falling 4 per cent in F2016 and 7 per cent in F2017 (Mar-31 fiscal year end). Moreover, we would argue that the cash flows generated by Crius' deregulated energy segment are at least as stable as those of Just Energywhile, based on consensus estimates, Just Energy's forecast EBITDA CAGR of just 5 per cent between F2017-F2019 compares to our estimates for Crius' 2 year CAGR at close to 35 per cent … We note the relative EV/EBITDA spread between Just Energy and Crius peaked in late 2015 at close to 6.0 times and has since narrowed to roughly 2.5 times which, in light of the foregoing commentary is a trend we expect will continue. We attribute the historical discount to several factors including 1) the fact that Crius only became 100% public via an offering in Jun-2016 and has only recently begun to see the stock's liquidity improve and bid-ask spread narrow; 2) some mis-steps by the company in the early days of its 2012 IPO that, while since addressed, are lingering in investor minds; and 3) a temporary overhang represented by 3.215 million shares that will come off lock-up in Dec-2017 and Jun-2018 respectively, representing 11 per cent of the company's total float (note: much of this stock is held be insiders who we believe are less likely to sell). It is also worth noting the 3.3 million shares now owned by MVC Capital (the prior owner of US Gas & Electric) will be locked up for a period of 4-6 months from closing of the transaction in early July of 2017. We emphasize our view that Crius' valuation discount is primarily a function of transitory factors that we expect will be resolved in coming months and we therefore see current levels as an opportunity to add to positions."

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Echelon Wealth Partners analyst Russel Stanley lowered his target price for shares of Emblem Corp. (EMC-X) in reaction to the marijuana producer's lower-than-expected second-quarter revenue results.

On Monday after market close, Toronto-based Emblem reported revenue of $0.5-million for the quarter, falling below the analyst's $1-million projection due largely to a lack of wholesale product sales. Earnings before interest, taxes, depreciation and amortization of a loss of $1.5-million also missed his estimate significantly ($3.6-million) with higher operating expenses as the main reason.

"Our estimate revisions are relatively minor, with our 2017 revenue estimate now $3.1-million down from $5.0-million, reflecting a slower ramp up than we had previously assumed. Our EBITDA estimate for 2019 is unchanged," said Mr. Stanley. "However, since we initiated coverage of EMC, the adjusted average enterprise value/2019 estimated EBITDA multiple (based on consensus estimates) has fallen 40 per cent from 11.6 times to 7.0 times. We attribute this group multiple compression to a combination of increased uncertainty as to the forthcoming recreational market's structure, as well as an increased number of issuers (i.e. a larger sample size). We are therefore reducing our valuation multiple from 17.5 times to 8.5 times, which still represents a 21-per-cent premium to the current peer group average."

Keeping a "speculative buy" rating for the stock, Mr. Stanley's target fell to $2.25 from $4.50. Consensus is $2.56.

Elsewhere, GMP analyst Martin Landry downgraded the stock to "hold" from "buy" and lowered his target to $1.75 from $2.50.

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MacDonald, Dettwiler and Associates Ltd.'s (MDA-T) pending acquisition of U.S.-based DigitalGlobe Inc. is a "smart diversification play at [an] attractive valuation," according to Credit Suisse analyst Robert Spingarn.

"We believe that the pending (imminent) acquisition of DGI is a positive outcome for MDA, and helps to offset some continued pressure in the cyclical commercial satellite business," he said.

"We see the strategic appeal of this combination, particularly given the attractive price, and we fundamentally believe that DGI's strong and unique competitive positioning and financial profile justify our target valuation."

Adding DGI to his financial model, Mr. Spingarn raised his 2017 to 2019 EPS estimates are $5.60, $6.75,  and $7.35, respectively, from $6.01, $6.34 and $6.64.

"The transaction will create a leading supplier of end-to-end satellite, earth imagery and geospatial solutions," he said. "Importantly, the deal accelerates MDA's pre-existing 'U.S. Access Plan', which is intended to expand MDA's business with U.S. government agencies (the largest consumers of space solutions). DGI brings with it significant existing U.S. government business, and the new capabilities of the combined company will enable further opportunities with this major customer set. The transaction also increases scale and diversifies MDA's portfolio with a stream of more predictable data and services revenue. It also reduces DGI's EnhancedView SLA contract concentration from 46 per cent of total revenue in 2016 to less-than 15 per cent pro forma revenue."

"The new company will leverage a full suite of space-related capabilities, including communications and Earth observation satellites and robotics, ground stations, integrated electro-optical and radar imagery, and advanced data analytics. MDA's technology portfolio includes communications and remote sensing satellites, robotics, surveillance and intelligence systems, geospatial data, analytics and services, while DigitalGlobe is a leader in Earth imaging and geospatial solutions, and is firmly integrated into the workflows of industry's largest customers."

With an "outperform" rating (unchanged), his target price for MDA stock rose to $97 from $93. Consensus is $85.27.

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Finish Line Inc. (FINL-Q) is "another victim" of the turbulence being experienced in the athletic wear industry, said Canaccord Genuity analyst Camilo Lyon.

On Monday, the Indianapolis-based company pre-announced "weak" second-quarter financial results. It now expects earnings per share of 8 to 12 cents (U.S.), well below Mr. Lyon's expectation of 36 cents and the Street's 37-cent estimate. That drop was due largely to a 4.6-per-cent dip in comparable sales as well as gross margin pressure.

For the third quarter, Finish Line is guiding comps of a 3-5-per-cent decline and a loss per share of 32 to 40 cents. For the fourth quarter, comps are a 3-5-per-cent decline and a loss of 50 to 58 cents per share.

"This sharp collapse of FINL's business underscores the category challenges facing athletic, largely promulgated by [Nike Inc.'s] innovation lull and ensuing aggressive promotional stance," said Mr. Lyon. "Simply put, it is crippling the retailers. To make matters worse, it appears that some of the top performing platforms until recently (Roshe, Hurache, Jordan Retro) are slowing at a much faster rate than previously anticipated, requiring more aggressive promotions to move slower turning inventory, likely leading to a market-wide step up in promotions in the 2H17. Unfortunately, we do not expect the athletic space to show any signs of stabilization until we see meaningful innovation out of NKE, which we believe will take another 9-12 months. Until that happens, we expect continued under-performance from all the athletic retailers in our universe."

Mr. Lyon dropped his EPS estimate for 2018 to 49 cents from $1.15. For 2019, his projection is now 81 cents from $1.32.

Maintaining a "hold" rating for the stock, his target fell to $8 (U.S.) from $14. The analyst average is $9.97.

"We firmly believe that this downturn in the athletic category is product driven, and it starts and ends with NKE," he said. "We have seen little to no material innovation from the company in more than two years, with the exception of the Vapor Max. To stem its market share losses, NKE pressed Jordan into the market to such an extent that it too has begun slowing at an accelerated pace. While initial sellthrus of the Vapor Max have been good, the platform lacks depth and scale to outweigh the negative mix impact from all the other slowing platforms. Over the coming months, NKE will be introducing different iterations and color patterns of the Vapor Max, but more innovation is needed. Similarly, platforms from Adidas have also slowed (e.g. Stan Smith and Superstars) and the allocations of the expanding platforms like the BOOST are still facing manufacturing constraints. The one consistent comment we are getting from retailers is that consumer appetite for new/innovative product remains strong, it is just that there is not enough of it in the market. Once we begin to see broad based innovation from NKE in both footwear and apparel (likely around mid-next year), we believe it could mark a turnaround for the retailers as well."

Meanwhile, FBR Capital Markets analyst Susan Anderson downgraded the stock to "neutral" from "outperform." Ms. Anderson lowered her target price to $9 from $22.

Buckingham Research Group analyst Scott Krasik lowered the company to "underperform" from "neutral" with a $5 target, falling from $14.

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In other analyst actions:

Peters & Co Ltd analyst Dale Lewko initiated coverage of Brookfield Renewable Partners LP (BEP.UN-T) with a "sector perform" rating and $48 target. The analyst average target is $42.84.

Vertical Research Partners analyst Chip Dillon downgraded Norbord Inc. (OSB-T) to "hold" from "buy" with a $44 target, down from $46. The average target is $46.28.

Dundee Securities Corp. analyst Ralph Profiti downgraded Polaris Materials Corp. (PLS-T) to "neutral" from "buy" and raised his target to $2.79 from $1.15.

Roth Capital Partners analyst Joseph Reagor initiated coverage of Silvercorp Metals Inc. (SVM-T) with a "buy" rating and $4.37 target. The consensus target is $4.79.