Tuesday’s analyst upgrades and downgrades

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

Inter Pipeline Ltd.'s (IPL-T) stock has "significantly" underperformed this year and is now "attractively" valued, according to BMO Nesbitt Burns analyst Ben Pham.

Blaming the dip on concerns about its future growth and increased commodity price exposure alongside "weak" second-quarter results, he raised his rating for the Calgary-based company to "outperform" from "market perform" in a research note on the energy infrastructure industry.

"With NGL Processing cash flow poised to rebound in the second half of 2017 following planned outages in Q2 and supported by higher frac spreads over the next year, the recent share price weakness provides for a great long-term investment opportunity, in our view," said Mr. Pham. "Coupled with an attractive 24-per-cent upside to our unchanged target price of $27 including a 7-per-cent dividend yield (70-per-cent payout), we are upgrading our rating."

Mr. Pham said the company's NGL (natural gas liquids) processing appears set to grow going forward, with the acquisition of Williams Canada last year bolstering its processing footprint.

"OPL is now benefitting from the same positive trends driving NGL levered names like KEY [Keyera Corp.] and PPL [Pembina Pipeline Corp.], namely due to the increase in liquids-rich drilling and NGL production," he said. "One opportunity is the proposed $3.1-billion PDH + PP [[propane dehydrogenation and polypropylene]  project, where FID is expected H2/17 ($2 per share of potential upside), while another is the potential increase in frac spreads that would benefit existing operations. The Cochrane facility should also return to strong utilization following a planned outage in Q2. The unfortunate consequence of the NGL business is the increase in commodity exposure it comes with: to 18-per-cent year-to-date 2017 versus 10 per cent in 2016. While the higher commodity exposure could continue to weigh on valuation, we think it will be contained and highly reliable cash flow in Oil Sands Pipes should offset.

"As NGL processing adds to cash flow in the near term, opportunities related to intra-Alberta oil sands projects could arise in the medium term. Last year, IPL announced a new TOP contact for the Kirby North project; $125-million is expected to be invested at attractive returns. We believe this announcement illustrates that IPL still has considerable hidden value in the expansion potential of its oil sands/diluent pipelines. About $4-billion of potential investment has been identified and is not reflected in our model."

Mr. Pham maintained a price target of $27 for Inter Pipeline shares. The analyst consensus price target is $29.31, according to Thomson Reuters data.

"IPL shares are down 19 per cent versus a 3-per-cent decline for the group on a slowdown in dividend growth (we model for 4 per cent in 2018) and higher commodity exposure," he said. "IPL now trades at a discount compared to its historical premium: 2018 estimated enterprise value/EBITDA has compressed to 12.5 times from 14.0 times since the beginning of the year, while the 2018 estimated FCF [free cash flow] yield has risen to 9.5 per cent from 8 per cent. We believe the company's assets deserve a premium multiple given their long-life nature with creditworthy counterparties."

On the industry as a whole, Mr. Pham said he's shifting his preference to pipelines over utilities, noting: "Following a review of our Energy Infrastructure Top-Down Investment Framework, we have shifted our investment preference towards pipeline & midstream equities over power & utility within Canadian Energy Infrastructure. Why? (1) Midstream has significantly underperformed utilities this year and the sector is now trading at an attractive 9-per-cent FCF yield vs. the historical five-year average of 8%. In contrast, utility names are trading at a 7-per-cent FCF yield, which is generally in line with its five-year historical average. (2) pipeline stocks offer higher dividend growth; and (3) we believe the combination of rising bond yields and a range-bound oil price is more positive for pipeline than the utility portion of our infrastructure coverage."

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Mr. Pham also upgraded his rating for Keyera Corp. (KEY-T) based on its "robust" growth pipeline and "attractive valuation."

"Given the downdraft in Canada's midstream sector lately, we are becoming more bullish on the stocks generally," he said. "KEY is perhaps a riskier proposition than most due to its gas processing throughput risk and Marketing volatility. Having said that, the stock has gone nowhere over the last two years and now trades at a modest discount to the group vs. a historical premium. We think cash flow per share should accelerate next year and the 16-per-cent implied upside to our unchanged $42 target is attractive. Accordingly, we are upgrading the shares to Outperform from Market Perform."

Mr. Pham admitted he recently saw limited upside for Keyera shares due to a number of factors, including a drop in gas processing throughput, "heightened" counterparty risk, downside in market profit and midstream fee compressions.

"Those risks have mostly surfaced now and are more than reflected in the share price, in our opinion," he said. "Marketing delivered $23-million EBITDA in Q2/17 versus $60-90-million per quarter in 2015, gas processing throughput saw 5-10-per-cent declines in 2015 and 2016, and frac fees have come under pressure due to the infrastructure over-build. As a result, the stock has gone nowhere over the last two years, while sector values have risen, with most midstream stocks up 15-20 per cent over that similar period.

"Given that relative performance, the stock is trading at a discount on 2018 estimated FCF yield (9.2 per cent versus the pipeline/midstream average of 8.8 per cent). Historically, KEY garnered a premium to the group due to strong management, a conservative balance sheet, and a premium organic growth outlook. Robust Marketing profit during 2014-2015 probably also drove valuations higher than they would normally go on infrastructure growth alone."

His target remains $42. Consensus is $44.27.

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Falco Resources Ltd.'s (FPC-X) Horne 5 project is "to be advanced to production or be attractive as a potential acquisition target given the rarity of large scale, long life, and low cost projects in safe jurisdictions," according to Raymond James analyst Tara Hassan.

Initiating coverage of the stock with an "outperform" rating, Ms. Hassan said Horne 5, located in Rouyn-Noranda, Que., stands out from its development stage peers based on its potential scale in production as well as its low cost profile and extended mine life. Falco owns the entire stake in the project, previously mined by Noranda Mines Ltd.

"The project's proximity to a mining centre eliminates many of the challenges that can face a development project as Horne 5 is easily accessible, has power and water to site, proximity to equipment suppliers, and access to a highly skilled labour pool," the analyst said. "With the project being located on a brownfield site and in an active industrial area, permitting risks are perceived to be low, particularly given that the bulk of the tailings will be placed underground as paste fill or at other past producing operations on its claims. We note that Falco will need to add a surface tailings facility for the material it does not return underground; however, it is in talks to acquire a brownfield site that it could expand for its needs. It is also in discussions to acquire surface rights in two areas that it will require for surface infrastructure. The areas that it is looking to acquire will necessitate relocation of a school and an administrative building. We expect these discussions to conclude in 4Q17."

She added: "The PEA outlined average annual production of 236,000 ounces Au at AISC of $427 (U.S.) per ounce (net of by-products) over a 12 year mine life. This pegs Horne 5 in the top 10 Canadian development projects (with a published study) on an annual production basis and in the bottom two on a cash cost basis. When evaluating development projects not held by a major or intermediate producer, Horne 5 ranks in the top 3 Canadian development projects on a production basis."

Ms. Hassan also emphasized the advantages stemming from Falco's experienced management team.

"One of the biggest challenges facing many development stage companies is establishing the team with the right skillsets and experience to carry the project through to production," she said. "When a project the scale of Horne 5 is proposed, we view this to be a bigger challenge as there are generally limited people available with the relevant experience building a project of that scale. In the case of Falco however, we believe it is uniquely positioned as it already has this team in place. The management team and Board of Directors behind Falco include many of the major players involved in designing, permitting, constructing, and operating the Canadian Malartic mine, one of Canada's largest gold mines. With relevant recent experience in the region and with a large scale, high capital cost project, we believe the Falco team is well positioned to advance Horne 5 to production. While building a mine of the proposed scale of Horne 5 introduces unique technical complexities, the Falco team has encountered many of the same challenges in building the Canadian Malartic mine and are thus well positioned to address these challenges at Horne 5 and ensure risks remain low during the construction and operating phases. The common elements between the projects include the financing of a large scale, high capital cost project and advancing the project through the permitting process in the same jurisdiction. Unlike at Canadian Malartic, however, the Horne 5 project is situated in a heavily used industrial area and is on a brownfield site, which we believe will simplify the permitting and social license components of the project."

Ms. Hassan set a price target for the stock of $2. The analyst consensus price target is $1.91, according to Thomson Reuters data.

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Jefferies analyst Philippe Houchois expects Tesla Inc. (TSLA-Q) to post losses until 2020, a year longer than the consensus projection on the Street.

He believes the company's vertically integrated business model (from manufacturing to distribution and supercharging) cannot become profitable as quickly as his peers expect or valuation multiples imply.

Mr. Houchois initiated coverage of the stock with an "underperform" rating and $280 (U.S.) price target, which implies 27-per-cent downside from Monday's close. The average target is $333.78.

"Given capital intensity, we don't think DCF can justify the current valuation, let alone upside," said Mr. Houchois. "We appreciate the growth upside from a brand whose reach goes well beyond auto markets and that valuing Tesla today assumes some form of 'steady-state' that is unlikely to happen anytime soon."

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Though RBC Dominion Securities analyst Gary Bisbee believes there's "some" value in Equifax Inc. (EFX-N) for patient, risk-tolerant investors, he said there's no rush as financial estimates for the scandal-ridden company need to fall and negative news could stem from Congressional hearings.

In the wake of a 34-per-cent drop in share price following the Sept. 8 disclosure of a data breach, Mr. Bisbee said "uncertainty remains high" and pointed to three lingering questions for investors: "1) How will the underlying earnings power of Equifax be impacted by the breach?; 2) What risk of market share losses to competitors exists as fallout from the breach continues?; 3) Is there risk of tightened regulations or new legislation that "changes the rules" for the credit bureaus and hurts their profitability or growth prospects?"

Mr. Bisbee reduced his 2018 revenue forecast for Equifax by 3.1 per cent and his earnings per share expectation by 11 per cent (to $5.96 from $6.68). His GAAP EPS estimate fell 37 per cent to $3.55 from $5.68 including direct breach-related costs and estimated insurance recoveries.

"Clearly we have made many assumptions that could prove to be wrong, though we believe that they are reasonable under the circumstances and given what we know," he said. "On the negative front, it is possible that providing monitoring to consumers could cost far more than our $260-million forecast, depending on the number of consumers that sign up or the cost to provide the service. And, we have not assumed any regulatory fines or legal settlements or judgements, though both are possible.

"On the positive front, insurance coverage could be larger, and we may have been too punitive in assuming that there is no cost reduction to partially offset the Global Consumer revenue decline (we don't assume this because the business will likely actually be staffing up to provide the free monitoring to the much larger number of consumers getting free monitoring). We also may be double counting somewhat by assuming no cost takeout in Global Consumer while assuming that the monitoring costs (including Equifax's own costs) are fully in the model in the breach-related line."

He maintained an "outperform" rating for the stock and dropped his target to $113 (U.S.) from $154. The analyst average is $124, according to Bloomberg

"We have been conditioned to recommend buying Equifax on weakness (January-February 2016, October-November 2016), and that may well be the right approach here," the analyst said. "However, there remains significant uncertainty into the costs and potential repercussions of the breach, and Equifax will likely suffer in the court of public opinion in the short term. We also see little to be excited about in the near-term financial picture, as Equifax faces USIS deceleration in H2/17 as mortgage refinancing volumes fall and it laps the US mortgage industry's adoption of trended data last summer. Estimates need to fall (consensus 2018 adjusted EPS is 8 per cent above our new $5.96 estimate). Add in some ACA uncertainty, tough comps through Q1/18 and likely lingering uncertainty about the financial and operational impact of the breach, and we see few potential short-term catalysts to drive a rebound in the shares, especially heading into what will likely be a difficult Congressional hearing on Oct. 3.

"Despite this challenging near-term outlook, we retain our Outperform rating, as we believe that current levels offer value for patient, risk-tolerant investors. We continue to believe in the quality of the management team and business model, and we believe that the franchise will work through this issue and continue to be a good (likely above average) compounder over time. However, in the short term we see no rush to step in to the stock, and prefer other recommended stocks where the risk side of risk-reward is more quantifiable."

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Citing its "attractive" real estate positioning, Credit Suisse analyst Christian Buss raised his rating for Gap Inc. (GPS-N) to "neutral" from "underperform."

The upgrade stems from Mr. Buss's analysis of real estate for 32 softline vending and retail companies. He examined companies across eight "key criteria of retail health."

"The biggest surprise in our analysis was The Gap Inc.'s top 10 score," he said. "GPS scored 57.1 per cent versus the group average of 50 per cent, and well above other mall-based specialty retail companies (LB [L Brands Inc.] 50 per cent, ANF [Abercrombie & Fitch Co.] 50 per cent, and KORS [Michael Kors Holding Ltd.] 43.8 per cent). GPS pulled ahead by scoring higher in the mall exposure and mall quality categories."

Mr. Buss also said he was "encouraged" by the company's recent announcement of a decision to close 200 low-quality Gap brand and Banana Republic locations with the aim to focus on its Old Navy and Athleta chains.

"We believe the move to a healthier fleet and an increased focus on digital is prudent as sales continue to shift online," he said.

Mr. Buss raised his fiscal 2017 comparable same-store sales growth, revenue and earnings per share projections to 1.1 per cent, $15.517-billion (U.S.) and $2.06, respectively, from 0.9 per cent, $15.512-billion and $2.02. His 2018 estimates moved to 1.6 per cent $15.912-billion and $2.27 from 0.8 per cent, $15.765-billion, and $2.15.

His target price for the stock increased to $30 from $23. The analyst average is $26.47.

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Believing its merger with AT&T Inc. (T-N) is close to receiving regulatory approval, Credit Suisse analyst Omar Sheikh downgraded Time Warner Inc. (TWX-N) to "neutral" from "outperform."

"In the U.S., we believe it would be difficult for the DOJ to block the transaction on antitrust grounds given its vertical nature and the precedent from Comcast's acquisition of NBCU," he said. "The main outstanding antitrust barrier is in Brazil, where the regulator (CADE) has highlighted competition concerns about the merger – however, we note that in the worst case T could divest Sky Brasil to alleviate these concerns."

Mr. Sheikh raised his 2017 and 2018 earnings per share projections to $6.09 and $6.63 from $5.95 and $6.62.

He said: "We have confidence in Time Warner's future earnings growth given (1) as a pure-play content owner, it is structurally well-positioned as consumption of video content migrates online and new opportunities to monetize content emerge; (2) the roll-out of HBO NOW should tap new demand for the product and could substantially boost 2020 HBO EBITDA; (3) Turner screens well on our proprietary genre analysis, and we remain bullish on the company's ability to grow affiliate fees over the long term."

He maintained a price target of $107.50 (U.S.). Consensus is $105.85.

"Time Warner's guidance of 'high single-digit' growth in adjusted operating income in 2017 suggests the company is still benefiting from strong organic operating trends, notably in its core Turner cable networks division where the most recent affiliate renewal cycle continues to drive strong revenue growth despite softening subscriber trends," the analyst said. "Absent a merger proposal, we argue TWX would likely trade in the 9.3-9.6 times 2018 enterprise value/EBITDA range today, based on 8.5-9 times for Turner, 11 times for HBO and 9.5 times for Warner Bros., suggesting fair value if AT&T were to walk away or the deal is blocked of $83-87. If the deal were to break, we believe the stock would likely trade above fair value given the quality and scarcity value of TWX's assets and their attractiveness to other potential merger partners."

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In other analyst actions:

RBC Dominion Securities analyst Paul Quinn upgraded Cascades Inc. (CAS-T) to "outperform" from "sector perform" with a target of $20, rising from $16. The consensus average is $18.29.

Dundee Securities Corp analyst Jacques Wortman upgraded Major Drilling Group International Inc. (MDI-T) to "buy" from "neutral" with a target of $8.75. The average target is $8.50.

Kepler Cheuvreux analyst Ola Sodermark initiated coverage of Lundin Gold Inc. (LUN-T) with a "buy" rating and without a specified target. The consensus target is $7.29.

Mizuho Securities USA Inc analyst Haendel St. Juste downgraded Lennar Corp. (LEN-N) to "neutral" from "buy" with a target of $53 (U.S.), down from $59. The consensus is $58.89.

Sam Poser at Susquehanna downgraded Nike Inc. (NKE-N) to "neutral" from "positive" with a target of $54 (U.S.), falling from $64. The average target is currently $60.37.