Wednesday's analyst upgrades and downgrades

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

Centerra Gold Inc.'s (CG-T) acquisition of the Mount Milligan mine in central British Columbia is a weight off the shoulders of Royal Gold Inc. (RGLD-Q, RGL-T), said Raymond James analyst Phil Russo.

On Tuesday, Centerra announced a $1.1-billion (U.S.) deal to acquire Thompson Creek Metals Co. Inc. (TCM-T), a Colorado-based miner. Concurrently, Royal signed an amended term sheet with Centerra relating to its streaming interest in Mount Milligan to take effect when the deal closes. Royal's previous 52.25-per-cent gold streaming interest will become a 35-per-cent gold stream and a 18.75-per-cent copper stream. It will continue to pay $435 (U.S.) per ounce of gold delivered and 15-per-cent of the spot price per metric ton of copper delivered.

Mr. Russo said the greater certainty with Mount Milligan's cash flow warrants greater investor confidence. Accordingly, he upgraded his rating for Royal Gold to "outperform" from "market perform."

"Incorporating the amended streaming terms into our model results in a largely neutral outcome with regards to amount and timing of cash flows," he said. "Shipment of metal under the amended terms won't take effect until 5-6 months after closing, or calendar year 2017. The certainty in receipt of payments going forward, however, which accounts for one-third of Royal's cash flows, removes a significant overhang in the stock."

In the wake of the deal, he raised his valuation for the mine "on comfort with new, proven operators with a manageable balance sheet."

Maintaining his 2016 earnings per share projection of a loss of $1.78, he increased his net asset value per share forecast to $40.78 from $38.92. His 2017 EPS estimated rose to $2.03 from $1.98.

"Given the market's previous concern surrounding Thompson Creek's ability to service its debt profile has now been removed, we have revised our NPV [net present value] discount rate for Mount Milligan to 8 per cent from 10 per cent previously," said Mr. Russo. "The stream on Mount Milligan continues to be the largest component of Royal Gold's NAV at $829-million, or 26 per cent of the gross asset value."

Mr. Russo bumped his target price for the stock to $85 (U.S.) from $72. The analyst average is $76.34, according to Bloomberg.

Elsewhere, National Bank analyst Shane Nagle also upgraded the stock, moving his rating to "outperform" from "sector perform." His target rose to $85 from $72.

Dundee Securities analyst Josh Wolfson raised his rating to "buy" from "neutral" with his target rising to $85 from $60.

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Centerra Gold Inc.'s (CG-T) $1.1-billion (U.S.) deal to acquire Thompson Creek Metals Co. Inc. (TCM-T) is an attempt to diversify at a high cost, said Canaccord Genuity analyst Rahul Paul.

He downgraded his rating for the stock to "hold" from "buy."

"Overall, we believe the negatives of the acquisition outweigh the positives," the analyst said. "With the positives largely contingent on higher metal prices, we believe Centerra's investment appeal has been diminished. We see meaningful value in TCM's flagship asset, the Mount Milligan Au-Cu mine. However, we believe that the Royal Gold Inc. (RGL-T), stream and the high levels of debt significantly limit the value to Centerra's equity holders."

Mr. Paul cited a pair of positives in analyzing the deal: "materially" increased leverage to higher gold and copper prices, "largely the result of a weaker balance sheet," and diversification of its cash flow by adding a second Canadian producing asset.

However, he said the deal adds "little" value to equity holders, estimating the net value at negative $222-million. He also emphasized a lack of meaningful geopolitical diversification, citing a continued reliance on cash flow from its Kumtor mine in Krygyzstan.

"Prior to the transaction, Centerra had a net cash position of $428-million (at the end of Q1/16)," he said. "Pro forma the transaction, we estimate a net debt position of $240-million. While this may not seem significant, we had viewed Centerra's net cash position as its most valuable asset. Further, we believe the weaker cash position will likely necessitate the assumption of additional debt to finance Greenstone (or else delay the development timeline)."

Mr. Paul lowered his price target to $7.50 from $10. The analyst average is $7.94.

"Our valuation has been updated for the impact of the acquisition, explaining the reduction in target price … based on 0.65-times (previously 0.70-times) our operating NAV [net asset value] estimate plus net working capital/other adjustments," said Mr. Paul. "Aside from the NAVPS dilution and a lower multiple (reflecting our negative view of the transaction), the change in our target price is also explained by the material decline in the net cash position as a result of this deal (we typically use a 1.0-times multiple for cash and debt)."

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Alta Corp Capital analyst Dirk Lever upgraded Superior Plus Corp. (SPB-T) in reaction to the sale of its construction products distribution business for $325-million (U.S.) to Foundation Building Materials  LLC.

"Based on previous analysis, we believe Superior obtained a fair price for the division," said Mr. Lever, who moved his rating to "outperform" from "sector perform."

Mr. Lever adjusted his financial models for Superior Plus under the assumption the deal closes at the beginning of the fourth quarter. His 2016 EBITDA forecast fell by $11-million (Canadian) to $221-million, while his 2017 estimate declined to $203-million from $286-million.

Superior Plus intends to use the proceeds of the deal to repay debt under its credit facility. Mr. Lever said his 2016 net debt projection has fallen to $269-million from $667-million, while his 2017 estimate moved to $262-million from $613-million.

 "After the closing of the sale of the CPD division, Superior should be able to pay down a significant portion of its debt and have a strong balance sheet, which should allow the company to expand its remaining two divisions (energy services and specialty chemicals) by pursuing acquisitions and growing organically," he said.

The analyst lowered his price target for the stock by a loonie to $12. The average is $12.50.

"Superior is viewed as a small conglomerate as its operating divisions have no overlap and operate autonomously," said Mr. Lever. "Conglomerates typically trade at a discount to the sum-of-the-parts relative to sole purpose businesses, for which we have applied a discretionary 20-per-cent discount. Pro forma the sale of the CPD Division, our sum-of-the-parts analysis suggests a value of $13.50 per share (after the conglomerate discount), 26 per cent higher than the current market price of $10.75 per share."

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Expressing concern over its domestic subscription growth trajectory, Netflix Inc. (NFLX-Q) was downgraded to "underperform" from "hold" by Jefferies analyst John Janedis.

Upon assuming coverage of the stock, Mr. Janedis said Hulu and Amazon.com Inc. (AMZN-Q) are likely to increase the battle for subscribers in the U.S. over the next five years. He estimated Neflix will reach 58.3 million paid domestic subscribers by 2020, falling short of the company's long-term target of 60 million to 90 million.

"The low end of this range implies a BB home penetration rate of 52 per cent (from 44 per cent in '15) -- well ahead of all peers," said Mr. Janedis. "Given the platform's existing penetration rate, and the threat of building competition, we expect growth to moderate going forward."

He cut his target price for the stock to $80 (U.S.) from $120. The analyst average is $117.92.

On Monday, Netflix was downgraded to "hold" from "buy" by Needham analyst Laura Martin, who expressed concerns about international subscription "growth risk." She cited the possibility of a U.K. and European Union GDP slump following the Brexit vote.

"These heightened fundamental risks suggest valuation multiple contraction, in addition to negative currency translation risks beginning immediately," said Ms. Martin. "We note that content fees are typically at fixed rates over multi-year contracts and typically not based on subscriber levels. Separately, in May, the EU proposed legal changes that would force NFLX to fund European-made films, implying higher costs and lower ROICs (return on invested capital) as local content often does not travel well globally. If NFLX chooses to exit certain EU markets to avoid these requirements, this would slow international subscriber growth."

The stock briefly dipped by over 3 per cent before recovering to finish up 1.3 per cent to $97.91 after reached an agreement with Comcast for its services to be available on the cable company's set-top box.

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Clarus Securities analyst Joseph MacKay said there remains the potential for "significant" share price appreciation for Intertain Group Ltd. (IT-T).

He raised his target for the stock following Tuesday's analyst day to introduce its new management team, which he said is "seasoned with significant gaming experience.

"Over the next 12-18 months the new management team intends to 'rehabilitate' the organization by putting in place best of class corporate governance with 'nothing out of the ordinary taking place,' said Mr. MacKay. "Management intends to focus on organic growth of the business including expanding the existing business in markets such as Spain, increasing mobile penetration and partnering with land based casinos in new markets such as Mexico.

"Despite the appointment of a new management team, the special committee of the company continues its strategic review process and continues to consider offers for the entire company or divisions of the company. Despite the U.K. voting to exit the Euro zone, potential acquirers have not abandoned their bids for the company but have taken more time to reflect on the outcome of the vote and what the potential implications will be."

He also emphasized the gaming company's steps toward listing its shares on the London Stock Exchange, which should improve the valuation discrepancy between Intertain and its online gaming peers.

In reaction to the weakness of the Sterling following the Brexit vote, Mr. MacKay adjusted his forex assumptions for the second half of the year. Accordingly, his EBITDA projection for 2016 declined by $2.7-million and his 2017 estimate fell $17.5-million.

"In Canadian dollar terms the decline in Sterling has had the positive impact of reducing Sterling based contingent consideration associated with the acquisition of Jackpotjoy by $33.5-million," he said.

"The decline in Sterling also has a positive impact on Intertain's cross currency swap. In November, 2015, Intertain entered a swap at GBP/USD at $1.5135. The swap mitigates Intertain's exposure to exchange rate fluctuations between the GBP and the U.S. dollar as the principal and interest rate payments on Intertain's credit facility are in U.S. dollars. As the GBP/USD currently stands at $1.30, the swap currently has a positive fair value of $46-million."

Based on his revisions, he did lower his target price to $26.50 from $28. Consensus is $23.88, according to Thomson Reuters.

Saying the stock "remains deeply undervalued," he maintained a "buy" recommendation.

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In a research note on U.S. airlines, Credit Suisse analyst Julie Yates said she is "less optimistic overall on the industry's ability to recapture pricing in a rising fuel environment."

"Capacity growth continues to outpace GDP in all regions and the industry's willingness to meaningfully trim growth with oil still in a historically inexpensive range of $50 per barrel is low," the analyst said. "Absent capacity cuts or a macro reacceleration, it is becoming increasingly unlikely unit revenue growth will be positive in 2017. International headwinds (FX, terrorism, downward GDP revisions) remain strong. In this reality, we find it challenging to recommend all three network carriers and move to only recommend the highest quality of the three and reiterate our Outperform on DAL [Delta Airlines]. While correlation has been high year to date, we expect more divergent relative performance in H2 as investors shift focus to 2017."

Ms. Yates downgraded American Airlines Group Inc. (AAL-N) to "underperform" from "outperform." Her target fell to $28 (U.S.) from $47, compared to the analyst average of $42.09.

"Investors are keenly aware AAL is less attractive than DAL and UAL when considering higher leverage and diminished free cash flow with bears often citing a lofty relative EV/EBITDAR valuation as well," the analyst said. "Consequently, an attractive micro story is required to be overweight AAL unless one is simply bullish on the entire industry and views AAL as the preferred vehicle given higher beta, or is more constructive on the international geographies AAL is heavily exposed to."

Her rating for United Continental Holdings Inc. (UAL-N) moved to "neutral" from "outperform," "as the higher leverage and absence of FCF [free cash flow] tips the scales between the two." Her target fell to $42 (U.S.) from $64. The average is $60.33.

"While both UAL and AAL appear inexpensive on P/E [price to earnings] and are repurchasing significant portions of their market caps, it has become increasingly clear that airline investors are not interested in relying on a valuation argument (particularly when consensus is too high) or putting much value on sizeable repurchases," she said. "At this point in the cycle, in an industry that has historically struggled with higher leverage, and with such little variance in multiples between clean and complex balance sheets, the market has shown it is not interested in taking on the higher-beta without a greater discount. We see limited opportunity for AAL to change investors' minds without improving industry fundamentals."

She maintained an "outperform" rating for Delta Air Lines Inc. (DAL-N) despite noting a preference for domestic carriers, like Southwest Airlines Co. (LUV-N) and Spirit Airlines Inc. (SAVE-Q), and raised her target to $51 from $48. The average is $57.92.

"Until unit revenues show firm evidence of improvement, which requires capacity discipline or a macro reacceleration, the disillusion with owning airlines will persist with rallies limited to those led by risk-on appetites instead of improving fundamentals," said Ms. Yates. "Heading into Q2 earnings, we worry sequential improvement in Q3 unit revenue growth at network carriers will underwhelm and now forecast just 60 basis points of improvement on average. For a sustained rally in the sector, we think investors need more and will want to hear capacity is being cut to drive improvement in unit revenue."
 
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In other analyst actions:

CIBC World Markets analyst Jacob Bout downgraded Canexus Corp. (CUS-T) to "sector performer" from "sector outperform" upon resuming coverage of the stock after it failed to obtain FTC approval for its merger with Superior Plus. He moved his target to $1.50 (Canadian) from $2, compared to a consensus of $1.48.

Citing its "strong organic growth rate," C.L. King analyst George Godfrey upgraded TASER International Inc. (TASR-Q) to "buy" from "neutral" with a Street-high target of $32 (U.S.). The average os $28.40.

Hilliard Lyons analyst Carol L. Kemple downgraded Tanger Factory Outlet Centers Inc. (SKT-N) to "neutral" from "buy." She did not specify a target. The consensus is $38 (U.S.).