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Wednesday's analyst upgrades and downgrades

Air Canada planes sit on the tarmac at Pearson International Airport in Toronto in this file photo.


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

Though Raymond James analyst Steve Hansen remains "optimistic" Chemtrade Logistics Income Fund's (CHE.UN-T) bid to acquire Canexus Corp. (CUS-T) will be successful, he said the previous failed attempts at a deal "substantively skewed the risk-reward proposition" for Canexus investors.

Mr. Hansen added Chemitrade now has only "modest latitude" to sweeten its offer, compared to "more substantial downside" if the transaction fails.

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Following Chemtrade's announcement on Monday that it decided to bypass management with a $1.50-per-share offer directly to Canexus shareholders, the analyst downgraded his rating for the stock to "market perform" from "outperform."

"While not its preferred method of engagement, CHE's latest offer notably aligns with the last price issued to CUS via formal letter," he said. "It also pulls the idea of $1.60/share, a price previously contemplated (via letter) on condition CUS cancelled its high-yield note offering (since completed and oversubscribed). All said, the offer represents an 8.4 times enterprise value-to-EBITDA multiple based on the mid-point of CUS' 2016 guidance and a 21-per-cent premium to the 20-day VWAP [volume weighted average price] of CUS' shares prior to the announcement of CHE's offer on Sept. 13."

Mr. Hansen said a higher offer is possible, but he said the opportunity to do so is "quickly fleeting."

"Despite the obvious roadblocks thrown up thus far (unresponsive CUS management, high-yield offering), we remain optimistic that a deal can still be consummated, either through the current hostile process, or a negotiated solution," he said. "On the latter, while the recent CUS high-yield offer clips the upside previously contemplated, we believe CHE could still offer $1.55 to $1.60/share while still making the deal solidly accretive (assuming $10-million of synergies). A consensual transaction would benefit CHE by increasing the probability of a successful transaction, expediting and simplifying the M&A process (in light of the mandatory 105 day bid period during which we do expect any competing offers), and reduce associated legal/advisory/transaction costs."

Mr. Hansen lowered his target price for Canexus stock to $1.60 from $1.65. Consensus is $1.52, according to Thomson Reuters.

"As suggested, we believe recent events have substantively skewed the risk-reward proposition for Canexus investors, leaving only modest latitude for Chemtrade to sweeten its offer, versus more substantial downside should the transaction fail. In the context, we feel it prudent to downgrade our rating," he said.

At the same time, he maintained his $20 target and "outperform" rating for Chemtrade. Consensus is $19.25.

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Ag Growth International Inc. (AFN-T) is a "unique" platform to benefit from the long-term trend of increasing global crop production, according to RBC Dominion Securities analyst Andrew Wong.

He initiated coverage of Winnipeg-based manufacturer of agricultural equipment with an "outperform" rating.

Mr. Wong said the company provides exposures to agriculture industry growth trends, adding: "Ag Growth is the only publicly available pure-play investment into the global grain handling equipment market that is primarily driven by long-term growth in crop production volumes. The company is an industry-leading provider of grain handling and agricultural equipment, with a strong presence in North America and a growing International business."

The analyst expects near-term headwinds to "abate" and reveal "stronger" long-term fundamentals, including free cash flow growth in the middle of 2017.

"We expect improving financial performance starting mid-2017 based on several factors: (1) North American grain handling equipment 'fleet' will likely need to be refreshed ahead of the 2017 fall harvest; (2) International Commercial sales should normalize as delayed orders in 2016 turn into firm projects; (3) margin pressures from negative product mix and higher steel prices start to ease; (4) new manufacturing plant in Brazil ramps up; and (5) cash flow benefit from weaker Canadian dollar will be finally realized as long-dated currency hedges expire in early-2017," said Mr. Wong.

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"We believe FCF will improve as near-term headwinds give way to stronger performance and capex investments are completed, – we forecast 2017 and 2018 FCF yield at 7 per cent and 10 per cent, up from 2 per cent in 2016. As FCF stabilizes, we think this may result in potential share price and dividend upside. Assuming a historical 60-per-cent annual sustainable FCF payout floor, we see a potential 15-per-cent dividend increase to $2.75/share, from $2.40/share currently."

He set a price target of $50 for the stock. The analyst consensus price target is $40.44.

"We understand that investors may be hesitant to enter at current levels given that valuation is not inexpensive (slightly above historical), ag fundamentals remain challenged, and year-to-date stock performance has been strong relative to peers (up 30 per cent versus 10 per cent for the group)," said Mr. Wong. "However, we think there are good reasons to make a positive investment case: (1) we forecast a significant FCF starting mid-2017 despite using what we believe are relatively conservative growth assumptions; (2) potential downside relatively limited by a sustainable dividend – at the current $2.40-per-share dividend and 6-per-cent average historical yield, shares would trade at $40 per share while also paying the dividend; (3) the company has made several acquisitions over the past 18 months that have yet to be fully integrated or optimized; and (4) long-term fundamentals of the business remain intact, offering investors a relatively 'safe' way to invest in agriculture."


BMO Nesbitt Burns analyst Fadi Chamoun raised his estimates and target price for Air Canada (AC-T) after a series of meetings with senior management.

"Notwithstanding the challenges faced in the past few quarters from a weaker Canadian economy, a stronger Canadian dollar, security concerns in Europe, etc., Air Canada has executed well and, in our opinion, is likely to deliver results more consistent with the high end of the company's 2018 targets in terms of EBITDAR margin (15 per cent to 18 per cent) and return on invested capital (13 per cent to 16 per cent)," said Mr. Chamoun. "We estimate that by the end of this year, Air Canada will be approximately 70 per cent through its 21-per-cent cost per available seat miles (CASM) reduction target by 2018. We sense the cost-reduction runway can extend further beyond 2018 from a number of initiatives including the modernization of the narrow-body fleet and renegotiation of the loyalty program contract, among other factors."

Mr. Chamoun said the airline's decline in CASM puts it in a strong position to combat growing competition from the international market as well as domestic regional peers.

"The improved cost structure allows the company to access markets that would not have been profitable in the prior cost structure, improves overall profitability, and, by extension, de-leverages the balance sheet," he said. "All of these factors are supportive of higher margins/ROIC over the cycle compared to previous periods with a significantly reduced risk profile. This is supportive for valuation, which we view to be attractive even after the most recent rebound observed in the recent weeks."

"Management noted that the demand environment remains favourable with the booking curve going into the winter season largely consistent with expected trends. We heard similar comments recently following our meetings with WestJet senior management …. F2017 should represent the peak year for capital spending. Assuming the company continues to fund future aircraft through a mix of leases and ownership (i.e., four of the nine B787 deliveries in 2017 are expected to be leased), free cash flow should turn positive in 2017 and grow at a fast pace from 2018 onward."

With increases to his 2016 and 2017 revenue, enterprise value and EBITAR projections, Mr. Chamoun's target price for the stock rose to $15 from $13. Consensus is $13.86.

He did not change his "outperform" rating.

"We expect improving margins, ROIC, and credit profile to support a gradual re-rating in valuation over time," the analyst said. "A reduced cost structure is facilitating expansion in the leisure market, particularly on international routes. We believe substantial cost- reduction opportunities remain untapped, including: Aeroplan renegotiations, further fleet modernization/densification, and regional cost management."


The federal government's new stricter regulations on mortgage lending will lead to a decline in new business volumes at Genworth MI Canada Inc. (MIC-T), said BMO Nesbitt Burns analyst Tom MacKinnon.

"Under current mortgage insurance rules for transactional insurance, which accounts for 85 per cent of net premiums written, the calculation of maximum debt servicing ratios in order to qualify for mortgage insurance was based on the 5-year government of Canada posted rate for all variable mortgages and all mortgages with a fixed period under 5 years," he said. "For all other mortgages, the debt service ratios were based on the mortgage contract rate, which is often about 200 basis points lower than the posted rate.

"Effective Oct. 17,  Finance will base the qualification for mortgage insurance using maximum debt servicing ratios that utilize the greater of the mortgage contract rate and the 5-year government of Canada posted rate for all mortgages. Finance also is implementing similar tougher mortgage insurance rules for bulk/portfolio insurance."

On Genworth, specifically, he said: "MIC claims that in terms of the business it has written year to date, a little over one third of its transactional business and 50-55 per cent of its bulk business would not qualify. Our 20-per-cent reduction for transactional and 36-per-cent reduction for bulk reflects our belief that in some cases the buyer would look to improve the debt service ratio by increasing the down payment or purchasing a lower priced home."

With the changes, Mr. MacKinnon reduced his projections for Genworth's 2017 net premiums written for transactional insurance and bulk insurance, which accounts for 15 per cent of its business,  by 20 per cent and 36 per cent, respectively. His 2017 earnings per share declined to $3.99 from $4.05.

"Over a 6-8 year earned period the discounted hit would be 55 cents, which when multiplied by 8 times (MIC's EPS multiple) represents a $4 stock price hit," the analyst said. "This analysis does not reflect the benefit of an improved risk profile, or the potential for rate hikes."

With an "outperform" rating (unchanged), Mr. MacKinnon reduced his target price for the stock to $38 from $40. The analyst average is $36.07, according to Bloomberg.


Artis Real Estate Investment Trust's (AX.UN-T) $211-million sale of retail and industrial assets in Alberta is "a good outcome, all things considered," said Canaccord Genuity analyst Jenny Ma.

On Tuesday, Artis announced it has agreed to sell eight industrial properties in Calgary and Edmonton for $171.1-million and a retail property in Calgary for $40.2-million. Management is expecting to use proceeds from the deals to pay down debt, including a $300-million outstanding credit facility.

"Notably, the sale price of the industrial portfolio and retail property was slightly higher than the IFRS value as at June 30 ($165-million for the industrial portfolio and $40.1-million for the Calgary retail property)," said Ms. Ma. "Given that Artis has written down the value of its Alberta portfolio by approximately $400-million ($2.62 per unit) since the beginning of 2015 (most of it attributed to the Calgary office portfolio) it is difficult to ascertain the true gain or loss on the properties. However, Artis is trading at a significant discount to its IFRS value per unit of $15.40 per unit (as at June 30); therefore, we view the sale of assets located in Alberta close to IFRS value to be a good outcome, though we expect the impact on Artis to be largely neutral."

"A key priority of Artis has been to diversify away from Alberta and increase exposure to the U.S. Following the announced dispositions, Alberta represents 29-per-cent of pro forma net operating income (consisting of 14 per cent Calgary office and 15 per cent Other Alberta). We note that management recently announced that the Board of Trustees approved an increase to the target weighting for property NOI from the U.S. to 40 per cent (from 35 per cent), and also hinted at the possibility of pushing the limit to 50 per cent in the future. In addition, it has been reported in the press that Artis is looking to sell Calgary office assets. Therefore, we believe management will continue to expand its U.S. portfolio and potentially sell more Alberta properties."

With the deals, Ms. Ma reduced her 2017 funds from operations projection to $1.47 from $1.50.

She maintained a "buy" rating and $14.50 target. Consensus is $14.22.

"Artis has an attractive distribution yield of 8.9 per cent which is fully covered by cash flow and trades at a relatively low multiple compared to its diversified commercial peers (weighted average of 12.8 times estimated 2017 adjusted FFO)," she said. "In our view, Artis' exposure to the soft Alberta market is reflected in its discount valuation. Our target price for Artis remains $14.50, which equates to our updated NAV. Combined with an annual distribution of $1.08 per unit, the forecast total return is 28 per cent."


Goldman Sachs analyst Andrew Quail removed Barrick Gold Corp. (ABX-N, ABX-T) from the firm's Americas Conviction list, citing "visible" acceleration of macro headwinds.

However, he said Barrick remains well-positioned to outperform its peers and emphasized its "idiosyncratic investment thesis."

Mr. Quail did not change his "buy" rating and $27 (U.S.) target. The analyst average is $23.47.


In other analyst actions:

Taseko Mines Ltd.
(TKO-T) was downgraded to "sector underperform" from "sector perform" by Scotiabank analyst Orest Wowkodaw with a target of 65 cents (down from 80 cents). The average is 84 cents.

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Globe Investor Content Editor

David Leeder is a content editor in the Report on Business. He was previously Deputy Sports Editor and Weekend Digital Editor at The Globe.  He holds an undergraduate degree from McMaster University and a graduate degree from Ryerson University. More


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